The U.S. Securities and Exchange Commission’s Division of Examinations (“the Division”) issued a new Risk Alert on March 27, 2023 that takes newly-registered investment advisers to task for three recurring issues its staff has noted in its examinations of rookie advisers. Below, we recap the Division’s warning, which also provides insights and resources that will benefit all investment advisers, no matter how green or seasoned.
Background: Newly-Registered Investment Advisers Are Longstanding Priority for Examiners
According to the Division’s Risk Alert, “[f]or the past several years, [it] has prioritized examining newly-registered advisers within a reasonable period of time after the adviser’s SEC registration has become effective.” In fact, the Division notes that it has prioritized examining newly-registered advisers every year since 2013. During these exams, examiners generally review documents and interview personnel, with a particular focus on “the adviser’s: (1) business and investment activities; (2) organizational affiliations; (3) compliance policies and procedures; and (4) disclosures to clients.”
Three Areas to Improve:
After at least a decade of prioritizing the examination of newly-registered advisers, the results are in and they… aren’t stellar. According to the Division, tenderfoot advisers need to strengthen (1) their compliance policies and procedures, (2) disclosures, and (3) marketing practices.
First, the Division highlighted several problems it encounters with new advisers’ compliance policies, including, for example, “off-the-shelf compliance manuals that were not tailored for consistency with the advisers’ operations and business lines,” undisclosed, unmitigated conflicts of interest, and chief compliance officers saddled with extraneous responsibilities separate from their core compliance function.
Second, the Division reports that its staff has observed disclosures and required filings that are incomplete, inaccurate, untimely, or even missing altogether. For instance, the Division states that its staff has observed omitted or inaccurate disclosures related to disciplinary information, conflicts of interest, and fees and compensation.
Third, the Division wrote that its staff uncovered “adviser marketing material that appeared to contain false or misleading information,” including inaccurate information about advisers’ experience, credentials, and performance. The Division also found marketing material that was—if not outright false—unsubstantiated.
Conclusion:
After diagnosing these too common problems, the Division closed its Risk Alert with something of a carrot and a stick. On one hand, it warned new advisers that the Division “will continue to focus” on examining them. On the other, it encouraged new advisers to view these exams as a learning opportunity offering “early engagement” with examiners and a chance to strengthen compliance efforts. The Division also provided an appendix of resources to help guide advisers through their regulatory obligations.
At a time when the SEC’s enforcement division has taken an aggressive approach to enforcement, it is imperative that all registered advisers be mindful of the warnings from the Division of Examinations, as today’s exam priority areas are sure to become tomorrow’s enforcement actions.
