In its answers to frequently-asked questions, the North American Securities Administrators Association (“NASAA”) makes preparing for a securities examination sound easy. NASAA gave the following guidance to Registered Investment Advisers (“RIAs”):
Many state securities regulators conduct audits/exams of the investment adviser firms registered in their states. If you are notified that your firm will be the subject of an audit/exam there are some simple steps that you can take that will facilitate the process. First, if the regulator, prior to the exam/audit date, provides you with a list of documents that are needed for the exam/audit, be sure to have the documents available ahead of time and organize them according to the request. Second, make sure the regulator has a work space and access to a copier. Finally, if there are multiple employees at the firm, identify a point of contact for the regulator.
Examiners expect the firm’s Chief Compliance Officer (“CCO”) to be the RIA’s point of contact.
The CCO’s Role in Compliance Examinations
The CCO for an advisory firm makes certain that the RIA is fully prepared for the compliance examination and should set the right tone for the office. Employees should be briefed regarding how to conduct themselves when examiners arrive. Upon arrival, the CCO should give examiners an overview of the firm’s business model. A short PowerPoint presentation is a useful tool. It is also important for high-level members of the firm to be present at this presentation.
As the point of contact, all questions from the examination team should be directed to the CCO. Employees should be instructed to make sure the CCO is involved when examiners address questions to them. Although it is very normal to call upon other members of the firm to answer specific questions, all interactions with examiners should take place while the CCO is present. The CCO should keep notes regarding the questions examiners asked and the responses provided. All questions e-mailed to the adviser from examiners should be answered in writing.
It is imperative that the firm’s CCO be knowledgeable and cooperative with the examination team. Examiners will not respond favorably to a CCO who is argumentative, defensive, confrontational, or attempts to stonewall the examination team. The CCO should be willing to accept constructive criticism rather than turning the examination into an adversarial situation. By being uncooperative, a minor compliance mistake may escalate into an enforcement action.
Being cooperative does not mean an adviser should give examiners carte blanche to roam through the office or go through file cabinets. Employees should be encouraged to be friendly but professional in their dealings with examiners. They should not volunteer information and should only answer the questions asked. Employees should be on their best behavior while examiners are in the office. Conversations with clients and colleagues should be discrete. Files not being worked on should be locked up. Computers should be logged off when employees leave their work stations.
Examiners have high expectations of the firm’s CCO. The CCO should possess enough seniority and clout within the organization to enforce the firm’s policies and procedures. Although CCOs may delegate some of their duties to a subordinate, they are still responsible for compliance deficiencies. Examiners will be very critical of CCOs who delegate too much to subordinates or continually refer questions to someone else to answer. These are signs that the firm’s CCO is not fully engaged with the RIA’s compliance program.
An important element of setting the right tone for the examination is making sure that examiners have a pleasant environment in which to do their jobs. They should be provided with a comfortable work area, as well as access to whatever office supplies they need. Hot and cold beverages should be made available to the examination team, as well as access to kitchen and break areas. Generally, examiners are not permitted to accept meals from RIAs, so advisers should avoid offering to bring in lunch.
Supplying Books and Records to Examiners
Upon receiving the list of books and records requested by examiners, advisers should gathering the requested information. Ideally, an adviser will have already tested the firm’s ability to obtain books and records in a timely manner.
The State of Florida Examination Request List provides a space on page 1 that says:
After diligent search of the firm’s books and records, I am unable to provide the Office of Financial Regulation the following information for the following reason(s).
The adviser must then explain why those records will not be produced. An adviser should never backdate or fabricate records requested by securities regulators. It is better to admit that the firm did not create or retain the documents requested. An adviser should ask for additional time to produce records that are not readily available.
Once an adviser learns that an examination has been scheduled, it is too late to file amendments to Form ADV. It is quite likely that examiners already read the firm’s Form ADV before scheduling the exam.
While RIAs may make mistakes that are uncovered during compliance examinations, they can still make a positive impression on examiners. Advisers should request an exit interview if examiners have not been offered one already. Advisers should take notes during the exit interview and show their willingness to correct deficiencies. The examination team should leave the office with the belief that every member of the RIA is committed to compliance. An RIA should make good on that commitment by correcting any deficiencies found in a timely manner.
When advisers disagree with examiners’ findings, they can and should state their positions without being confrontational. Nevertheless, some advisers receive deficiency letters and attempt to contest every finding, which causes them to lose credibility with examiners.
Where compliance errors have occurred, advisers should assure securities regulators that they will make the improvements requested. If those deficiencies have not been corrected by the time of the next compliance examination, which might happen weeks, months, or years later, they will be viewed as recidivist violations. At that point, the matter may be referred to the SEC or state’s enforcement division.
Hopefully, RIAs’ examinations will go smoothly with little criticism from the examination team. Keep in mind that even though an examiner did not identify certain weaknesses and deficiencies, advisers should not assume that all of their activities are in full compliance with federal securities laws or other applicable rules and regulations.
If you’re concerned that examiners will find compliance problems at your firm, consider having NCS conduct a mock audit. These audits can help RIAs discover compliance deficiencies before examiners show up at your door. NCS’ March 2013 compliance checklist can help you determine if you are creating and retaining the books and records needed for an examination. You should also review NCS’ November 2011 newsletter, which identifies the top investment adviser deficiencies found by state securities examiners.
Les Abromovitz, JD, is the author of two RIA compliance books and is a senior consultant with National Compliance Services (www.ncsonline.com), where he is responsible for conducting compliance reviews of web sites, marketing materials, social media communications, presentations, brochures, books, blogs, newsletters, proposals, radio programs, commercials, YouTube videos, performance reports, and performance advertising. He earned a JD from Duquesne University School of Law. Contact him at 561-330-7645, Ext. 213 or firstname.lastname@example.org.