Coordinated state exams conducted by members of the North American Securities Administration Association (NASAA) for 2015 uncovered the top registered investment adviser (RIA) compliance deficiencies across 20 categories. Recently, we discussed the most common investment adviser compliance deficiencies in the book and records category, specifically suitability documentation, missing written agreements, and issues with financial statements.
In this week’s installment, we are covering another common RIA compliance deficiency category: contracts. The latest report shows that of the 1,170 investment advisory firms examined in 2015, 49.5% of all firms with assets under management (AUM) examined had at least one contracts-related regulatory deficiency. This figure is particularly notable due to the fact there was a 5.5% increase in this category compared to the results from the 2013 NASAA investment adviser examination report at which time 44.0% of advisory firms which were audited were found to have a contracts-related deficiency.
In this most recent 2015 report, about 45% of RIA firms with AUM greater than $30 million had at least one such deficiency compared to roughly 50% of investment advisory firms with less than $30 million in AUM. Also notable, there was not much of a difference in the number of contracts-related deficiencies if there were one or more investment adviser representatives at the firm. In the contracts category, about 50% of firms audited with only one investment adviser representative (IAR) had at least one deficiency. On the other hand, about 48% of firms with more than one IAR which were examined had one or more deficiencies related to contracts.
The Chief Compliance Officer (CCO) at every investment advisory firm needs to be aware of the top contract-related compliance deficiencies. In 2015, the top five issues were:
- Fee (12.3%)
- In Writing (9.6%)
- Fee formula (9.5%)
- Not properly executed (9.3%)
- 48 hour rescission clause (9.2%)
In 2013, the top five issues were:
- Not properly executed (10.9%)
- Fee (10.5%)
- Fee formula (10.4%)
- Hedge clauses (9.0%)
- In writing (6.4%)
Given the increase in contract-related deficiencies from 2013 to 2015, it is apparent that RIA firms need to take a step back and ensure that the investment advisory agreements that the firm has in place with clients are in proper compliance with the relevant state or federal statutes. Investment adviser examiners, particularly at the state level, will often spend considerable time reviewing an investment advisory firm’s contracts. 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:
- Does the firm have a properly executed, written client agreement on file for each client relationship
- Do the services outlined in the agreement match the current services being provided to the client?
- Does the fee amount, calculation formula, and frequency match how the client is billed?
- Does the contract include any hedge clauses that may conflict with the firm’s fiduciary responsibility?
- If the firm has discretionary authority, is it properly outlined in the executed agreement?
- Does the contract properly address how pre-paid fees will be refunded in the event of termination?