RIA Compliance and Practice Management Blog

SEC Announces Investment Share Class RIA Exam Sweep Initiative

Posted by RIA in a Box

Jul 13, 2016 6:21:45 PM

Today, the Securities and Exchange Commission (SEC) Office of Compliance Inspections and Examinations (OCIE) announced a new examination program focus on "conflicts of interest tied to advisers' compensation or financial incentives for recommending mutual fund and 529 Plan share classes that have substantial loads or distributions." The OCIE is calling this new registered investment adviser (RIA) examination focus the "Share Class Initiative."  In the RIA world, this new focus may particularly apply to dually-registered investment advisers that also operate or are affiliated with a broker-dealer "that receives fees from the sales of certain share classes, and situations where the adviser recommends that clients purchase more expensive share classes or funds for which an affiliate of the adviser receives more fees." 

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This new audit focus has been a priority area for a number of years but appears to now be receiving renewed scrutiny. The SEC OCIE previously listed "fee selection and reverse churning" as a top 2015 investment adviser examination priority. In particular, the SEC staff previously noted in 2015 that it would "focus on recommendations of account types and whether they are in the best interest of the client...and disclosures made about such relationships."

According to the most recent publicly available SEC RIA registration data, there are 2,471 RIA firms presently registered with the SEC that have disclosed in Item 7A of the Form ADV Part 1 that the firm or a related person of the firm is also engaged in broker-dealer activity. Thus, over 20% of the 12,091 investment advisory firms registered at the federal level appear to be under particular focus. As such, this new SEC OCIE risk alert should serve as a strong reminder to hybrid advisors that there will be additional scrutiny placed on the potential conflicts of interest created by such a business model.

The SEC OCIE notes that it will be focused on three key compliance areas:

  • Fiduciary Duty & Best Execution: Investment advisory firms should expect the examination staff to "review advisers' books and records to identify share classes held and purchased in clients' accounts and any compensation received by the adviser or any of its associated persons related to such investments."
  • Disclosures: The examination staff makes it clear that they will be reviewing the firm's current and past Form ADV conflict of interest disclosures to ensure that what the firm discloses matches the firm's actual business practices. In particular, advisory firms should expect examiners to review "clients' accounts with a focus on assessing the accuracy, adequacy, and effectiveness of the adviser's disclosures regarding compensation for the sale of shares and the conflicts of interest created."
  • Compliance Program: In addition, auditors will be reviewing the RIA firm's written policies and procedures to ensure that the firm has the proper policies in place to prevent potential violations.

As RIA compliance consultants, we strongly recommend that the principals and Chief Compliance Officer (CCO) of all investment advisory firms use this notice as an opportunity to review the firm's books and records to ensure proper records are being maintained and reviewed, the firm's Form ADV Part 2 brochure for proper conflict of interest disclosures, and the firm's internal policies and procedures to ensure that this potential area for abuse is properly addressed. 

To read the full SEC National Examination Program Risk Alert, please click here.

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Topics: RIA Compliance

RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

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