Now that the so-called fiscal cliff has been avoided, investment advisors may think they can relax until the next financial crisis draws near. Unfortunately, a compliance examination is always looming, which can lead to disastrous results if an advisor is unprepared. An examination may leave advisors hanging by their fingernails on the edge of the compliance cliff. Once advisors go over the cliff, they will have difficulty recovering from the fall.
When it comes to compliance, past performance almost always guarantees at least one specific result. If an exam uncovers weaknesses in an advisor's compliance program, examiners may schedule a return visit much sooner than would otherwise be the case. Compliance mistakes may cause securities regulators to view the firm as a higher risk to investors for years to come.
Not having books and records is a sure way to fall off a compliance cliff. Just as taxpayers need receipts to document their tax deductions, an advisor must have books and records to prove the firm has met its compliance obligations, whether an advisor is state- or SEC-registered. Most books and records must be maintained in an easily accessible place for at least five years.
A recent SEC deficiency letter criticized an investment advisor for a number of compliance mistakes. Many of this advisor's deficiencies and weaknesses related to books and records. It is easy for securities regulators to spot these deficiencies because the records are either there or not there. In many instances, this particular investment advisor appeared to have fulfilled certain compliance obligations but failed to keep the required records.
The SEC's deficiency letter criticized the advisor for failing to conduct an annual review of the firm's compliance policies and procedures. Although these reviews were conducted, the advisor failed to maintain documentation to prove they occurred. The SEC recommended that the firm establish procedures to formalize its annual compliance review. The firm was also told to memorialize its risk inventory, which identifies the conflicts and compliance factors that pose a threat to clients.
The risk of a disaster occurring is a significant one for every investment advisor. Unfortunately, the SEC found that the firm failed to perform an annual test of its disaster recovery plan.
