February 6, 2014 – According to NASAA (the North American Securities Administrator’s Association), their members performed over 1,000 audits of Investment Advisers in the first six months of 2013, resulting in over 6,000 deficiencies! The Syndicate, in its effort to proactively assist its members and provide education on business and regulatory matters, would like to direct your attention to an information website provided by the Missouri Securities Division for RIA’s and IAR’s. The website provides information about common deficiencies and how to avoid them and can be found here. Having private counsel available by phone or in person during the audit and reviewing key information provided in the pre-audit packets regulators provide for most not-for-cause audits is also wise. Audits can be stressful and time consuming, but being prepared will play a big role in reducing the stress and helping you reduce the potential number of deficiencies.
Too many small and mid-size investment advisory firms fail to adequately self-audit. There – I said it. Do you agree with me?
There was much debate and wrangling over the SEC to state regulatory transition prompted by the Dodd-Frank Act. The state regulators vowed that they had the capacity to regulate and audit the over 3,000 mid-sized RIA’s that came under their purview with the increase in the SEC AUM threshold. And they have been living up to their vow. As such, small to mid-size independent RIA’s are more likely to be subjected to a routine exam. In just the first six months of 2013, state regulators conducted over 1,000 audits, finding over 6,000 deficiencies. In my experience, the vast majority of these firms fail to retain outside legal counsel for routine guidance, to assist with self-audits, or to step in quickly when the regulators arrive at the front door.
A couple of years back, my law firm represented an investment advisor representative whose small satellite office was subjected to a routine state exam. The regulators found a myriad of problems a self-audit would have discovered. Rather than accepting responsibility for the exam deficiencies, the RIA threw the representative under the bus and blasted him on his U-5. An arbitration panel subsequently awarded our client almost $3.5 million. Regular counsel and self-exams would have been a lot less expensive.
Not long after that case, I served as an expert witness for an investor whose representative steered her towards unregistered securities purportedly backed by real estate in England. The small RIA’s CCO couldn’t even define a security during the hearing. A more robust audit program would have unveiled the representative’s arguably well-intentioned but utterly ignorant advice regarding the investment contracts.
So my admittedly self-serving advice is this: if you are a small or mid-sized RIA, budget for consistent legal advice and self-exams. Saving a buck on compliance isn’t even “penny wise”.