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RIAs failed to supervise employees who had disciplinary history: SEC

Failure to disclose conflicts, lax supervision, omitting crucial discipline details … these are just a few of many compliance lapses the SEC said it found after scrutinizing dozens of RIAs that employed individuals with a disciplinary history.

A new risk alert published by the SEC's Office of Compliance Inspections and Examinations warns of these and other errors it observed in 2017 when it visited more than 50 advisors who collectively served nearly 220,000 clients and managed roughly $50 billion in assets. Of those, the SEC says, the "vast majority" cater to retail investors.

Almost every firm the SEC visited in the sweep received a letter detailing some compliance failures including supervision, disclosures and conflicts of interest.

"The staff observed that many advisors did not adopt and implement compliance policies and procedures that address the risks associated with hiring and employing individuals with prior disciplinary histories," the division says in the risk alert.

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Joe Ratterman of Bats Global Markets Inc., Nasdaq OMX Group Inc arrive for a meeting at the Securities and Exchange Commission in Washington, D.C., U.S., on Monday, May 10, 2010. The chief executive officers of the biggest U.S. stock markets were called to a meeting at the U.S.Securities and Exchange to discuss last week’s selloff in equities, according to four people familiar with the situation. Photographer: Joshua Roberts/Bloomberg

Many of the firms relied on supervised individuals to self-report their disciplinary histories and failed to ensure that those self-attestations were thorough and accurate. In many cases, the SEC found, they weren't.

"OCIE encourages advisors, when designing and implementing their compliance and supervision frameworks, to consider the risks presented by hiring and employing supervised persons with disciplinary histories and adopt policies and procedures to address those risks," OCIE says.

Regarding disclosure issues, nearly half of the deficiencies stemmed from a firm failing to provide information about disciplinary actions taken against supervised individuals. Those included omitting material disclosures about disciplinary histories, which are required by the regulations governing Form ADV. Or, alternately, the disclosures could have made a glancing mention of a disciplinary action, but left out crucial details such as the nature of the misconduct, the dates when it occurred and whether the supervised person was deemed to be at fault.

In evaluating firms' supervisory procedures, SEC examiners didn't just focus on oversight of the individuals with disciplinary history, but rather looked "firm-wide," OCIE says, citing the importance of "setting a strong, 'tone-from-the-top' compliance culture."

OCIE examiners found numerous incidents where advisors failed to disclose certain compensation arrangements or other conflicts of interest, and broadly cited firms for lax supervision.

The office suggests firms adopt written policies and procedures for hiring individuals with disciplinary histories and strengthen their due diligence work in the onboarding process. Likewise, OCIE encourages firms to tighten up supervision of individuals who have been disciplined in the past, especially those who work in remote offices.

"In sharing the information in this risk alert," OCIE says, it "is encouraging advisors to reflect upon their practices, policies, and procedures and to consider ways that they may improve their supervisory practices and compliance programs."

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