The SEC is examining your advisor. Cause for concern?

My entire body of work has been dedicated to helping independent investment advisors launch and build successful investment advisory firms while ensuring they meet their registration obligations, adhere to their fiduciary duty and maintain proper regulatory compliance at all times.

Lately, however, I've been thinking a great deal about all the confusion that continues to plague our entrepreneurial yet highly regulated industry. If professional advisors are challenged in keeping up with complex and evolving regulatory requirements in their own business, certainly their clients must feel completely in the dark.

Businessman magnifying glass
Ferlistockphoto | iStock / 360 | Getty Images

It's important to shine a light on the inner workings of an advisor's business—providing insights that may help investors better understand exactly what happens inside a firm they trust to manage their money and make decisions about their financial future. I thought a good place to start would be to examine the regulatory examination process itself.

Registered investment advisors tend to loathe the thought of being examined by securities regulators. It's time-consuming and creates an amazing amount of anxiety, even for those who have done nothing wrong. It's akin to heading in for a full medical exam after not seeing a doctor for years. At the same time, investment advisors share a sense of gratitude for the examination process, that there are "cops on the beat."

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The Securities and Exchange Commission is the governing regulatory agency for registered investment advisors that manage more than $100 million in assets, while each state's securities regulators generally oversee other investment advisors. Let's not confuse them with the Financial Industry Regulatory Authority, which is the self-policing organization that oversees brokerage firms.

I can imagine that if you hear of regulators turning up at your investment advisor's office, your thoughts might immediately turn to Bernie Madoff as panic takes hold. Fear not!

It is highly unlikely that your advisor has done anything at all to trigger the examination. Every registered investment advisor is subject to regular examinations. While the industry, regulators and lawmakers would like to increase the frequency of examinations, fewer than 1 in 10 firms will undergo a routine regulatory audit in any given year. In 2014, that meant that 1,164 investment advisors were examined by the SEC and only a small number of those—firms referred to enforcement—had significant problems.

What are regulators looking for?

As part of its consumer protection mission, the SEC has implemented an examination program that all SEC-registered investment advisors undergo on a periodic and somewhat random basis.

These examinations are routine but comprehensive inspections to ensure that the firm is furnishing clients with proper disclosures and notices, maintaining adequate policies and procedures, a system of controls and the books, records and information it is obligated to keep.

Typically these examinations last anywhere from a few days to a few weeks, depending on the complexity of the firm, the scope of the examination and the firm's responsiveness to the SEC.

During an examination, regulators will look at the entire operation of the firm. They'll request and review a lot of documents, including communications with the public and the type and extent of client information gathered by the advisor in order to make their investment recommendations.

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They'll pore over the firm's policies and procedures relating to trading and service, business continuity and data security plans. And they'll look at client agreements, marketing materials and disclosures.

Essentially, they want to see that all these materials adequately and accurately reflect the operations of the firm; that the advisor is meeting his or her fiduciary duty by ensuring that the activities being undertaken in client portfolios are, at all times, in the client's best interests; and that the firm is supervising the activities of its staff and taking corrective actions when and if any deficiencies are found.

From time to time, regulators may also conduct "sweep" examinations, where they focus on a particular area of interest or concern and conduct quick examinations at a number of advisory firms limited to that specific topic.


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For example, in the wake of Hurricane Sandy in October 2012, the SEC initiated business-continuity sweep examinations in an effort to better assess the general state of disaster preparedness and contingency planning among advisory firms.

Last year the SEC ran with a campaign of sweep examinations surrounding issues related to cybersecurity. Following the sweep, they released a report on their findings.

Very few examinations are conducted "for cause" or because the SEC believes the advisor is involved in any wrongdoing or impropriety.

Following the examination

In most instances (about 80 percent of the time), the SEC will follow up its examination by sending a "deficiency letter," highlighting those areas where the advisor needs to improve their regulatory compliance program and will provide the advisor with sufficient time to remediate those deficiencies.

As with regulatory examinations, however, it's important to realize that a deficiency letter is by no means an indication that your advisor is a bad guy. It merely means that there are some potential operational flaws that need to be fixed or there are areas for improvement.

Typically, these deficiencies are of a relatively minor nature: things such as failing to annually distribute the firm's privacy-policy notice, having missing client contracts in their records, failing to maintain a record of advertising or having an inadequate business-continuity plan or supervisory procedures.

"Although time-consuming, resource-intensive and somewhat disruptive, SEC examinations are just part of doing business as a registered investment advisor."

Advisors are afforded time to remedy these deficiencies and are instructed to respond in writing as to the corrective actions taken. A small number of examinations (about 12 percent) result in a referral to the SEC's enforcement division where, in addition to mandated corrective action, fines and other sanctions could be imposed. Any enforcement action, including settlements, must typically be disclosed on the firm's regulatory filings.

Although time-consuming, resource-intensive and somewhat disruptive, SEC examinations are just part of doing business as a registered investment advisor and by no means indicative of anything nefarious or untoward occurring at your advisor's firm.

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In fact, clients should really take comfort in knowing their investment advisor is being examined. So relax, sit back and enjoy the fact that your tax dollars are at work protecting your financial well-being.

—By Brian Hamburger, J.D. Hamburger is the founder and CEO of regulatory compliance consulting firm MarketCounsel.