As increasing regulations continue to strain resources, entrepreneurs who once viewed an independent RIA as a path to greater independence are discovering the costs and risks can often outweigh the rewards.
After seeing a continually growing list of compliance and supervision demands robbing her of valuable time spent with clients, Andi Kang, owner of Crown Wealth Management, a state-registered RIA in Costa Mesa, California, opted to outsource those responsibilities to her independent advisory and brokerage firm's corporate RIA.
“Keeping the supervisory manual updated and making sure we did every line item in the manual was stressful,” Kang said. “We spent at least two weeks preparing for an audit and then another three to five days on the audit itself. I decided it was not the best use of my precious time and money.”
In addition to keeping forms and manuals current and prepping for SEC and state audits, an independent RIA must appoint a chief compliance officer, implement a thorough compliance program and conduct annual updates to disclosure documents such as the Form ADV Part 1, 2A and 2B.
For many associated independent RIAs, an SEC examination is unfamiliar territory, and it's easy to be caught off guard by the scope and detail of the regulators' requests.
To prepare for these examinations, an independent RIA must commit long hours to examining their internal policies and procedures and know their specific obligations under the Investment Advisers Act of 1940.
As one independent RIA recently learned, it's also important to know a broker-dealer is not obligated to conduct reviews or branch office visits pertaining to independent RIAs or IARs.
In that investigation, which was ongoing at the time this article was being written, the independent RIA, believing he was covered by his broker-dealer's records and processes, failed to complete several reviews and updates. Investigators documented 19 pages of deficiencies that could result in a substantial fine along with the possibility that he will be forced to close his firm.
What to Expect During an Examination
A few of the more common examiner requests you can expect during an examination include:
- Provide documented compliance reviews for the past 18 months.
- Provide documentation from the annual compliance meetings you've held over the past 18 months. Indicate what topics were discussed and provide materials distributed during the meeting.
- Provide documentation in relation to employee and IAR training with respect to your policies and procedures for the past 18 months. Also, provide the materials used, list of topics discussed, indicate who provided the training and which employees and IARs attended.
- Provide signed attestations for all employees and IARs attesting to your procedures and code of ethics, stating they do not provide performance disclosures to clients and do not allow advisors to advise investment companies.
- Provide a branch office audit schedule, a list of all advisors you have visited in the last 18 months, the scope of each branch office visit, reports and letters associated with the visit and follow-up on issues noted during the visit.
- Provide a description of your firm's review of IARs' emails.
- Describe the process with respect to reviewing personal securities for conflicts of interest or suspicious activity. Additionally, provide the quarterly certification of personal securities transactions from employees who have identified personal securities holdings.
- Describe what you do to review for insider trading and practices. Additionally, provide the written acknowledgments from each employee.
This isn't a complete list of the items regulators will review, and you should be prepared to field many more requests and to provide other materials.
The High Cost and Risks of Securing Data
The SEC has increased its focus on cybersecurity and issued guidance to advisory firms to establish and implement formal, written procedures to address data breaches.
By all indications, cybersecurity will become an even greater area of regulatory focus, and independent RIAs will need to implement additional safeguards and processes to protect client data.
In the SEC's view, independent RIAs must identify their respective compliance obligations under the federal securities laws and take these obligations into account when assessing their ability to prevent, detect and respond to cyberattacks including the use of third-party vendors such as portfolio management systems.
What You Can Do
To safeguard your practice from financial penalties, routinely review and update your policies and procedures to ensure they're in line with the latest regulations. To get started identifying and fixing deficiencies, consider these actions you can take right away:
- Document conversations with clients, both written and verbal, to ensure recommendations are compliant and accessible for review.
- Ensure your contracts and Part 2 of your ADV match your fee disclosure and you are charging correctly.
- To help avoid dual billing of clients and the custodian, make sure client invoices match agreements and properly notify all parties.
- Review your advertising to ensure information is true and complete, testimonials are used properly and your website has a complete disclaimer.
- Make an offer of delivery of your ADV annually to your clients and include updates and material changes.
- Ensure your policy and procedures include a section for nonpublic information.
- Periodically assess and update your compliance supervisory programs to ensure they're keeping up with your needs.
- Keep advisory books and records separate from other areas of your practice.
From protecting sensitive client data and drafting and maintaining records, today's independent RIAs are shouldered with an ever-growing list of demanding responsibilities that leave little time to serve clients and grow their business.
Add to that the high price of making even an unintended compliance error, and it's clear why many are handing those responsibilities over to their advisory and brokerage firm's corporate RIA.
The financial advisory business is in the midst of great change. Increasing regulations, evolving technologies and new competitors are altering the landscape in ways few would have thought possible just a few years ago. To learn why these changes have made Super Branches an increasingly popular business model, download Securities America's free guide, “Inside the Super Branch Model: Why It Works for Managers and Advisors.”
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