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RIA Compliance Testing.  Registered Investment Advisors are required pursuant to Rule 206(4)-7 to perform an annual review of your firm’s policies and procedures to determine applicability to how your investment advisory firm operates.  RIA compliance testing is required by investment advisors to ensure your firm’s procedures are appropriate for your current business model and to uncover any risks.

The federal and state regulators give RIA firms quite a bit of latitude in this area and do not specify how firms are to achieve this testing.  Rather, they allow for RIA firms to perform testing that best suits how the RIA firm operates.

Performing the testing is one requirement to complete, but the other requirement is to ‘document’ what you have done.

Example of Testing:

For example, if your RIA firm uses Sub-Advisors to manage your client’s portfolio, you need to perform due diligence about that Sub-Advisor before and during the client relationship.  Your testing can include any of the following:

• Review of the Sub-Advisor’s Form ADV Part 1, Form ADV Part 2A Brochure and Form ADV Part 2B Brochure Supplement;
• Review of the BrokerCheck and IAPD systems to confirm any disclosures on behalf of the Sub-Advisor or its Investment Advisor Representatives;
• Ask the Sub-Advisor to complete a questionnaire outlining any civil lawsuits, arbitrations, customer complaints, SEC violations, etc. that the firm has been involved in;
• Visit the Sub-Advisor at their office and meet the staff;
• Ask the Sub-Advisor for references;
• Compare services of multiple Sub-Advisors for their fees, services and product offerings;
• Review the Sub-Advisor’s performance information, in detail. What type of investments do they use/what level of risk do they undertake.
• Have a quarterly due diligence call with the Sub-Advisor.

‘Documenting’ any of the above suggestions or more is the requirement of RIA compliance testing.  Registered investment advisors will be asked at the time the firm is examined by their regulator to ‘prove’ what you have completed to meet the requirement of Rule 206(4)-7.  The more an advisor is able to document their testing requirement, the more this will help during an examination.

Any questions about compliance testing?  Contact Registered Advisor Services today for help!

RIA state registrations and SEC notice filings.  As registered investment advisors approach renewal season this is the perfect time of year to review your advisory firm’s current RIA state registrations and SEC notice filings.  Confirming which states your RIA firm is currently registered in or required to be registered in will help with your year-end compliance requirements and your firm’s renewal fees.

State Registered RIA firms:

State registered RIA firms are required to register in states where they have a principal place of business; or where the firm has more than five nature persons as clients.  There are four states that do not recognize this requirement and require RIA firms to register in those states before they take on one nature person as a client.  Those states of New Hampshire, Nebraska, Louisiana and Texas.

Alternatively, your RIA state registered firm may be registered in a state where you no longer have a principal place of business or more than five nature persons as clients.  In those instances, the RIA firm needs to make a decision if it is appropriate to de-register from that state.

SEC Notice filings:

For federally registered RIA firms, the same requirement holds true as with state RIA firms.  That is, your firm is required to notice file in a state where you have an office or more than five clients in that state.  The same four state exception applies for federally registered RIA firms.  As well as no longer notice filing in a state if the firm is not required to.

Make today the day you review your RIA state registrations and SEC notice filings!  Have questions or need help with these filings?  Contract Registered Advisor Services today!

State Registered Investment Advisor.  Recently, the North American Securities Administrators Association, Inc. (“NASAA”) issued a request for public comment regarding a proposed Investment Advisor model rule for information security and privacy.

NASAA is requesting public comment on a proposed state registered investment advisor model rule to address three items:

1. First, a proposed model rule to require investment advisers to adopt policies and procedures regarding information security (both physical security and cybersecurity) and to deliver its privacy policy annually to clients (“Proposed Information Security and Privacy Rule”).
2. Second, a proposed amendment to the existing investment adviser NASAA model recordkeeping requirements rule to require that state registered investment advisors maintain these records (“Proposed Recordkeeping Rule Amendment”).
3. Third, a proposed amendment to the existing investment adviser NASAA model Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers (collectively “UBP Model Rules”) to include failing to establish, maintain, and enforce a required policy or procedure to the enumerated list of unethical business practices/prohibited conduct (“Proposed Unethical Business Practices Rules Amendment”).

While states can independently require investment advisers to adopt information security policies and procedures through existing state statutes or rules, NASAA hopes the Rule Proposal accomplishes the following three objectives:

• Highlight the importance of data privacy and security in our financial markets along with the need for state registered investment advisors to have information security policies and procedures;
• Provide a basic structure for how state registered investment advisors may design their information security policies and procedures; and
• Create uniformity in both state regulation and state registered investment adviser practices.

