The rule requires SEC registered investment advisers (“RIAs”) to annually review “the adequacy of the policies and procedures established pursuant to this section and the effectiveness of their implementation.”[i]
Annual reviews have been cited by the Office of Compliance Inspections & Examinations (“OCIE”) as one of the top five (5) “most frequent compliance topics” during SEC exams.
Among their observations, OCIE has found that RIAs have failed to perform annual reviews outright; sufficiently reviewed and tested the adequacy of their policies and procedures (“P&Ps”); and, failed to implement changes or make updates to their P&Ps based on their annual reviews. [ii]
In fact, the SEC has brought enforcement actions against RIAs that failed to conduct annual reviews, including cease-and-desist orders, censure, and civil-monetary penalties, such as the case of Hudson Housing Capital, LLC, wherein the adviser failed to both implement and review their P&Ps as required by the Compliance Rule.[iii]
In consideration of the importance of the Compliance Rule’s requirement for conducting an annual review of your P&Ps, we believe RIAs should evaluate their Code of Ethics when conducting their annual reviews.
Code of Ethics
Rule 204A-1 of the Advisers Act requires RIAs to maintain a Code of Ethics (“COE”) reasonably designed to ensure that the business conduct of RIA personnel is commensurate with federal securities laws and to prevent misconduct on the part of the RIA; set requirements for employees to comply with federal securities laws; administer certain reporting requirements; require employees to receive and acknowledge a copy of the COE and any amendments; and, require employees to report violations of the COE to the RIA’s CCO as soon as possible.[iv]
Among other things, RIAs should review and test (1) when COE acknowledgements are received; (2) if any personal trading activity by access persons has violated the COE or disadvantaged any clients; (3) if the firm has received any material non-public information (“MNPI”), and if proper restrictions were placed on personal trading activity and client trades when the firm was in receipt of such information; (4) if gifts and business entertainment were documented and if any violations of de minimis amounts were made; and, (5) if any employees have made charitable or political contributions and verifying that those contributions have been made commensurate with the firm’s COE and state and federal securities laws.
Your firm’s COE and its administration are bound to be highly scrutinized by the SEC during an exam and since this is one of the most sensitive areas of a firm’s P&Ps, it is important to prioritize it during an annual review.
As you can see there are several of areas of your RIA’s compliance program that need to be taken into consideration when conducting an annual review.
While the task of testing all of the different areas of your firm, analyzing your results, and recording findings and recommendations based on your review might seem difficult, it is not insurmountable. Good planning, working with stakeholders and key employees, and employing a strategic approach to testing your P&Ps will allow you to approach your annual review with confidence.
Jacko Law Group can help your firm with your annual reviews, including providing guidance on how to conduct an annual review, assisting with testing different areas of your compliance program, or conducting the annual review in its entirety on behalf of your firm.
Our team of attorneys will use our extensive experience to assist you with your annual review in order to ensure the successful fulfillment of your annual review obligation under the Compliance Rule.
Be on the lookout for our next topic in the series, custody.
[i] See 17 CFR § 275.206(4)-7 – Compliance procedures and practices
[ii] Office of Compliance Inspections and Examinations. “Risk Alert: The Five Most Frequent Compliance Topics Identified in OCIE Examinations of Investment Advisers.” SEC.Gov, U.S. Securities and Exchange Commission, 7 Feb. 2017, www.sec.gov/ocie/Article/risk-alert-5-most-frequent-ia-compliance-topics.pdf.
[iii] See “In the Matter of HUDSON HOUSING CAPITAL LLC, Respondent.”
[iv]See 17 CFR § 275.204A-1 – Investment adviser codes of ethics.