According to the U.S. Securities and Exchange Commission’s 2021 Examination Priorities, in the last five years the number of Registered Investment Advisers the SEC Division of Examinations oversees increased from about 12,000 to more than 13,900, and the assets under management of RIAs increased from approximately $67 trillion to $97 trillion.
Because of the totality of assets managed, RIAs are always going to be a priority for the SEC. Examinations are not going anywhere. The Division has made significant process, staffing and technology updates to keep up with the growth and increase RIA coverage. In 2020, a year where COVID forced a mid-year switch to remote examinations, Division coverage of RIAs was 15%.
Craig Moreshead, Managing Director at Foreside, says there’s no doubt that regulation over private funds is here to stay. Firms should be focusing on preventing deficiencies by developing solid policies and procedures and effectively managing conflicts. A panel on key legal and regulatory issues facing private client firms at the recent SIFMA C&L Virtual Forum echoed that sentiment. Carrie Bechtold, Managing Counsel at Wells Fargo noted that “enforcement themes that are going to be coming up in the space aren’t going to be particularly new themes.” She also predicts continued focus on fiduciary duty, conflict of interest and disclosures will be on the horizon for enforcement.
Are disclosures clear and consistent?
Failure to provide accurate and timely disclosures is a common—and avoidable—deficiency. SEC leadership has clearly indicated that they will use data analytics to uncover difficult to detect disclosure violations. Simply filing disclosures is not enough. According to Curtis Flippen, Senior Director at Foreside, a disclosure must be substantive, clearly written, and meet or mitigate the conflict of interest in terms of regulatory expectations. If SEC examiners see a disclosure practice that they think is unfair or misleading they are going to have a hard time getting past that.
Firms should consider a disclosure consistency review by a third party to ensure that their disclosures meet current and evolving regulatory expectations. Automated technology can also help manage the disclosure process.
SEC’s Annual Agenda Includes Focus on ESG Disclosures
Solid policies and procedures prevent deficiencies and enforcement
Conflicts are all around us. From a compliance perspective, private advisers need to keep a firm focus on eliminating and mitigating conflicts of interest. Two major types of conflicts that advisers must watch out for are conflicts between the firm and clients, and conflicts between funds.
Moreshead notes that how well a firm manages conflicts tells the tale of the likelihood of deficiencies and weaknesses found during an SEC exam. Solid controls to manage conflicts of interest should be baked into a firm’s operations. According to Flippen, private adviser firms must have policies and procedures that not only mitigate conflicts of interest, but that also substantively control those conflicts of interest. Firms that don’t do this face penalties. In February and May of 2020, the SEC fined adviser firms for failing to have policies and procedures reasonably designed to prevent the misuse of material nonpublic information without findings of actual insider trading.
Firms should have an understanding of the inventory of risks and conflicts that form the basis of their policies and procedures and review them at least annually. According to Morehead, two areas of risk that can lead to deficiencies are Outside Business Activities (OBA’s) and Pay to Play Compliance. Any OBA’s that are investment related need to be documented and vetted. Political contributions and donations must be recorded and verified. Not having policies and procedures in place, or not following the defined operational processes can get both the firm and the individual involved in trouble.
Private adviser firms should also ensure that they do due diligence, especially on affiliated providers to document that they are providing a high level of service and meeting regulatory expectations. Watch this quick video and get to know MCO’s Third Party Risk Solution.
Culture of compliance and an empowered CCO
A solid culture of compliance that permeates the firm and influences how it conducts its activities can lessen the chance of a deficiency. Tone from the top can set expectations for conduct across the organization. When policies and procedures are supported by senior management and enforced by compliance it’s easier to spot potential issues earlier. Learn about using technology to build a culture of compliance.
The SEC expects Chief Compliance Officers to be empowered, senior, and with authority. For effective compliance, the CCO needs to be fully able to discharge their responsibilities. In small firms, the CCO often wears multiple hats. If that’s the case, the CCO must have compliance knowledge and put time and effort into the role. A CCO in name only is not adequate.
When asked about SEC thoughts on outsourced CCOs, Morehead said that the SEC just wants to see that there is a solid compliance program in place, saying “I think we're past the point where the SEC or the states have a bias against outsourced CCOs. I think what they want to see as an effective compliance program, whether it's run by someone inside or outside the organization.”
There are nuances to a compliance program for private funds. To effectively manage compliance private fund advisers must understand their business model. To keep pace with evolving regulatory expectations CCO’s must stay attuned to what’s going on in the industry and continuously evaluate policies and procedures to make sure they are both adequate and effectively administered. Firms face deficiencies or enforcement actions if they don’t.
For more details on the unique regulatory risks faced by private fund firms watch the on-demand webinar Exam Deficiencies for Private Fund Advisers featuring Curtis Flippen and Craig Moreshead from Foreside.
And if you’d like to have a conversation about how MyComplianceOffice helps firms of all sizes manage conflicts of interest and mitigate conduct risk, let us know.