On March 27th, the SEC Division of Examinations (the “Division”) published a risk alert affirming its long-standing interest in conducting reasonably prompt examinations of newly registered advisers. The risk alert provides an examination ‘how to’ guide for new advisers, describing the materials those advisers should expect to provide to staff in an examination. Advisers should expect exam staff to focus on (i) proper identification and mitigation of conflicts of interest; (2) adequacy of client disclosures; and (3) effectiveness of compliance programs.
Of broader interest to all advisers, the risk alert also included observations from recent new adviser exams:
Compliance Policies and Procedures – The staff observed policies and procedures that 1) did not adequately address certain risk areas applicable to the adviser; 2) omitted procedures to enforce stated policies and 3) were not followed by advisory personnel. Two primary themes shine through the deficiencies noted. First, an adviser’s compliance policies must truly be tailored to its business, and must be actively reviewed, updated and communicated to personnel to ensure that what an adviser says on paper and what it does in practice remain aligned. Second, the staff stressed the importance of a qualified chief compliance officer with sufficient time and resources to monitor both the adviser’s personnel and any third party service providers such as compliance consultants. Advisers who utilize “off the shelf” compliance manuals and dual- or tri-hatted chief compliance officers do so at their peril. This risk alert issue seems destined to be cited in the final outsourcing rule, which the SEC expects to adopt this year and which is discussed in our Alert Memo available here. The staff also highlighted business continuity plans, including succession plans. Given the recent volatility in the financial markets, all advisers should ensure that they have a business continuity plan in place and that it is regularly reviewed and updated, particularly where there is turnover in personnel.
Disclosure Documents and Filings – The staff observed omissions or inaccurate information in required disclosure documents as well as untimely filings. Inaccuracies and omissions were related to 1) fees and compensation; 2) business or operations; 3) services offered to clients, including disclosures related to investments and aggregate trading; 4) disciplinary information; 5) websites and social media accounts and 6) conflicts of interest. These comments highlight the importance of rigorous and documented processes around the filing and updating of required disclosure documents such as Form ADV Part 1 and the Form ADV Brochure. While market participants were laser focused in 2022 on updating marketing materials to prepare for the launch of the Marketing Rule last November, the same scrutiny should be applied to Brochure disclosures, particularly with respect to the description of adviser compensation and conflicts of interest.
Marketing – The staff highlighted false and misleading marketing materials containing inaccurate information regarding 1) the professional experience or credentials of advisers; 2) third-party rankings and 3) performance. The staff also highlighted the inability to substantiate factual claims in marketing materials. The focus on performance and substantiation is unsurprising given the new Marketing Rule, and all advisers should carefully review all presentations of performance information in marketing materials for compliance with the rule, as well as any existing marketing materials that may still be accessed by clients or investors.
While the Division’s risk alert did not contain any surprises, it underscores the continued focus on newly registered advisers, as well as the staff’s more broadly applicable focus on the adequacy of compliance programs and the comprehensiveness of disclosures. Newly registered advisers should continue to expect prompt examination upon registration with the SEC and existing advisers should ensure that their current and evolving business practices are correctly and fully reflected in their policies and disclosures.