On July 23, 2019, the Office of Compliance Inspections and Examinations (OCIE) published a Risk Alert on Supervision and Disclosure of Conflicts primarily related to hiring and employing supervised persons with disciplinary histories.
Supervised persons include principals and officers of the adviser, and other individuals performing services on behalf of the adviser (other than clerical), regardless of whether these individuals are independent contractors or employees of the adviser.
Key takeaways from the Risk Alert include:
All advisers and broker-dealers:
- Firms should verify information provided via self-attestation from employees, such as running background checks, verifying education, contacting references, obtaining prior U5s and searching social media activity.
- Importantly, the SEC has access to reportable events via Form ADV, Form BD, Forms U4 and U5. Firms should review their filings to ensure that their background check/diligence process includes such activities as:
- Recent bankruptcies
- Felony convictions
- Misdemeanor convictions involving fraud or financial activity
- Regulatory sanctions
- The SEC continues to focus on fees and expenses. In this context, firms should:
- Ensure that all fees and expenses charged to clients by supervised persons are disclosed and that these services are actually performed.
- Include robust testing on the fees/expenses and services in their compliance programs.
- The risk alert underscores the conflicts of interest that exist when compensation arrangements are undisclosed. In this instance, the SEC noted the necessity to adequately disclose transactions between advisers and supervised persons such as forgivable loans.
Advisers with Separately Managed Accounts or Wrap Fee Programs should implement policies and procedures for monitoring client account types, including maintaining evidence of review and documenting the factors considered in such a review where appropriate.
Advisers and broker-dealers who hire supervised persons with disciplinary histories:
- Should provide full and adequate disclosures regarding disciplinary events and avoid incomplete, confusing, or misleading information, such as failing to state whether the supervised person was found to be at fault.
- Are required file prompt amendments to all items in their filings relating to reportable events.
- Should consider any additional policies and procedures as relevant. These may include:
- Enhanced review and escalation of client complaints;
- Additional procedures for supervising their activities if they work remotely or in a branch office;
- Processes to independently identify the accuracy of supervised persons’ attestations.
