Richards Cautions Against Reductions in Compliance Resources

Lori Richards, the director of the SEC’s Office of Compliance Inspections and Examinations, last week reviewed the steps that advisory firms should take to assure that they meet the fiduciary standards owed to their clients. In a speech to IA Week and the Investment Adviser Association, Richards noted that the investment adviser compliance program rules, having been adopted six years ago, are no longer in the implementation stage. SEC examiners will be reviewing the adequacy of firms’ compliance programs and expect to find fully operational, effective and compliant programs, she said.

Compliance programs should be capable of addressing new and emerging risks. Advisers must consider significant compliance events, changes in business arrangements and regulatory developments when conducting their periodic compliance reviews. Richards noted that many compliance professionals consider their programs to be “evergreen,” meaning that they are in a constant state of improvement to identify new issues and compliance risks and to adopt new technology.

Richards recommended that compliance professionals take a fresh look at their firm’s disclosure, custody, performance claims and the resources that support the compliance program. Inadequate disclosure is among the top five most common deficiencies that SEC examiners found last year, she reported. Richards urged advisers to ensure that they are disclosing complete and accurate information about any conflicts of interest, compensation arrangements, fee arrangements and the use of client commissions.

In order to identify Ponzi schemes and other types of frauds, Richards said the examination staff will be reviewing advisers’ controls over custody. She recommended a number of steps that advisers might take such as obtaining statements that were sent to clients from the custodian, comparing custodian statements with advisory records and reviewing the reconciliation process. Richards suggested that advisers take additional steps to confirm assets when custody is with the adviser of an affiliate. She urged compliance personnel to consider the risk of theft or falsified transactions. She also recommended reviews of client account statements sent by the adviser.

If the client is a hedge fund, Richards said that compliance personnel could review whether the auditor is in fact independent and ensure that audited financials, if required, are distributed in a timely manner to investors.

SEC examiners also frequently find problems with performance claims, according to Richards. Some of the problems are due to errors in calculation, but others are intentional deception. She said the problems found by examiners include overstatements of firms’ performance returns, assets under management or length of operation. Some firms fail to include information that is necessary to prevent the performance claims from being misleading. Others inappropriately include or exclude information or data in composites. Richards said a best practice is to have an outside firm verify performance claims.

Richards urged firms to use greater care when crafting performance composites for marketing materials. She suggested tests to ensure that complete records are kept with respect to marketing and performance advertisements, and the establishment of procedures to periodically review marketing materials to ensure the information is truthful and not misleading.

Richards also cautioned against cuts in compliance programs that may impede the compliance personnel’s ability to perform effective reviews. If the resources are lacking to the extent that they undercut a chief compliance officer’s ability to perform an effective review, that information should be included in the CCO’s annual report. Richards suggested that CCOs consider alternative ways to target resources so that the areas that pose the greatest risk of harm to investors are monitored.

Richards said that firms may leverage the work of others within the organization such as internal audit and risk management. Another option is to increase technological resources for front-end compliance and monitoring. These investments may save money in the long run, she said, if they help firms detect and correct or avoid compliance problems.