On September 12, 2016, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a National Exam Program Risk Alert (the “Risk Alert”) announcing that it will be conducting examinations of registered investment advisers that employ or contract with supervised persons who have a history of disciplinary events, including individuals who have been disciplined or barred from a broker-dealer. As a basis for its concern that “such individuals may present an increased risk of future misconduct,” the Risk Alert cites a 2016 study of broker-dealer representatives conducted by the National Bureau of Economic Research. This study concluded that FINRA-registered broker-dealer representatives (“financial advisors”) with disciplinary histories were five times more likely to engage in misconduct than the average financial advisor and that “while approximately half of the offenders lose their job after the misconduct, 44 percent of the offenders are reemployed in the financial services industry within one year.”
According to the Risk Alert, the exam initiative will focus on the following key risk areas:
- Compliance Program. Examiners will review advisers’ hiring processes, ongoing reporting obligations, employee oversight practices, and complaint handling processes and evaluate whether the advisers foster robust compliance cultures and tone at the top.
- Disclosures. Examiners will likely review registered advisers’ practices regarding their disclosures of regulatory, disciplinary or other actions with a focus on assessing the accuracy, adequacy and effectiveness of such disclosures.
- Conflicts of Interest. Examiners will assess conflicts of interest faced by a registered adviser or supervised person, with particular attention to conflicts that may exist with respect to financial arrangements (e.g., unique products, services, or discounts) initiated by supervised persons with disciplinary histories.
- Marketing. Examiners will review a registered adviser’s advertisements, including pitch-books, website postings, and public statements, to identify any conflicts of interests or risks associated with supervised persons with disciplinary histories.
The Risk Alert notes that OCIE is using OCIE’s analytical capabilities to evaluate information from a variety of sources to identify registered advisers for examinations under this initiative. These sources include SEC databases and filings as well as external sources. In addition to information in the firm’s Form ADV, OCIE also will review information about other legal actions (e.g., private civil actions) not required to be reported on Form ADV and information from SEC enforcement actions that barred or suspended individuals from certain financial industries.