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IA Watch: Exam roundup: Hot Issues OCIE’s Pursuing with Your Peers



Compliance4 president and Chief Compliance Officer, Peter R. Guarino, was quoted in the September 17, 2018 edition of IA Watch, the premier compliance weekly briefing for compliance news, guidance and best practices.

Here is the full article:

If you manage a mutual fund, get ready. IA Watch has learned that OCIE has launched an initiative probing advisers of registered funds – and asking lots of questions. This is just one of the hot developments currently taking place on exams. Examiners are also scrutinizing performance advertising, fee calculations, best execution, disclosures, the size of compliance staff, and more. In two separate OCIE exam regions – spanning the entire country – examiners questioned whether one compliance professional was enough at larger advisers. The examiners “couldn’t believe that only one guy or one woman was administering” the compliance program, says Peter Guarino, president/CCO, Compliance4 in Falmouth, Maine. “It was raised in the exit interview as well,” he adds. Private equity fund advisers take note. Be sure your disclosures state that your owner may get better deal terms than investors. Augment your disclosures around capital call lines of credit and the use of the lines, counsels a CFO at a PE firm that survived a recent exam characterized as “brutal.” “The SEC is absolutely going to err on the side of over-disclosure” so disclose if you’re uncertain, says the CFO. “If the SEC pulls a thread, they will keep pulling the thread until they’re satisfied with the answer .... You need to be patient and cooperative.”

Share class déjà vu

A CCO at an adviser in the South ran into the mutual fund share class allocation issue that has snagged so many firms of late (IA Watch, April 12, 2018). The firm is updating its disclosures “to make sure we have all of our fees disclosed ... so this won’t happen to us again,” says the CCO. Another lesson this CCO passes on is to update your compliance P&Ps or risk a deficiency. Reported assets are getting checked as well. A CCO at a firm in the West encourages peers to be sure to report pension client consultant assets as non-discretionary assets on your Form ADV. “Every single exam is focusing on the calculation of advisory fees,” reports Michelle Jacko, managing partner of Jacko Law Group and CEO of Core Compliance & Legal Servicesin San Diego. Pay special attention to breakpoints, and how you define “household,” she recommends. Examiners questioned why some clients weren’t given fee reductions when they hit certain asset thresholds. In one case, an adviser was forced to rebate eight years worth of fees, Jacko says. She predicts this issue could become the SEC’s next mutual fund share class topic and spread nationally. If you’ve gone through a merger, seek to consolidate the two firms’ fee structures, if you can, suggests Lauri London, an attorney with Cohen & Buckmann in New York. “I had a process in place and they were very happy with that,” says a CCO at a firm in the South who impressed examiners with the firm’s procedures for billing and reconciliation. If you don’t actively manage a client’s money, keep good notes. A source in the Midwest tells us examiners cited an adviser for “reverse churning” (IA Watch, May 4, 2017). Investors had been placed in cash positions (sometimes at the client’s request) and left there for two months without any documentation supporting the continuation of that move.

Questions for mutual fund advisers

IA Watch has obtained an OCIE document request letter as part of the mutual fund initiative. It’s quite extensive. For instance, it asks for all advertisements including, but not limited to “pitchbooks, one-on-one presentations, pamphlets, brochures, websites, blogs and social media, voice or video broadcasts, fund fact sheets, performance summaries, newspaper or periodical ads, television or radio ads, and any other promotional” materials. The adviser is directed to convert any websites or blogs into PDFs, as well as to share all RFPs, RFIs and DDQs. Expect examiners to ask you to identify shareholders by their percentage of assets in retail, institutional and adviser categories. The letter also asks for clients to be identified by “investment strategy (e.g., global equity, high-yield, aggressive growth, long-short, or statistical arbitrage).” Examiners requested a list of any “employees, partners, officers” and directors who resigned during the exam period and “the reason for their departure.” They wanted details on all committees, their membership, how often they meet and whether minutes were kept. The adviser was asked to divulge any loans given to it by a client, as well as a listing of any “no-action” letters or exemptive orders the adviser relies upon. The bios and compensation arrangements of board members were sought, as well as a “list of any third-party websites or databases for which the Adviser has provided performance or marketing information.”

Aging clients

We’ve previously noted OCIE’s interest in how advisers handle elderly clients (IA Watch, Aug. 9, 2018). A CCO fresh from a new exam recommends that your compliance manual include P&Ps “designed to protect vulnerable senior clients.” These would be P&Ps for those nearing or at retirement; for the changing of beneficiaries; for engaging third parties who act under a power of attorney or trustee; and P&Ps governing what to do after the death of a client. More lessons from the exam include to train staff on how to identify red flags that may indicate a “senior client is being manipulated or abused by another person, as well as state/local reporting requirements for suspected neglect/crime/abuse.” Here are other tips passed along by your peers who have been through recent exams:

· Don’t leave it to your clearing firm to seek best execution. That responsibility resides with you. One CCO says the firm has started downloading hundreds of daily trades and sampling about 10% but even this has proven too challenging for the small compliance staff. “It’s just another new thing” compliance must do, adds the CCO. Another CCO tells IA Watch examiners expected a best execution effort for clients placed in wrap fee programs.

· Performance advertising continues to attract persistent attention. “The typical hypothetical disclosures that were given in the past, they’re just not good enough” anymore for models, says Jacko. Examiners “want all of the inherent limitations in the model actually specified,” she adds. A CCO warns you should revisit footnotes on older advertisements to ensure they’re not misleading.

· Scrutinize historical agreements with third-party money managers. One exam team went back more than five years, insisting the adviser re-paper the agreements because they objected to how the agreements worded fee arrangements.

· Consider showing actual brokered values rather than notional values. A CCO says examiners rejected the latter for leveraged assets.

· Be sure to do a final audit on any hedge fund you shut down.

· Have proof that you have a fidelity bond that complies with Investment Company Act rule 17g-1 (bonding of officers and employees of registered management investment companies).

For more information:

www.regcompliancewatch.com or call 800-455-5844

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