Every advisor with assets under management (AUM) over $25 million must register with the Securities and Exchange Commission (SEC) and file a Form ADV. This action makes advisors potential targets for an SEC audit, which can be a stressful and costly experience. Those investment advisors with less than $25 million in AUM are required to register with state securities authorities instead. (For more, see: Introduction - Registering as an Investment Advisor.)
The truth is that as an investment advisor, there is a good chance you will be audited at some point. However, this is routine and should be seen as a checkup, not an accusation. As long as you are compliant with the SEC's rules and expectations, you will have nothing to worry about. To help ensure that you don’t run into any trouble, consider hiring a compliance officer. (For more, see: Compliance: The Price Companies Pay.)
The list of things that can catch the SEC’s attention in a negative manner is extensive. But as long as your Form ADV is updated regularly and accurately, there should be no reason for panic. Annual updates to your Form ADV are required, but that’s still a long time frame to let it go without a review. In order to decrease the odds of the SEC knocking on your door for a compliance exam, advisors should strongly consider updating their Form ADV on a more regular basis. (For more, see: Regulation of Investment Advisors - Federal (SEC) vs. State Registration.)
Here are some issues that may get the attention of the SEC and trigger an audit. (For more, see: The Pitfalls of Financial Regulation.)
- Inconsistencies in Form ADV.
- Not amending Form ADV’s regulatory profile in a timely manner. Solution: Conduct a comprehensive review of Form ADV. According to the National Compliance Service, this should include Part 1A, Part 2A, Part 1B (state-regulated firms), Part 2B and Appendix (wrap program sponsors).
- Not disclosing conflicts of interest.
- Exaggerating assets under management.
- Rounding down assets under management (for regulatory convenience purposes).
- Not knowing how to calculate assets under management.
- Not providing exact number of clients (if under 100).
- Not providing exact number of clients that are not United States citizens.
- Not fixing errors from prior exam.
- Backdating documents to make it looks as though compliance is retroactive. This happens often and is one of the biggest reasons for SEC compliance exams.
- A compliance officer who doesn’t know security laws.
An important note on client complaints: Address all client complaints immediately. Not doing so will once again lead to more headaches down the road. In order to address complaints immediately, report them to your compliance officer. At that point an investigation should ensue, which should formulate a solution and help pinpoint any errors so they can be avoided in the future. Always keep the client up to date on the progress of the investigation, including any decisions and proposed courses of action. From the instant the complaint is submitted to the end of the investigation, it is imperative that you keep all communications between yourself (or your firm) and the client. You will also be required to maintain a separate file for the complaint. This complaint should include who, when, the advisor names associated with the client, a description of the complaint, and a written response explaining how the complaint was handled. (For more, see: Tips for Resolving Disputes with Your Financial Advisor.)
The Bottom Line
The information above should be seen as a basic guide to reducing the odds of attracting negative attention from the SEC and triggering an audit. The two keys to success for any advisor are prevention and appointing a qualified compliance officer. (For more, see: The SEC: A Brief History of Regulation.)