These FAQs are part of a series of frequently asked questions that address four primary areas of interest to investment advisers:
- Compliance Program Components;
- Daily Operations;
- Client Protection; and
- Registration and Disclosure
Q1: Are SEC-registered investment advisers required to conduct an annual review?
A1: Rule 206(4)-7 under the Advisers Act (commonly known as the Compliance Rule) requires each SEC-registered investment adviser to review its policies and procedures annually.
Q2: Are state-registered investment advisers required to conduct an annual review?
A2: Some states have incorporated the Compliance Rule into their own regulations and therefore, also require advisers registered with their state regulatory authority to conduct an annual review.
Q3: What are the goals of the annual review?
A3: The primary goals of the annual review are to determine whether the adviser’s compliance policies and procedures are adequate and how effectively they have been implemented.
Q4: What is meant by the adequacy of the policies and procedures?
A4: An adviser’s compliance policies and procedures should (i) address all applicable areas of the advisory firm’s business (e.g., portfolio management, trading, disclosures, custody, books and records, privacy, valuation, advertising and marketing, etc.); (ii) cite the applicable rule; and (iii) require the advisory firm to do what the rules requires.
Q5: How can an investment adviser determine if their compliance policies and procedures are adequate?
A5: It is a two-step process. In the first step, the adviser can review the firm’s inventory of the compliance obligations under state and federal laws, SEC rules, contracts with clients, offering documents and disclosures made to clients. The second step is for the adviser to compare this inventory of obligations against the firm’s existing procedures.
Q6: What is meant by the effectiveness of the policies and procedures?
A6: Are the policies and procedures reasonably designed to detect violations and promptly correct any violations that have occurred and is there sufficient supervision; employee training; compliance testing; and problem detection and correction.
Q7: How does an adviser determine the effectiveness of a procedures?
A7: For each procedure the adviser should evaluate whether the procedure:
- Makes violations less likely;
- Results in prompt identification of violations;
- Collects in a timely fashion the information necessary to allow the investment adviser to correct problems as they are identified;
- Is written in plain English articulating the goal of compliance and how it is supervised; and
- Is adequately supervised by responsible personnel of the advisory firm.
Q8: What are some key points of analysis?
A8: Advisers should determine whether there have been:
- Compliance issues because there was not a particular procedure in place;
- Situations in which the required procedures have not been clear; and/or
- Compliance issues even when there were clear procedures, but they were not known by the personnel involved.
Q9: Should an adviser include some sort of compliance testing into the annual review process?
A9: Advisers should be conducting compliance testing on a regular basis throughout the year. Advisers should use the results of their ongoing testing program as the basis for analyzing the effectiveness of their compliance policies and procedures.
Q10: Is an investment adviser required to document the annual review?
A10: The Compliance Rule does not require an adviser to document the results of the annual review. However, the SEC expects to see some documentation of the review as proof that the review actually took place. It is good business practice to prepare a report to document the work that was performed, the findings of the annual review and any recommendations for improvements. Note that the SEC is highly skeptical when they see a report that does not find any compliance issues.
Q11: What should an advisory firm do following the annual review?
A11: If the advisory firm identifies gaps with respect to policies or procedures, gaps with respect to how the firm’s personnel are carrying out the policies and procedures, or detects a compliance deficiency that resulted in client harm, it should establish new policies and procedures.
Q12: Is an investment adviser required to conduct interim reviews?
A12: An investment adviser must conduct interim reviews in response to significant compliance events, changes in the advisory firm’s business arrangements or regulatory developments.
Q13: How will SEC examiners approach their review of the annual review?
A13: While the unique facts and circumstances of a firm will impact the work SEC examiners do and the information they will request, SEC examiners will typically ask questions in at least nine broad areas as they scrutinize a firm’s annual review:
- Who conducted the annual review?
- What was reviewed?
- When was the annul review conducted?
- How was the annual review conducted?
- What were the findings from the annual review?
- What recommendations were made?
- What is the current status of implementing those recommendations?
- What documentation was created/retained to reflect the work done?
- What was the involvement of senior management in the annual review?