Comments on the Rule Proposal are due on or before November 26, 2018.  State registered investment advisors needing compliance assistance with their written policy and procedures should contact Registered Advisor Services today!

RIA Registration Renewal Season.  As we approach the fourth quarter of 2018, the 2019 RIA Registration Renewal Season comes into focus.  It is an important time of year for registered investment advisors to review your registrations.  That is, for both your firm and your Investment Advisor Representatives (IARs).  It is also important for federally registered investment advisors to confirm your notice filings.

Every year, FINRA publishes a Renewal Program Calendar with important dates for firms to pay upcoming RIA Registration Renewal Season Fees.  Paying this fee keeps  both the investment advisor firm and Investment Advisor Representatives (IARs) registered in the upcoming year.

Important Dates

This year, the Preliminary Renewal Statements will be prepared and ready for download on Monday, November 12, 2018, with FULL payment due by Monday, December 17, 2018.

Begin the review process today!  Complete the review by November 1, 2018 and confirm you are only paying for RIA Renewal Registration Fees where your firm and Investment Advisor Representatives (IARs) need to be registered.

Be proactive!  Begin your review today and let Registered Advisor Services assist with this process.

Registered Investment Advisor.  As a registered investment advisor, you are a fiduciary on behalf of your clients.  You have a responsibility to select broker-dealers and execute client trades that seek to obtain ‘best execution’ taking into consideration the circumstances of the particular transaction.

Recently, the Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert outlining the most common deficiencies associated with a registered investment advisor obligation to seek best execution on behalf of your advisory clients.

Here are the topics included within that Risk Alert:

• Best execution reviews were not performed;
• Materially relevant factors were not considered during best execution reviews;
• Comparisons from other broker-dealers were not sought;
• Best execution practices were not fully disclosed;
• Soft dollar arrangements were not disclosed;
• Not properly administering mixed use allocation;
• Inadequate policies and procedures relating to best execution; and,
• Not following best execution policies and procedures.

To read the Risk Alert in its entirety, click here.

As a registered investment advisor, you have ongoing compliance requirements.  Contact Registered Advisor Services today for assistance with Best Execution and other compliance requirements.

RIA Compliance Checkup.  As we enter the third quarter of 2018, now is a great time to review your books and records requirements both from a state or federal investment advisory registration perspective to confirm your investment advisor firm is keeping up with your ongoing review requirements.  Here are some areas to review and thoughts to consider as you perform your firm’s RIA Compliance Checkup:

• Are your Investment Advisor Policies and Procedures up to date? SEC Rule 206(4)-7 requires that you have policies and procedures in place that fit the advisory firm’s current business practices.  Perform a review and determine if any policies need to be updated or revised for how your RIA firm now operates.
• Custody Rule 206(4)-2-do you have custody of any of your client’s cash or securities? Have you or any of your Investment Advisor Representatives become a Trustee of a client trust account?  Are you using your client’s user id and password to access their account to place trades?  These are just two examples of how investment advisors may have custody of client cash or securities.  Review your RIA firm practice in this area to determine if custody comes into play.
• Code of Ethics Rule 204A-1-have you obtained the annual attestation from all of your access persons? Have you obtained your access persons quarterly brokerage statements or transactions and holdings reports?  Are there any issues with gifts received by your access persons from clients or otherwise?  Again, all suggestions of what to consider when thinking about your investment advisory firm’s compliance with the Code of Ethics.
• Risk Assessment-has your registered investment advisory firm entered into any new engagements that has created risk for the firm? If so, what have you done to mitigate the risk; and, has that risk been properly disclosed within your Form ADV Part 1 and ADV Part 2A Brochure?
• Client Agreement Review-have you performed a review of your signed client agreements to confirm that what your clients are being charged is consistent with what is spelled out in the client agreement?
• Are all of your investment advisory entity documents up to date and in good order? Have address changes been made with the appropriate corporate authority to ensure your documents are current?
• Are all your Investment Advisor Representatives Form U4s up to date and current with outside business activities and address changes? Do any of the outside business activities create a conflict of interest for the firm?

This list is by no means exhaustive!  There are many other areas that require an investment advisors attention in order to complete a thorough review of your books and records requirements.  Complete your RIA Compliance checkup today!  If you have questions or need assistance with compliance, contact Registered Advisor Services for a free consultation.

New RIA business.  Are you wondering if you need to register as a new RIA business?  If so, it is important to understand the definition of a Registered Investment Advisor (RIA) to help answer your question.  The Investment Advisers Act of 1940, Section 202(a)(11) defines an investment advisor as any person or firm that:

• For compensation;
• Is engaged in the business of;
• Providing advice to others or issuing reports or analyses regarding securities.

