RIAs Warned of Heightened SEC Scrutiny

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WASHINGTON -- With regulators vowing to crack down on bad actors in the advisory sector, RIAs need to get serious about compliance, a regulatory expert cautions -- adding that it falls to the senior management of the firm to set the tone.

Thomas Giachetti, the chair of the securities practice at the law firm Stark & Stark, warns RIAs to get their house in order in anticipation of a visit from the SEC. It's not a question of whether an examiner will visit a practice, but rather when, he said in a presentation at Fidelity's Inside Track conference this week.

"It is the most aggressive regulatory environment I have ever seen," Giachetti said. "This whole game has changed markedly. And if you value your firm, you will make sure you're ready for an exam, because they are getting into the weeds like never before."

Giachetti, who has a penchant for salty talk and statements that press at the edges of hyperbole -- "This administration hates your business," he said at one point -- says he is dead serious about the aggressive reorienting of the SEC toward enforcement under Chairman Mary Jo White.


A former federal prosecutor, White herself has spoken frequently of the need for more rigorous oversight of the financial services industry. In one memorable speech, she said that her SEC would pattern its oversight after former New York City Mayor Rudy Giuliani's "broken windows" approach to police work, in which no infraction was too minor to get the attention of the cop on the beat, not even a window in an abandoned building smashed by a vandal.

The extent to which the SEC will be able to make good on that tough talk, given its limited resources, is an open question -- particularly in the advisory sector, where some 40% of RIAs under the commission's purview have never been examined.

But Giachetti notes that the commission has been staffing up, hiring many former prosecutors among others, and counsels advisors to take to heart the warnings of the agency's Office of Compliance Inspections and Examinations.


Come exam time, the pivotal figure within a firm will be the chief compliance officer, who serves as point person for the SEC examiners. But in their review of a practice, examiners will also be looking at how the CCO's role is structured within the firm to determine whether that individual has the power to investigate specific instances of questionable conduct, Giachetti said.

"Has the CCO been given the authority and the tools necessary to discharge his responsibilities?" he said. "If they don't believe that the CCO has the ability, the authority, the tools, you're going to have some explaining to do."

SEC officials have said as much. At a conference earlier this month, Norman Champ, the head of the commission's Division of Investment Management, cited a recent case in which the SEC barred a portfolio manager from the industry for five years for misleading the advisory firm's CCO about personal trades that he had made. Champ said that that case "should send a clear message" that the SEC "will not tolerate interference with CCOs."

Giachetti argued that within the firm's hierarchy, the CCO should be established as a senior management position, working in close proximity to the CEO. "If you haven't got a tone at the top, it's going to be an ugly ride downhill," he said.

Giachetti also recommends that firms with internal committees give their CCO a seat on each, because every facet of a firm's activities touches on compliance.


Beyond the scrutiny of a firm's compliance culture, SEC examiners can be expected to drill down on a number of specific areas of the practice, including questions over custody, Giachetti said.

In many of his meetings with firms gearing up for exams, he said, the advisors believe that they don't have custody of their clients' assets, but he finds evidence to the contrary.

He advises firms to quickly seek out an accounting firm to conduct the "surprise exam" that the SEC requires for advisors with custody to affirm the existence of clients' assets.

If the SEC discovers multiple accounts where an advisor had custody, but failed to report them, the firm can expect to be referred to the commission's enforcement division, Giachetti warned: "Find them before they find you."
Among the other SEC priorities that Giachetti highlighted:

  • Information security policies to safeguard clients' data are another area the SEC has identified as a priority for RIA exams in 2014.
  • In the broad categories of marketing and disclosure, examiners will be scrutinizing how advisors represent their firms -- the AUM figures they advertise, how they handle conflicts of interest, and whether they advertise performance results.
  • Conflicts are an area of particular SEC concern. Simply put, every advisor has them, and while many conflicts are benign, the SEC has put the industry on notice that it expects thorough disclosures in regulatory filings and marketing materials. "If I don't see conflicts of interest at least twice on your ADV, you've got a problem," Giacehtti said.

On performance, Giachetti argues strenuously against advertising specific numbers, which he called an automatic trigger for closer exam scrutiny.
That's particularly true for financial planners who are promoting a high-touch service that goes well beyond portfolio construction, he pointed out.

"You should never give performance," he said. "You're not selling on performance."

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Compliance Law and regulation RIAs Financial planning