As a born and bred New Englander, certain things are expected of me. A dry wit. A Boston sports obsession. Knowing how to pahk my cah in Hahvahd yahd. Enjoying a good lobster roll on a warm summer day in Maine while gazing at a picturesque lighthouse. Anytime I savor that sweet, buttery crustacean and the accompanying view, my thoughts inevitably wander back to my day-to-day work with investment adviser firms.
In particular, I think about firms without full-time compliance staff dedicated to assessing the current regulatory landscape for investment advisers. I want to know how I can best support those firms so they can spend as much time as possible focused on the most important thing—their clients.
For advisors who work with me and the other compliance consultants on Commonwealth’s RIA Consulting team, one question often comes up: “What am I not thinking about?” It’s a reasonable question asked by advisors who legitimately want to do the right thing, both by their clients and by the regulators. Given the demands of advisors operating their own registered investment adviser (RIA), there’s rarely time left over to plan for changes in compliance expectations. So, I’ve put together some regulatory areas of focus that deserve attention in the current landscape.
Off-Channel Communications
Off-channel communications has been a particular area of focus for regulators. Since 2022, no fewer than 40 firms, both broker/dealers and investment advisers, have been fined a combined total of more than $1 billion for not properly capturing, retaining, and monitoring business-related communications.
In a September 2022 press release, for example, the SEC said that “18 firms’ employees routinely communicated about business matters using text messaging applications on their personal devices. The firms did not maintain or preserve the substantial majority of these off-channel communications. By failing to maintain and preserve required records relating to their businesses, the firms’ actions likely deprived the Commission of these off-channel communications in various Commission investigations.”
Consider taking practical steps to mitigate your firm’s risk of noncompliance in this area.
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Regularly remind staff about the issue. Let them know there’s a financial risk to your firm, considering previously levied fines on other firms. These reminders can take any form as long as they are documented (e.g., annual or regular compliance meetings and emails). Make it clear that, much like any firm policy violation, there are consequences for noncompliance, including termination.
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Inform staff about how they can communicate. Hosted email accounts are not the only permissible method for business-related communications. For example, clients and prospective clients may wish to communicate with your staff using social media messaging functions. Be sure your staff knows which platforms are being monitored and are approved for use and which are not. Compliance services providers like Global Relay offer a range of capture capabilities for social media messaging, text messaging, and more.
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Test your compliance program. Tailored testing can uncover instances where your staff may be using unapproved communication methods. For example, try using phrases in your communications monitoring lexicon like “text me,” “text you,” or “take it offline,” and see if you get any results. Corrective action may be required. As always, document your efforts as part of your annual compliance program testing so you can “show your work” to a regulator if asked to do so.
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Complex Products
Regulators have viewed “complex products” with suspicion for years. The SEC’s 2024 Examination Priorities cited the Commission’s continued focus on investment advice around products, strategies, and account types, particularly for:
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Complex products, such as derivatives and leveraged ETFs
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High-cost and illiquid products, such as variable annuities and non-traded REITs
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“Unconventional strategies,” including those that claim to address rising interest rates
If your firm uses these types of products in either customized or model portfolios, consider taking measures to mitigate your risk during a regulatory examination:
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Conduct reasonable due diligence. Look carefully into both the product and the product sponsor, not just when you start using a product but also on an ongoing basis. Ascertain whether the product has a substantial asset base and an established long-term track record.
For the product sponsor’s background, look into any recent litigation and regulatory issues to understand its information security posture and financial position based on the most recent audited financial statements. As part of this process, you may need to make difficult decisions about how many products can be reasonably overseen on an ongoing basis.
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Look into other options. Determine whether there are comparable less complex products in the marketplace. If so, could you reasonably explain to a regulator why you included the more complex product in portfolios?
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Require training. Advisors who wish to use complex products in client portfolios should receive training specifically tailored to each type of complex product included on your firm’s platform. This training should be reviewed regularly to ensure that the content remains current as products evolve.
Bear in mind that this training could take many forms. For smaller firms, documented meetings with individual advisors who fully understand the product and its features, risks, and benefits may be sufficient. Larger firms may require online courses through a compliance education provider like RegEd before allowing advisors to solicit the sale of the product.