An individual must satisfy all three elements mentioned above, to fall within the definition of an investment advisor.  If your business model easily falls within these three elements, then your question is answered and you need to register your new RIA business.

However, if you are still unclear on your firm’s RIA registration requirements, the Division of Investment Management published a release (No. 1092) in 1987 to help provide guidance to these three elements. I’ll share some of the information from that release for clarity:

Compensation-This term has been broadly construed.  Generally, the receipt of any economic benefit, whether in the form of an advisory fee, some other fee relating to the total services rendered, a commission, or some combination, satisfies this element.

Engaged in the Business-A person must be engaged in the business of providing advice. This does not have to be the sole or even the primary activity of the person. Factors used to evaluate whether a person is engaged are:

• whether the person holds himself/herself out as an investment adviser;
• whether the person receives compensation that represents a clearly definable charge for providing investment advice; and
• the frequency and specificity of the investment advice provided. Generally, a person providing advice about specific securities will be “engaged in the business” unless specific advice is rendered only on a rare or isolated occasion.

Advising Others about Securities

1. Advice about Securities. A person clearly meets the third element of the statutory test if he/she provides advice to others about specific securities, such as stocks, bonds, mutual funds, limited partnerships, and commodity pools. The SEC staff has stated that advice about real estate, coins, precious metals, or commodities is not advice about securities. The more difficult questions arise with less specific advice, or advice that is only indirectly about securities. The SEC staff has stated in this regard:

(i) advice about market trends is advice about securities;

(ii) advice about the selection and retention of other advisers is advice about securities;

(iii) advice about the advantages of investing in securities versus other types of investments (e.g., coins or real estate) is advice about securities;

(iv) providing a selective list of securities is advice about securities even if no advice is provided as to any one security; and

(v) asset allocation advice is advice about securities.

As you consider this information and contemplate whether to register a new RIA business, contact Registered Advisor Services today for help and guidance on the RIA registration process.

State Registered Investment Advisors.  The North American Securities Administrators Association (NASAA) released its first annual report identifying the state registered investment advisor population and related regulatory activities.

This annual report provides some great insight into smaller state registered investment advisors firms.  The two main areas of the report that warrant close scrutiny is the 2017 Coordinated Exams Report and the Cybersecurity Checklist for RIA firms.

2017 Coordinated Exams Report

This report provides insight into areas where state registered investment advisors should focus their attention.

The Top 5 Deficiency Categories:

Books & Records – 64.6%

Registration – 54.3%

Contracts – 45.5%

Fees – 27.2%

Custody – 27.2%

Cybersecurity Checklist

In 2017 the state securities examiners reported to NASAA that they found almost 700 cybersecurity related deficiencies during the 1,200 examinations of state registered investment advisors.

The top five Cybersecurity issues noted by the regulators:

1. No or inadequate cybersecurity insurance
2. No testing for potential cybersecurity vulnerabilities
3. Inadequate procedures with securing or limiting access to devices
4. Failure to retain an IT or technology consultant
5. Inadequate procedures related to hardware/software upgrades

To assist state registered investment advisors, the Cybersecurity and Technology Project group from NASAA created “The NASAA Cybersecurity Checklist for Investment Advisors.” Which is a self-assessment that allows small firms to identify, respond and recover from cybersecurity weaknesses.  Click here for the Cybersecurity Checklist!

For a complete copy of NASAA’s first annual report, click here!  State registered investment advisors who need assistance with their compliance requirements, contact Registered Advisor Services today for a free consultation.

Form ADV Part 2 Brochure and Brochure Supplement.  In October 2010, the SEC adopted a new approach to the Form ADV Part II and Schedule F, which was more of a check-the-box format.  The new approach is intended to be a narrative plain English brochure that describes the registered investment advisor’s business, conflicts of interest, disciplinary history, affiliations with other entities and other important information.  This information is intended to help clients make an informed decision about whether to retain that registered investment advisor.

When the SEC adopted the new plain English Form ADV Part 2 Brochure, they adopted it to include two sub-parts, Part 2A and Part 2B. Form ADV Part 2A contains 19 disclosure items about the advisory firm that must be included in the investment advisor’s brochure.  The Form ADV Part 2B is referred to as the Brochure Supplement, which includes information about certain advisory personnel for whom clients rely for investment advice.

It has been more than seven years since the SEC adopted this new approach for registered investment advisors, however, I have recently become aware that there are still some RIA firms that have not yet transitioned over to this new format.  For more information on the requirements of the Form ADV Part 2 Brochure and Brochure Supplement, click here, for the final SEC rule.

RIA firms that need assistance creating a Form ADV Part 2 Brochure and Brochure Supplement, contract Registered Advisor Services today for a free consultation!

