On January 11 and 19, 2018, the Fort Worth, Texas Regional Office (the Office) of the Securities and Exchange Commission (the SEC) hosted conference calls during which the Director and Associate Regional Director of the Office (the Staff) discussed and summarized the findings from the Office’s fiscal year 2017 examinations. The stated purpose of the calls was to assist participants in building stronger compliance programs. This appears to have been the first time this type of call was held by any regional office. The Staff announced that it intends to hold these calls at least biannually.
The Staff members identified three particular areas in which compliance violations were reported during fiscal year 2017.
1. Rule 206(4)-7 of the Investment Advisers Act of 1940 (the Advisers Act).
The most prevalent violation involved Rule 206(4)-7 of the Advisers Act. That Rule consists of three parts:
a. Policies and procedures. Adopt and implement written policies and procedures reasonably designed to prevent violation, by you and your supervised persons, of the Act and the rules that the Commission has adopted under the Act;
b. Annual review. Review, no less frequently than annually, the adequacy of the policies and procedures established pursuant to this section and the effectiveness of their implementation; and
c. Chief compliance officer. Designate an individual (who is a supervised person) responsible for administering the policies and procedures that you adopt under paragraph (a) of this section.
The Staff expressed significant concern that many of the compliance manuals that they reviewed were clearly of the “off-the-shelf” variety and had not been customized for the particular firm. This strongly suggested to the Staff that the firm had likely never reviewed the manual and that it was likely not meaningfully tailored to the actual operations of the firm. In light of that area’s recent experience with Hurricane Harvey, the Staff noted that business continuity plans were being viewed with increasing importance.
With regard to sub-part (c), the Staff interestingly pointed out that, though not required, the Staff prefers that the chief compliance officer of a firm wear only one “hat” for the firm and report directly to the chief executive officer as opposed to any other member of the firm.
2. Anti-Fraud Provisions. The second most prevalent type of violation found in fiscal year 2017 was violation of the Advisers Act anti-fraud provisions. Section 206 of the Advisers Act prohibits misstatements or misleading omissions of material facts and other fraudulent acts and practices in connection with the conduct of an investment advisory business. As a fiduciary, an investment adviser owes its clients undivided loyalty and may not engage in activity that conflicts with a client’s interest without the client’s consent. In addition to the general anti-fraud prohibition of Section 206, Rules 206(4)-1, 206(4)-2, 206(4)-3 and 206(4)-4 under the Advisers Act regulate, respectively, investment adviser advertising; custody or possession of client funds or securities; the payment of fees by advisers to third parties for client referrals; and disclosure of investment advisers’ financial and disciplinary backgrounds. The Staff noted that among the violations they observed was the failure to fully disclose a firm’s compensation arrangements.
3. Form ADV. The third area specifically identified by the Staff involved violations related to updating Form ADV. The Staff noted that, for example, certain items of Form ADV require firms to promptly amend Form ADV with an other-than-annual amendment, and that this requirement was often not followed.
The overall message was that the Office’s principal goal is to resolve problems before they arise. The Staff encouraged firms to communicate with them about potential compliance issues, noting that if firms approach them in good faith (rather than having an issue discovered in an exam), the Staff will make an effort to resolve the issue in a timely manner. The Staff may still have to take action in response to a violation, but a proactive approach by a firm would be taken into account.