Whatever your policy, it should be laid out clearly in your compliance manual and monitored to ensure adherence. Further, consequences for noncompliance with the policy should be consistently enforced.
Advisory Fees
The SEC issued a warning three years ago that can be considered evergreen: “It is important for clients to receive timely and accurate information regarding fees and expenses when hiring an investment adviser because every dollar an investor pays in fees and expenses is a dollar not invested for the investor’s benefit,” said a 2021 SEC Risk Alert on investment advisers’ fee calculations.
On substantially every regulatory examination, examiners will look at client fees to ensure that they (1) are being calculated accurately, (2) are in line with the signed client agreement, and (3) are consistent with the firm’s disclosed fee schedules on Form ADV Part 2 and elsewhere.
To meet those expectations, consider taking the following measures for monitoring advisory fees:
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Create a solid, repeatable process for auditing client fees. This process can take many forms but generally should involve taking a representative sample of your firm’s client base and comparing fees charged to the agreed-upon rate or schedule memorialized in the client’s agreement. Document your findings and address any specific or systemic issues arising from the review.
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Review the fee rates or fee schedules used across your business. Are they consistent with the information disclosed in Item 5 of your Form ADV Part 2 brochure?
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Consider other fees and expenses clients may pay. For example, transaction fees, custodial fees, and internal product expenses should be reviewed regularly to ensure that they are reasonable. As with any such review, document it in your compliance files.
A Culture of Compliance
Cultures aren’t just for petri dishes anymore. In 2006, Lori Richards, the SEC’s then-head of the Office of Compliance Inspections and Examinations, said financial services firms need a strong “culture of compliance,” which means fostering an environment that encourages ethical behavior and decision-making throughout the organization. Richards added:
“This means instilling in every employee an obligation to do what’s right. This culture will underpin all that the firm does and must be part of the essential ethos of the firm, so that when employees make decisions, large and small, and regardless of who’s in the room when they make them, and whether or not lawyers or regulators or clients or anyone else is looking, they are guided by a culture that reinforces doing what’s right.”
Nearly a decade later, the need to establish a strong compliance culture persists. Here’s how:
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Be sure compliance starts at the top. The firm’s ownership and management must support the chief compliance officer (CCO). While important, dollars in the budget are not the only way. Senior leaders also need to model compliance best practices, communicate regularly with staff about the importance of adhering to firm policies, and be active participants in the creation and maintenance of the firm’s compliance program.
Senior leadership must share information with the CCO and compliance staff to ensure that, among other things, the firm’s conflicts of interest are identified, disclosed, monitored, and mitigated to the extent possible.
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Create a comprehensive training program. Earlier, I touched on the importance of training that is specific to complex products. Other elements of your training program should include an annual compliance meeting to discuss recent regulatory developments, risks to the firm, appropriate operational topics, and (as I’ll get into momentarily) an ethics component.
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Have an open-door policy. If a staff member identifies a potential compliance issue, they should feel empowered to bring that issue directly to senior management (the CCO or otherwise) and feel assured that doing so will not negatively affect them.
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Create an ethical culture. Ethics is not just an annual throwaway training module. Take steps to ensure that ethical behavior and decision-making provide the bedrock of your firm.
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Refrain from minimizing the work done by compliance staff. While inquiries from the compliance team may take time away from the important work that senior leadership performs on a daily basis, remember that those staff members are trying to keep you and your firm safe. Take the time to work with them to address any identified issues.
Lighting the Path Forward
Keeping your finger on the pulse of the regulators is incredibly challenging—compliance is constantly evolving, even in “normal” times. The unprecedented pace of rulemaking by the SEC in recent years makes these “interesting times” for operating an investment adviser firm. While new or updated rules like the marketing rule are critical to consider as part of a firm’s overall compliance strategy, they are not the only things firms should be thinking about.
Considering that the regulatory landscape for investment advisers rarely, if ever, becomes less challenging, seasoned compliance consultants can serve as a critical resource. They can keep you up-to-date on critical regulatory matters based on their experience and close attention to regulatory trends. Much like that Maine lighthouse, their observations and insights guide advisors through the darkness.
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