Top 2017 NASAA RIA Compliance Deficiencies: Contracts

Last month, the North American Securities Administrators Association (“NASAA”) released its 2017 Investment Adviser Coordinated Examinations Report. The biannual report is a must read for registered investment adviser (“RIA”) firms. As RIA compliance consultants, we recommend that the Chief Compliance Officer (“CCO”) of all investment advisory firms review the regulatory exam summary report to determine if any compliance changes need to be implemented at their firm.

In this week’s installment of our break-down of the new 2017 report, we focus on one of NASAA’s most common RIA regulatory compliance deficiency categories: contracts. Of the 1,227 investment advisory firms examined in 2017, 45.4% of all firms examined with regulatory assets under management (“AUM”) had at least one contracts-related regulatory deficiency. In total, there were 740 contracts-related deficiencies cited across all firms which were audited. In general, about half of firms audited had a contracts related deficiency.

As with books and records-related deficiencies, contracts-related deficiencies are slightly down compared to the 2015 report. In the table below you can see the changes year over year. The table below highlights the changes over the last 10 years of reports:

In 2017, the top 5 contracts-related deficiencies were:

1. The fee 12.03%
2. The fee formula 10.41%
3. In writing 9.59%
4. Other issues 8.92%
5. Capital gains compensation 8.78%

In 2015, the top 5 contracts-related deficiencies were:

1. The fee 12.3%
2. In writing 9.6%
3. The fee formula 9.5%
4. Not properly executed 9.3%
5. 48 hour rescission clause 9.2%

As RIA compliance consultants, we encourage the CCO of the investment advisory firm to consider these RIA compliance-related questions as he or she reviews the firm’s client agreements:

1. Does the firm have a properly executed, written client agreement on file for each client relationship
2. Do the services outlined in the agreement match the current services being provided to the client?
3. Does the fee amount, calculation formula, and frequency match how the client is currently billed?
4. Does the contract include any hedge clauses that may conflict with the firm’s fiduciary responsibility?
5. If the firm has discretionary authority, is it properly outlined in the executed agreement?
6. Does the contract properly address how pre-paid fees will be refunded in the event of termination?

Be sure to also check out our past blog post on the top investment adviser contracts-related compliance deficiencies from the 2015 NASAA report.