State Investment Adviser Exams Reveal Significant Deficiencies

The results of coordinated state examinations of investment advisers in the first half of 2011 by the North American Securities Administrators Association (NASAA) reveal significant deficiencies in a broad range of areas.  As investment advisers gear up nationally to register either with their state or the SEC in 2012, these results are important road maps of common pitfalls which investment advisers will need to address in their compliance programs going forward.  Additionally, investors performing due diligence on advisers certainly should take note of these findings.

The NASAA report looked at 825 state-level adviser exams. While the NASAA has published a summary of findings (referenced below), we would like to highlight several significant areas:

1. Over half the exams had a deficiency in the “registration” category, meaning that their registration paperwork was not done correctly or was inconsistent.   The registration process itself is complicated, and is getting more complicated as regulators add questions and requirements.  A large number of deficiencies in this category is an indication that more care needs to be taken in completing the registration documents.

2. About a third of the advisers had deficiencies in the “supervisory” category, meaning that they had inadequate business continuity procedures or even no compliance procedures at all.  While this can be a somewhat tricky area on the state level because some states may not technically require written procedures, the “best practice” clearly is to have written procedures.

3. About 20% of the advisers had deficiencies in the “financials” category, with violations such as inaccurate financials, non-GAAP financials, commingled accounts or poor financial condition.  This is clearly an area for investors to watch out for.

4. Almost 20% of the advisers had deficiencies in the  ”fees” category, with violations such as inaccurate calculation of fees, billing errors, and inconsistencies between contracts/disclosure documents and amounts billed.  While some of these deficiencies may be inadvertent or the result of failure to keep up with paperwork, advisers must be vigilant to maintain accurate billing.

The NASAA noted that “other areas in which investment advisers faced compliance challenges included privacy, fees, custody, investment activities, and solicitors. Among hedge fund advisers, the top deficiencies included valuation of holdings, cross trading, preferential treatment, registration-exemption issues, non-accredited investors issues and non-disclosed conflicts of interest…”

 The link to the NASAA report and related documents can be found at  http://www.nasaa.org/6156/coordinated-state-exams-identify-top-investment-adviser-deficiencies/