In the summer of 2009, the North American Securities Administrator Association issued a report based upon examinations of 448 state level investment advisers. The examinations found 1887 deficiencies in 13 categories that included books and records, financial records, privacy, advertising, and supervisory/compliance to name a few. The report also recommended 11 best practices for investment advisers, which I will focus on in this article. The first sentence of each bullet point is from the report and my comments follow.
1) Review and revise the Form ADV and disclosure brochure annually to reflect current and accurate information. There are a few states that do not require an annual update to be filed. However, now that your ADV Part 1 is available for the public to see through the SEC’s website, it is very wise to update this every year.
2) Review and update contracts. This is another area where an annual review of the Firm’s client contracts might reveal the need to update them. This is especially true for long standing client relationships. Perhaps over the years a client has been moved from one portfolio to a new portfolio or her fee has been reduced. When these situations occur, a best practice would be to have the client sign a new contract that has the new fee or portfolio.
3) Prepare and maintain all required records including financial records. Back-up electronic data and protect records. For those of you in states that have a minimum net capital requirement, it is extremely important to keep your financial records up to date. An auditor may select random dates to test whether Firm has maintained compliance with this requirement. The only way to insure your Firm is compliant is by keeping these records up to date.
4) Prepare and maintain client profiles. I am always amazed by Advisers that do not prepare and maintain client profiles. In order to fulfill its fiduciary duty an adviser should at least keep track of and update each client’s address, phone number, total net worth, liquid net worth, annual income, income needs, investment objectives, risk tolerance, age, tax bracket, social security number, and job situation. By keeping and updating this information, it helps ensure a client is in the right investment mix and his needs are being met.
5) Prepare a written compliance and supervisory procedures manual relevant to the type of business. Obviously the SEC requires federal investment advisers to have a compliance manual, but not every state requires one. Even without the government mandate creating written supervisory procedure manual can help simplify a state level investment adviser’s operations. Additionally, state auditors are starting to ask for compliance manuals as part of their routine examinations. Most state level RIAs have reasonably basic business models that can easily be translated into a manual.
7) Keep accurate financial records. File timely with the jurisdiction. Maintain surety bond if required. It is extremely important to keep accurate financial records on your firm. Most auditors will spend a large chunk of the audit on the financial records.
8) Calculate and document fees correctly in accordance with contracts and ADV. I have audited multiple Firms over the years and found more often than not that client fees are not consistent. A Firm should be consistent in the fees it charges. This prevents a Firm from favoring one client over another and it precludes an administrative nightmare when doing billing. Every quarter you should grab 10 random accounts and check the fees withdrawn by the custodian to see if: 1) they are calculated correctly; 2) they match the client investment management agreement; and 3) the client investment management agreement and the ADV.
9) Review and revise all advertisements, including websites and performance advertising, for accuracy. Over the past 10 years creating acceptable advertising has been like trying to hit a moving target. A marketing piece created less than a year ago may no longer be compliant. It is important to continually monitor what is acceptable advertising.
10) Implement appropriate custody safeguards, if applicable. While most Advisers do not have custody, it is important to make sure a Firm does not slip into a situation where they have custody and do not know it. The Firm should periodically review its policies and procedures that prevent it from having custody. After the review, the Firm should test the policies and procedures to ensure they work.
11) Review solicitor agreements, disclosure, and delivery procedures. These reviews should be done at least annually. It is especially important to review a Firm’s disclosure documents because new conflicts of interest may arise during the course of a year. The new conflicts may result from adding a new business line or hiring a new investment adviser representative. It is a good idea to periodically have an outside party review the Firm’s disclosures because they may be able to more easily see a conflict.