State securities cops find more compliance violations

In their biennial tracking of the compliance violations of small investment advisers, state regulators have found a slight uptick in deficiencies per adviser, with about 45% of advisers found to have at least one books-and-records violation.

The examinations of 825 investment advisers from Jan. 1 through June 30 turned up 3,543 problems, or an average of 4.3 deficiencies per adviser, according to the North American Securities Administrators Association Inc., the organizing body of state regulators. In 2009, investigators uncovered 1,887 deficiencies from 458 investment advisers, or 4.1 problems per adviser.

Most of the violations are paperwork problems that advisers resolve within weeks of being notified, regulators said. If problems aren’t remedied, or if firms continue to show the same deficiencies, they can be fined or have their registrations revoked by the states.

The most common deficiencies in the latest period involved registration, with 60% of the examined advisers incurring at least one such failing, state regulators said. They found at least 167 problems involving how firms kept track of suitability information about clients.

“That is so important for an investment adviser that is a fiduciary, because that documentation serves as the basis for the adviser’s recommendation to the customer,” said Mike Huggs, director of the Mississippi Securities Division and chairman of NASAA’s Investment Adviser Operations Project Group, which prepared the report. “There’s no way you can maintain that information in your head for each client, as some have tried to say.”

NASAA last week issued compliance guidance that it hopes will help the 3,200 midsize advisory firms that soon will fall under the jurisdiction of state securities officers.

“This year is really important because we want midsize advisers to have some “best practices’ before they come over,” said Linda Cena, Michigan’s securities director and chairwoman of NASAA’s investment adviser section.

‘SWITCH’ LOOMING

Next June, the Securities and Exchange Commission is scheduled to hand over to state securities regulators responsibility for overseeing investment advisers who manage assets under $100 million. The Dodd-Frank financial reform legislation raised the asset ceiling for advisers regulated by the states from the current $25 million.

In their review, state regulators found at least one advertising violation at 22% of the firms they examined, an increase from about 15% of firms in 2009. Firms with multiple advisers were even more likely to have advertising issues, according to the data.

Many of the advertising violations involved the use of misleading designations, including the use of “RIA” after a person’s name in correspondence or on business cards. The term “registered investment adviser” signifies registration of a firm, not an individual, said regulators, who noted that using the term after an adviser’s name implies that the person has attained some sort of industry qualification, which can be misleading to the public.

“Older people get impressed by initials,” Ms. Cena said. “It’s important that if we think any initials suggest the person has received specialized training, that it be true.”

Some compliance experts disagree.

“I think identifying yourself as a licensed representative is something that should be supported,” said Philip Feigin, partner at law firm Rothgerber Johnson & Lyons LLP and former Colorado securities commissioner.

Investment adviser representatives work at RIA firms, and they have to take and pass either the Series 65 or Series 66 exams to get their license or to be registered, so in fact that is an “earned” qualification, he said.

Advisers can identify themselves as a licensed investment adviser representative, or LIAR, “but I can understand why that one’s not very palatable,” he said.

Financial adviser Robert Frey of Lakeside Advisors Inc. said that he recognizes that states have been trying to protect the public from being misled by the “alphabet soup” of designations, but he criticized the Financial Industry Regulatory Authority Inc. for allowing registered representatives to operate under a wide array of titles.

“Finra allows so many titles that are potentially misleading,” such as financial planner, said Mr. Frey, who received a no-action letter from the SEC 27 years ago.

It said that in order to use the term RIA, he would have to write, “Registered Investment Adviser — Securities and Exchange Commission.”

Mr. Frey once had letterhead with that title, but now just lists the CFP designation after his name.

The increase in compliance problems over the two-year period wasn’t significant, and firms appreciate the compliance guidance that regulators offer, said David Tittsworth, executive director of the Investment Adviser Association.

“It’s helpful when regulators share information with advisory firms about the types of deficiencies they are finding and what firms can do to promote more-robust compliance programs,” he said.

The NASAA exams also found that 37% of advisers have engaged in unethical business practices, including contract-related issues such as altered documentation, signed blank documents and missing or nonexistent contracts. That is down from about 38% in 2009.

Less than 5% of the 504 deficiencies found in this category involved excessive fees, nondisclosed conflicts and problems with listing qualifications.

“Our goal in identifying deficiencies and recommending best practices is to help investment advisers strengthen their internal compliance programs and improve the services they provide to clients,” said Jack Herstein, president of NASAA and assistant director of the Nebraska Banking and Finance Department’s securities bureau.

Of the 71 hedge fund advisers examined, the most common deficiencies concerned the valuation of holdings, cross-trading, preferential treatment, registration exemption issues, nonaccredited investors and undisclosed conflicts of interest, he said.

Email Liz Skinner at [email protected]

Related Topics: North American Securities Administrators Association Inc (NASAA)