The US Securities and Exchange Commission (SEC) is on the prowl for registered investment advisors (RIAs) who are hiring people with a history of disciplinary problems, including those who have been barred from a broker-dealer.
A risk alert issued earlier in September by the SEC’s Office of Compliance Inspections and Examinations (OCIE) states that such people may be at risk for more disciplinary problems that, in turn, pose risks to clients.
A notation in the alert cites a study, published earlier this year by the National Bureau of Economic Research, that found that financial advisors with disciplinary histories are five times more likely to be repeat offenders than the “average” advisor. While about half of the offenders subsequently lost their jobs, the study also found that 44 percent of them found other jobs in the financial services industry within a year.
The OCIE is beginning examinations of the supervision and compliance programs of RIA firms that employ such people, especially those practices related to supervision of “higher-risk” individuals. Employees include principals and officers, and anyone else working on behalf of the advisor – except clerical employees. The alert also applies to independent contractors.
So, how will the OCIE determine which advisors to examine? Sources will include SEC databases and filings, including disciplinary information reported on advisors’ Form ADV, private civil actions, and information from SEC enforcement actions that barred or suspended people from certain financial industries.
Examiners consider the following as the four key risk areas.
1. Compliance. Advisors’ oversight practices, complaint handling, reporting obligations, and hiring processes will be examined. “Tone at the top” will be a key factor as it is “critical to setting the ethical environment of the organization and preventing misconduct,” the alert states.
2. Disclosures. Citing case law and Part 2 of Form ADV, the OCIE indicates that it will examine advisors’ disclosure of material facts, which is required of them as fiduciaries. Examiners are expected to review how advisors disclose regulatory, disciplinary, or other actions as a way of determining the adequacy of their disclosures.
3. Conflicts of interest. Advisors have a fiduciary obligation to disclose material conflicts of interest. Examiners will pay close attention to conflicts connected to financial arrangements made by supervised people with disciplinary histories.
4. Marketing. Advisors’ ads, website posts, and public statements will be examined to identify conflicts or risks associated with supervised people who have disciplinary histories.
Terry Sheridan is an award-winning journalist who has covered real estate, mortgage finance, health care, insurance, personal finance, and accounting and taxation issues for newspapers, magazines, and websites. A Chicago native and former South Florida resident, she now lives in New England.