In 2013, coordinated state exams of 1,130 investment advisory firms conducted by members of the North American Securities Administrators Association (NASAA) found 6,482 compliance deficiencies across 20 RIA compliance categories. The biannual coordinated investment adviser examination report recently published by NASAA offers tremendous insight into the RIA regulatory examination process by providing a terrific summary of the top RIA compliance deficiencies. As RIA compliance consultants, we recommend that all investment advisory firm Chief Compliance Officers (CCOs) review the regulatory exam report to determine if any corrective compliance changes need to be taken by their RIA firms.
In the 2011 study, NASAA examined 825 RIA firms and noted 3,543 total deficiencies (4.29 per firm) compared to 1,130 examined and 6,482 total deficiencies (5.74 per firm) in the 2013 report. This rise in 1.44 deficiencies per firm equates to 33.6% increase in average deficiencies per firm. Thus, it’s evident that CCOs need to continue to be vigilant in identifying potential RIA regulatory deficiencies as regulators continue to cite an increasing number of compliance deficiencies.
The three most common categories of RIA regulatory deficiencies cited by NASAA in 2013 were as follows (% of firms with at least one deficiency in the category):
- Books & Records (68.2%)
- Registration (58.5%)
- Contracts (44.0%)
Within the Books & Records category, the top three specific deficiencies were:
- Suitability documentation
- Missing client contracts
- Trial Balance / financial statements
As discussed in our Top 10 Steps to Prepare for a RIA Regulatory Exam Checklist, books & records deficiencies continue to be a leading culprit of investment advisory firm compliance examination issues. Unfortunately, such books & records deficiencies can at times lead to significant compliance problems for RIA firms. However, even putting RIA compliance obligations aside, keeping proper books & records is an operational best practice that should be a priority for all RIA firms regardless of size. Investment advisory firms which lack proper books & records systems not only are likely to have compliance issues, but will also have a very difficult time keeping the business organized as the firm grows. Thus, it is essential that an RIA firm’s initial compliance program be designed to ensure that all required books & records compliance requirements are met.
Within the Registration category, the top three specific deficiencies were:
- Form ADV: Part 1 vs. Part 2
- Form ADV: fee structure
- Form ADV: services provided
In the 2011 NASAA report, the registration category led all deficiency categories. In the 2013 report, it is once again one of the most common categories of RIA compliance deficiencies. All CCOs of RIA firms should pause for a moment and ask themselves a simple question: when is the last time you read your Form ADV Part 1 and Part 2 in its entirety? This simple CCO compliance exercise can help prevent a number of the common RIA registration deficiencies by helping to proactively identify mismatches between the Form ADV Part 1 and Part 2. In addition, it will also help to ensure that everything previously disclosed on the Form ADV is still accurate and matches current business practices. As an RIA firm grow over time, its business model often tends to evolve which requires a number of changes to be made to the firm’s Form ADV. RIA firms should view the Form ADV as the firm’s first chance to make a favorable impression on a regulator preparing for a regulatory examination. A poorly written or clearly outdated Form ADV can lead to a much more intensive regulatory audit.
Within the Contracts category, the top three specific deficiencies were:
- Not properly executed
- Fee
- Fee formula
It is vital that all RIA firms have properly executed contracts on files for all clients. Failure to have proper records of executed contracts can at times lead to serious compliance issues. Furthermore, it is essential that the CCO is regularly confirming that each client is being properly billed in accordance with the executed contract on file. What checks and balances has the RIA firm put in place to verify that client fee calculations are being handled properly and match the formula agreed upon in the client contract?
If interested in being better prepared for your RIA firm’s next regulatory audit, be sure to download our free Top 10 Steps to Prepare for a RIA Regulatory Exam Checklist.