As a registered investment advisor, whether new or well-established, you probably hear the word “compliance” on a daily basis. But what’s the best way to maintain compliance, why should you even bother with it (okay, yes you probably already know that one), and where did it originate? These are all great questions, and lucky for you, we’ve got all the answers ready for you in SmartRIA’s Complete Guide to RIA Compliance.
Just sit back, grab a snack if you want, and get ready to absorb the basics of RIA compliance — you’ll find it isn’t as bad as you thought when we’re done!
What is RIA compliance?
Let’s start from the beginning — what exactly is RIA compliance? In the simplest terms, the Investment Advisers Act of 1940 (the “Advisers Act”) requires RIAs to establish policies and procedures that will help prevent violations of the law. The Securities and Exchange Commission (the “SEC”) establishes rules and provides interpretations and guidance that help RIAs understand the responsibilities set forth by the Advisers Act.
While the actual Advisers Act has changed very little from its initial inception, the SEC’s rules continue to evolve and change to keep up with changes technology has brought to business and trading practices. Each of the SEC’s policies and procedures is designed to protect the investor while guiding the adviser in understanding the responsibilities of a fiduciary. Above all, the Advisers Act, in conjunction with the SEC’s rules are meant to prevent any law, rule, or regulation violation — whether intentional or accidental.
RIA compliance is all about exhibiting your company’s commitment to upholding the highest commercial standards and putting the interests of the investor first. It’s a badge for your commitment to doing what’s best for your clients without letting your own self-interests getting in the way — and that’s why it’s paramount to success in our industry.
Investment Advisers Act of 1940
As mentioned above, this is the U.S. federal law that outlines, defines, and communicates the responsibilities of an investment adviser. Essentially, this act empowers the SEC and grants them the legal precedence to conduct its mission to monitor financial representatives and advisers; protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.
The Advisers Act specifies exactly what qualifies as investment advice and sets forth who is required to register with state and federal regulators before being allowed to offer said advice.
SEC Examination Priorities
Each year, the SEC’s Office of Compliance Inspections and Examinations (OCIE) releases a list of particular practices, products or services that pose a higher risk to investors or markets. This list is provided in an effort to promote transparency and educate the public. For advisers, this list serves as an insight into what key areas SEC examiners will be looking into during their examinations of RIAs.
The SEC’s priorities are announced publicly that the beginning of each year in the form of a press release and are preserved fully online as a pdf in order to further their goal of transparency. All annual priorities are easily available and accessible for RIAs and are expected to be met. Although the priorities are generally specifically directed toward SEC-registered firms, state regulators often focus on similar issues during their exams. This means advisers should pay particular attention to the SEC’s Examination Priorities.
Form ADV is essential to the function of an RIA. It’s as vital to RIA compliance as Form 1040 is to an individual’s income taxes. So, chances are you already know all about it. But, just in case (there’s a surprising amount of confusion about Form ADV), let’s go over it.
First, the form is annual and must be filled out and resubmitted each year for your firm to remain compliant. Besides the annual update you submit, you will be required to update Form ADV when your contact information changes, your fee schedule changes or there has been a change in ownership, to name a few. Other changes, such as a change in assets under management (“AUM”) due to market fluctuations, do not require that you file an other-than-annual amendment.
Second, Form ADV has multiple parts to it. The first part is for information about your firm, your AUM, etc. Much like you do for your personal income taxes, your firm will answer the questions on the form and fill in all requested information. Keep in mind that the SEC and state regulators will use the information you submit in order to better assess and enforce regulations. They also use it to score how much of a risk your business model may pose to an investor using an algorithm. This, in turn, is used to determine how often your firm will be examined by the regulating body.
The second part of Form ADV is a brochure that you provide to your prospective client and all of your clients every year. The brochure of the form is information about your clients and potential clients. It requires RIAs to create detailed, easy-to-understand documents outlining their services, AUM, fee schedule, conflicts of interest, etc.
Compliance Officers (CCOs)
The SEC requires firms to designate a chief compliance officer (CCO) to oversee all RIA compliance policies, procedures, and processes. Many RIAs start with the owner taking on the role of Chief Compliance Officer, which provides cost savings in the short term but could cost the RIA more in the long term, in form of deficiencies and fines from a regulator.
Fortunately, most firms realize that having a CCO allows the owner to focus on revenue-generating activities and leaving the overall management of the RIA’s compliance program to the expert. An already daunting process becomes much simpler once an expert is in place to maintain efficiency while meeting each regulatory requirement.
Additionally, having someone dedicated to maintaining compliance will allow your firm to maintain a culture of compliance and will help prevent tasks, documents, and processes from falling through the cracks and creating a deficiency.
Funds & Assets
Typically, when calculating a firm or adviser’s AUM, several different factors will be taken into consideration- bank deposits, mutual funds, cash, funds under discretionary management, and more. Additionally, a firm’s management performance and management experience will also be taken into account, alongside the AUM, to evaluate them.
Of course, you probably already know all of that already, but what you may not know is that the AUM is very important in RIA compliance. Any discrepancies, such as a firm being lax in updating their AUM, could trigger an audit. That’s why any mention of AUM in marketing or sales materials should be constantly reassessed and updated to reflect the most accurate and up-to-date value. This doesn’t mean that you have to update your marketing materials every day, but when the AUM becomes significantly outdated.
Conflicts of Interest & Code of Ethics
As you probably already know, as a financial adviser you have a duty to do what is the client’s best interests and represent your client with the utmost competence and loyalty. But it’s still a business, right? There is not an expectation that you will be going into your relationship with your client without any self-serving purpose. I mean you aren’t running a non-profit! The goal is to disclose conflicts of interest and then how you are ensuring those conflicts don’t get in the way of serving your clients.
It’s important to remember that the SEC highly frowns on an adviser shirking this fiduciary duty. But keep in mind that it is not necessarily against SEC regulations to have a conflict of interest, it’s a violation to not disclose it when one occurs. Your clients have the right to be aware of any conflict so that they can make the most informed decision about their assets.
It’s also vital to keep in mind that this duty doesn’t only apply to you — it’s for everyone at your firm. You, or your CCO, should regularly check in with everyone on your team — and in your firm — to ensure a conflict of interest doesn’t happen and is immediately disclosed if it does.
This is also why having a code of ethics in place for your firm is both prudent and necessary. Training your advisers on how their behavior and interactions are monitored and the consequences of any violations instills a culture that minimizes potential compliance issues and regulatory disciplinary actions. By implementing a code of ethics process, such as SmartRIA’s Personal Trade Monitoring system, you will be able to more easily spot rogue or improper trading and take simple steps to address it, protecting both your firm and your clients.
Want to learn more about maintaining your firm’s RIA compliance? We can help! The comprehensive SmartRIA platform is a powerful RIA compliance management tool that is already assisting more than 1,400 firms in simplifying and maintaining their compliance. Schedule a demo now to learn how we can help your firm grow while meeting all the rules and regulations the SEC is ready to throw at you.