In 2013, members of the North American Securities Administration Association (NASAA) performed coordinated state exams in examiners uncovered the top registered investment adviser (RIA) compliance deficiencies across 20 categories. Last week we discussed the deficiencies in investment activities, specifically disclosure of soft dollars, inconsistent activity with client’s investment policy or contract, and unsuitable recommendations.
In the last installment we’ll cover another common RIA compliance deficiency category: Unethical practices. The 2013 NASAA investment adviser examination report contains results from 1,130 investment advisory firms examined. In the unethical practices deficiency category, of all RIA firms examined, 6.2% of audits noted at least one deficiency. This figure is particularly notable due to the fact that unethical practices-related deficiencies were found in 36.8% of firms examined in the 2011 NASAA investment adviser report. Clearly a significant improvement, however it may be overstated as NASAA re-categorized a number of items in its 2013 report that may have previously fallen under the unethical practices category.{{cta(‘3e4dea01-dac9-4572-9ca9-8874b935a59e’,’justifycenter’)}}
According to the 2013 report, 6.1% of firms with less than $30 million in assets under management (AUM) had unethical practices-related deficiencies, compared to 6.6% of investment advisory firms with more than $30 million in AUM. Around 6% of RIA firms audited for the first time had unethical practices-related deficiencies compared to around 4% of firms that had previously been examined. In other words, previously examined firms performed slightly better than their peers going through their first exam.
While NASAA did not rank the top unethical business compliance deficiencies in its 2013 report, it did previously rank the top deficiencies in its 2011 report. In 2011, the top unethical practices issues were:
- Contract: conflict with Form ADV, not updated, etc. (~29%)
- Contract: none or missing (~17%)
- Contract: hedge clause (~6%)
Even though there was a significant decrease in regulatory compliance deficiencies related to unethical practices from 2011 to 2013, as RIA compliance consultants, we still advise that RIA firms stay vigilant on this topic. In particular, we recommend that the chief compliance officer (CCO) of every investment adviser firm take some time to review all client files to ensure there is a proper contract on file, the client’s contract is not in conflict with the firm’s Form ADV, and that the contract is not outdated.