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 fees-related investment adviser regulatory deficiencies, specifically related to mismatched, excessive, or miscalculated client advisory fees. In this week’s installment, we cover another common RIA compliance deficiency category: custody.
The latest 2015 NASAA coordinated examination report shows that of the 1,170 investment advisory firms examined in 2015, 20.1% of all firms with assets under management (AUM) examined had at least one custody-related regulatory deficiency. Compared to the 2013 NASAA report, at which time 16.6% of firms which were audited had at least one custody-related deficiency and the 2011 NASAA report that cited 12.6% of advisory firms as having at least one custody-related deficiency, the frequency of custody-related regulatory compliance issues has continued to increase in 2015 compared to prior years.
According to the 2015 study, about 22% of RIA firms with AUM greater than $30 million had at least one such deficiency compared to roughly 25% of investment advisory firms with less than $30 million in AUM. Also notable, only about 22% of firms with only one investment adviser representative (IAR) had at least one custody-related deficiency, while around 30% of firms with more than one IAR had at least one such deficiency.
The Chief Compliance Officer (CCO) of every RIA firm needs to be sure to be aware of the top custody-related compliance deficiencies. In 2015, the top issues were:
- Direct fee deduction: Proper client invoice (48.8%)
- Direct fee deduction: Dual invoicing client and custodian (17.5%)
- Beneficial trust: Signed acknowledgement of beneficial owner (6.0%)
- Direct fee deduction: Written client authorization (4.2%)
- Safekeeping: Account statements from adviser (3.6%)
In 2013, the top custody-related issues were:
- Direct fee deduction: Proper client invoice (33.3%)
- Direct fee deduction: Dual invoicing client and custodian (10.5%)
- Direct fee deduction: Written client authorization (8.1%)
- Other ability to obtain customer funds or securities (5.7%)
- Direct fee deduction: Notice to administrator on ADV (5.2%)
Given the continued increase in custody-related deficiencies from 2011 to 2015, it’s evident that investment advisory firms need to take a step back and ensure they are meeting the requirements to stay in compliance with the relevant state and SEC statutes. NASAA recommends firms implement appropriate custody safeguards, as applicable, and pay close attention to direct fee deduction invoices. Many states require an investment adviser to send separate fee billing invoices in addition to the custodian statement. As RIA compliance consultants, we encourage the CCO of every investment advisory firm to take a few minutes to look over the firm’s current custody procedures and ensure that all parties, including clients, are being properly invoiced if required.