Registered Investment Advisor Consultants OCIE Risk Alert. In a recent Risk Alert, the Office of Compliance Inspections and Examinations (“OCIE”) issued a list of most frequently identified compliance issues relating to fees and expenses in deficiency letters provided to RIA firms. Although this Risk Alert is issued by OCIE and based upon their examinations of federally registered advisors, the compliance issues mentioned easily apply to state RIA firms too. Here are the Most Frequent RIA Compliance Issues: 

Fee-Billing Based on Incorrect Account Valuations. OCIE staff has observed registered investment advisers that incorrectly valued certain assets in clients’ accounts resulting in overbilled advisory fees. Because advisers generally assess fees as a percentage of the value of assets they manage in each client’s account, an incorrect account valuation will lead to an incorrect advisory fee being assessed to that client. For example, staff observed advisers that:

• Valued assets in a client’s account using a different metric than that which was specified in the client’s advisory agreement, such as using the asset’s original cost to value an illiquid asset rather than valuing the asset based on its fair market value.
• Valued a client’s account using a process that differed from the process specified in the client’s advisory agreement, such as:
  • Using the market value of the account’s assets at the end of the billing cycle, instead of using the average daily balance of that account over the entire billing cycle as specified in the advisory agreement.
  • Including assets in the fee calculation that were excluded by the advisory agreement from the management fee, such as cash or cash equivalents, alternative investments, or variable annuities.

Billing Fees in Advance or with Improper Frequency. OCIE staff has observed issues with registered investment advisers’ billing practices relating to the timing and frequency for which advisory fees were billed. Staff observed, for example, registered advisers that:

• Billed advisory fees on a monthly basis, instead of on a quarterly basis as stated in the advisory agreement or disclosed in Form ADV Part 2. Similarly, staff observed advisers that billed advisory fees in advance, despite the advisory agreement specifying that clients would be billed in arrears.
• Billed a new client for advisory fees in advance for an entire billing cycle, instead of pro-rating such charges to reflect that the advisory services began mid-billing cycle. Relatedly, staff observed registered investment advisers that did not reimburse a client a pro- rated portion of the advisory fees when the client terminated the advisory services mid-billing cycle, despite disclosing that they would do so in Form ADV Part 2.

Applying Incorrect Fee Rate. OCIE staff has observed advisers that applied an incorrect fee rate when calculating the advisory fees charged to certain clients. Staff observed, for example, advisers that:

• Applied a rate higher than what was agreed upon in the advisory agreement or double-billed a client.
• Charged a non-qualified client performance fees based on a percentage of their capital gains inconsistent with Section 205(a)(1) of the Advisers Act.

Omitting Rebates and Applying Discounts Incorrectly. OCIE staff has observed advisers that did not apply certain discounts or rebates to their clients’ advisory fees, as specified in the advisory agreements, causing the clients to be overcharged. For example, staff observed advisers that:

• Did not aggregate client account values for members of the same household for fee-billing purposes, which would have qualified such clients for discounted fees according to the adviser’s Form ADV or advisory agreement.
• Did not reduce a client’s fee rate when the value of that client’s account reached a prearranged breakpoint level, which entitled that client to a lower fee rate according to the adviser’s Form ADV or advisory agreement.
• Charged a client additional fees, such as brokerage fees, when such client was in the adviser’s wrap fee program and the transactions qualified for the program’s bundled fee.

Disclosure Issues Involving Advisory Fees. OCIE staff has observed several issues with respect to advisers’ disclosures of fees or billing practices. For example, staff observed advisers that:

• Made a disclosure in the Form ADV that was inconsistent with their actual practices, such as advisers that disclosed in the Form ADV a maximum advisory fee rate, but nevertheless had an agreement with a certain client to charge a fee rate exceeding that disclosed maximum rate.
• Did not disclose certain additional fees or markups in addition to advisory fees, such as advisers that did not disclose that they:
  • Collected expenses from a client for third-party execution and clearing services that exceeded the actual fee charged for those services by the outside clearing broker.
  • Earned additional compensation on certain asset purchases for client accounts or that they had fee sharing arrangements with affiliates.

Adviser Expense Misallocations. OCIE staff has observed advisers to private and registered funds that misallocated expenses to the funds. For example, staff observed advisers that allocated distribution and marketing expenses, regulatory filing fees, and travel expenses to clients instead of the adviser, in contravention of the applicable advisory agreements, operating agreements, or other disclosures.

For a complete copy of OCIE’s Risk Alert, Click Here!

Let Registered Advisor Services be your Registered Investment Advisor Consultants.  Contact us today for a free consultation!