RIA Compliance and Practice Management Blog

Top RIA Compliance Deficiencies: Investment Advisory Contracts

Posted by RIA in a Box

Aug 16, 2014 3:06:00 PM

In 2013, coordinated state exams conducted by members of the North American Securities Administration Association (NASAA) uncovered the top registered investment adviser (RIA) compliance deficiencies across 20 categories. Last week we discussed the most common investment adviser compliance deficiencies in the registration category, specifically in various sections of the Form ADV.

In this week’s installment we’ll cover another common RIA compliance deficiency category: investment advisory contracts. The 2013 NASAA investment adviser examination report contains results from 1,130 investment advisory firm examinations. In the contracts category, of all RIA firms examined, 44.0% of audits noted at least one deficiency. This figure is particularly notable due to the fact that contract-related deficiencies according to the 2011 NASAA investment adviser examination report were not even ranked within the top ten deficiency categories.

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According to the 2013 report, 46.0% of firms with greater than $30 million in assets under management (AUM) had contract-related deficiencies, compared to 41.2% of investment advisory firms with less than $30 million in AUM. Just under 50% of RIA firms examined for the first time had contract-related deficiencies compared to around 35% of firms that had previously been examined.

As previously stated, 44.0% of investment advisory firms examined according to the 2013 NASAA report had contract-related deficiencies. The top contract-related deficiencies in 2013 were:

  1. Not properly executed (10.9%)
  2. Fee (10.5%)
  3. Fee formula (10.4)
  4. Hedge clauses (9%)
  5. In writing (6.4%)

Given the significant increase in contract-related deficiencies between 2011 and 2013, it is apparent that RIA firms need to take a step back and ensure that the investment advisory agreements that the firm has in place with clients are in proper compliance with the relevant state or SEC statutes. Investment adviser examiners, particularly at the state level, will often spend considerable time reviewing an investment advisory firm’s contracts. As RIA compliance consultants, we encourage the Chief Compliance Officer (CCO) of the investment advisory firm to consider these RIA compliance-related questions as he or she reviews the firm's current contracts:

  1. Does the firm have a properly executed, written client agreement on file for each client relationship?
  2. Does the fee, formula for calculating the fee, and frequency match how the client is billed?
  3. Does the contract include any hedge clauses that may stand in conflict with the firm’s fiduciary responsibility?
  4. Are the firm’s current services provided and/or discretionary authority properly outlined in the executed agreement?

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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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