Tag Archives: 2013 Regulatory Priorities

Do Registered Investment Advisors Dare Roll the Dice with the Securities and Exchange Commission and Its Office of Compliance, Investigation and Enforcement?

An Analysis of the SEC’s Examination Priorities for 2013 in light of “the odds.”

In fiscal 2012 the Securities and Exchange Commission (“SEC”) had less than 150 enforcement actions against registered investment advisers (“RIAs”), of which there are now more than 11,000 subject to SEC jurisdiction. In addition, there are almost 2,000 new advisors that have had to register due to legal changes brought about by Dodd-Frank. Those include hedge funds, venture capital funds and those involving private equity. Annually, the SEC examines approximately only eight percent (8%) of RIAs per year.

The SEC released its examination priorities for 2013 with respect to registered investment advisors. We have narrowed them down to highlight and share some of the items we feel are most likely to impact firms. Those who wish to review the entire release may do so at the SEC’s website or contact the author.


One issue the SEC will address in 2013 examinations is conflicts of interest. The SEC will examine RIA’s policies, procedures and systems in an effort to determine whether they recognize, mitigate and disclose conflicts of interest present in the investment advisors’ business.


A)    Custody of Assets

Safety of assets remains a top priority for the SEC. In doing calculations of recent examination deficiencies, failure to comply with the Custody Rule (Investment Advisers Act Rule 206(4)-2) was present in over one third of the firms according to Office of Compliance, Examinations and Enforcement (“OCIE”). The SEC will be reviewing firm policies and procedures as well as books and records to determine whether firms are:

1)      Appropriately recognizing situations in which RIAs have “custody” as defined in the Custody Rule;

2)      Complying with the Custody Rule’s “surprise exam” requirement;

3)      Satisfying the Custody Rule’s “qualified custodian” provision; and

4)      Following the terms of the exception to the independent verification

requirements for pooled investment vehicles.

B)     Marketing/Performance

This is always a high risk area of concern because of the ultra competitive nature of money management. The SEC and OCIE will be reviewing instances of aberrational performance for signs of weak valuation procedures or fraudulent activity.  The SEC and OCIE’s staff will focus on the accuracy of advertised performance, including without limitation, back tested and hypothetical performance, methodologies and assumptions made and related disclosures. As always, the SEC will look at compliance with record keeping requirements by RIAs.

In conclusion, despite the odds, it makes little sense to roll the dice with an investment advisor’s fate because an adverse examination, investigation or enforcement from the SEC/OCIE could prove to be fatal to RIAs and/or their investment advisor representatives (“IARs”).


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With First Quarter in the books, what more do we know?
As you may recall, on January 13, 2013, FINRA came out with its letter listing its concerns. In counseling several clients and participating in a fair number of “On the Record” (“OTR”) interviews, this post will provide greater insight than simply relisting the priorities.

A) Suitability of Complex Products

Perhaps the prevalence of these products has to do with the extraordinary low interest rate environment that we find ourselves. FINRA believes that if you cannot effectively communicate the requisite information to them about such products upon request then you cannot hope to explain this to the customers. While that may not be the case, it certainly is a widely shared view at FINRA.

B) Exchanged Traded Funds and Products

Do you know the difference between an exchange traded fund (“ETF”) and an exchange traded note (“ETN”)? What about a commodity pool or grantor trust? You may not have cared before the collapse of Lehman Brothers, but now you should be able to explain the difference and the risk that certain products may not track the index that they are designed to follow.

C) Non-Traded REITs and Closed End Funds

On non-traded REITs, is the money paid from operations/investment or just return of principal? Are those stated prices accurate? For closed end funds, what sort of risk is taken on to juice returns and are distributions from investment return? All of the foregoing is fair game in an OTR!

D) Private Placements

FINRA now has Rule 5123; Securities Law and Compliance, previously covered this on December 12, 2012, and will be examining “due diligence procedures,” whether they are followed and documented and the disclosures of material risks of the offering. How are conflicts resolved between say investment banking and the end purchasers/customers?

E) The Not so “New” Suitability Rule and Customer Identification Procedures

This was covered in depth previously by Securities Law and Compliance in posts from February 10, 2013 and post from June 24, 2012.

My take away from the first quarter and the 2013 priority letter are:

  1. Can the registered representative fully explain the products features and risks? You sold the product to a customer so now you need to explain to FINRA how it works, and “no” you are generally not allowed to take the prospectus into this examination.
  2. Due diligence on private placements must be done even if one is not an underwriter and effective due diligence means asking questions and not simply accepting answers given.
  3. More and more suitability is being morphed into a test of understanding products’ features.

How do your firm’s practices, procedures and compliance program deal with the above insights and criteria? The time to act is now and not after FINRA shows up on your threshold unannounced and planning to stay for a several week “visit!”

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