Compliance is an integral part of any financial advisory firm. From registered investment advisers (RIA) to hedge funds and private equity firms, it’s essential to adhere to industry regulations and standards to maintain your clients’ trust and ensure their financial security. However, staying compliant is not always easy – and advisers can face various Securities and Exchange Commission (SEC) exam deficiencies that may lead to penalties, fines or even legal action.
The amount of firms selected for audits only grows each year. In 2011, the SEC reported that 8% of firms were selected for an audit. In 2022, that number doubled to 16% of all RIAs. How can your firm minimize your chances of an audit?
Although regulatory focus shifts through time and as technology evolves, there are a few common exam deficiencies which are always on the SEC’s radar. By identifying and implementing practices to prevent these common SEC exam deficiencies, your firm can avoid costly fines and reputational damage.
Five common regulatory compliance deficiencies (and how to avoid them)
1. Cybersecurity regulatory compliance
Cyber-attacks, data breaches and other cyber threats can compromise sensitive client information, leading to reputational damage and financial losses. Often, financial advisory firms will invest heavily in cybersecurity upon implementation, but fail to create a consistent plan for regular cybersecurity upkeep.
In 2021, a press release from the SEC marked a turning point for the regulatory body in which they would focus heavily on regulatory cybersecurity compliance. The press release detailed three sanctions across eight firms, outlining how lackadaisical cybersecurity practices resulted in a mass breach of client information and email takeovers.
How to avoid cybersecurity deficiencies:
To prevent cybersecurity deficiencies, advisers must have robust cybersecurity protocols in place, including firewalls, encryption and multi-factor authentication. It’s a good idea to work directly with your tech providers to ensure your team is up-to-date and has a comprehensive understanding of the tech’s security processes.
Additionally, firms should conduct regular risk assessments and ensure that their employees receive consistent cybersecurity training to minimize the risk of a data breach.
2. Compliance policies and Procedures
Rule 206(4)-7 by the SEC requires registered firms to have policies and procedures in place to prevent violations of the Investment Advisers Act of 1940. More specifically, the rule requires the creation and implementation of written policies and procedures which cover all aspects of their business operations, including investment advisory activities, trading, client communication and record-keeping.
However, advisers often face deficiencies in their compliance policies and procedures, which can lead to regulatory violations, fines or even legal action. Financial advisory firms can face policy and procedure deficiencies in various areas, including conflicts of interest, cybersecurity, trading practices and client communication.
For example, firms may fail to adequately disclose conflicts of interest or have insufficient procedures in place to prevent insider trading, leading to violations of the Investment Advisers Act and other regulatory requirements and putting the firm’s reputation and financial stability at risk.
How to prevent compliance policies and procedures deficiencies:
Firms should conduct regular reviews of their compliance policies and procedures to ensure they remain current and effective. This review should include identifying any gaps or weaknesses in the existing policies and procedures and taking corrective action to address them.
Advisory firms should also provide ongoing training to all employees to ensure they understand and comply with the compliance policies and procedures. It is also important to stay up to date with regulatory changes and make necessary updates to policies and procedures to remain compliant. By taking these proactive steps, firms can minimize the risk of policy and procedure deficiencies and ensure they operate ethically, responsibly and in compliance with regulatory bodies.
3. SEC Marketing Rule
The recent Marketing Rule aims to protect investors from misleading or false advertising while also expanding opportunities for firms to market their services.
While your firm can utilize new allowances to expand your marketing tactics, there are common deficiencies that advisory firms may face when it comes to complying with this rule. For instance, some firms may fail to adequately disclose the risks associated with their investment strategies, or may make exaggerated claims about their performance history. Others may not provide enough information about the fees and expenses associated with their services or may use misleading testimonials or endorsements.
These deficiencies can put investors at risk and potentially harm a firm’s reputation, so it is crucial for firms and its employees to thoroughly understand and comply with the SEC’s Marketing Rule.
How to prevent marketing deficiencies:
Financial advisers should regularly review and update their marketing materials to ensure that they are accurate, current and comply with SEC regulations.
They should conduct periodic internal reviews of their marketing materials and practices to identify and correct any potential deficiencies. This can include reviewing websites, brochures, advertisements and other marketing materials.
Lastly, advisers should avoid making misleading statements, including exaggerating performance history or using testimonials or endorsements that may be misleading to investors.
When in doubt, firms should conduct due diligence before publishing any marketing materials that may be in violation of the Marketing Rule.
4. Employee Trade Monitoring
Advisers must implement effective employee trade monitoring systems to detect and prevent insider trading. Insider trading occurs when an employee trades securities based on non-public information.
How to prevent employee trade monitoring deficiencies:
Advisers must have strict policies and procedures in place to prevent insider trading, including blackout periods and pre-clearance procedures which help identify any suspicious activity.
There should be a culture of open communication within your firm as well – if an employee suspects suspicious activity, they should be aware of next steps as far as notifying the proper channels.
5. Form CRS
Form CRS (Customer Relationship Summary) is a recent regulatory requirement from the SEC which aims to provide retail investors with easy-to-understand information about the advisory services they receive.
The form requires advisers to provide a clear and concise summary of their services, fees and potential conflicts of interest in Form CRS. Advisers must also update this form regularly to ensure it remains current and accurate.
How to prevent Form CRS deficiencies:
In addition to regular company-wide training, advisory firms should have an effective system in place to track and monitor Form CRS disclosures and ensure that they are delivered to clients in a timely manner. Form CRS delivery could be built into annual meetings or quarterly check-ins for convenience and efficiency.
Compliance can make or break your firm’s success – take a proactive approach to the most common compliance deficiencies to ensure your team can deliver optimal results for your clients.