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As we reflect back on Form ADV season, we are reminded that compliance officers face the thankless task each year of reviewing their policies and procedures to determine their adequacy and effectiveness, as required by Advisers Act Rule 206(4)-7. This review entails updating the firm's compliance program to reflect changes to relevant regulations and new regulatory guidance, and confirming the program is appropriately followed by the firm.
We’ve compiled a series of tips to help you focus on the U.S. Securities and Exchange Commission (SEC) focus areas for 2023. You can read our previous tips here:
- Tip 1: Get ready for SEC focus on hedge clauses in advisory agreements
- Tip 2: Keep tabs on Continuing Education requirements
- Tip 3: Update your compliance program to address the SEC Risk Alert about MNPI compliance issues
- Tip 4: Prepare for an SEC examination focused on Marketing Rule compliance
- Tip 5: Update Your Compliance Program to Prevent Identity Theft Under Regulation S-ID
- Tip 6: Environmental, Social, and Governance (ESG)
- Tip 7: Electronic Communications
- Tip 8: Prohibited Transaction Exemption
- Tip 9: Identifying and Addressing Conflicts of Interest Based on the SEC's Staff Bulletin
Two years after issuing Regulation Best Interest (Reg BI), Commission Interpretation Regarding Standard of Conduct for Investment Advisers (Form CRS), and Frequently Asked Questions Regarding Disclosure of Certain Financial Conflicts Related to Investment Adviser Compensation, the SEC has decided that investment advisers and broker-dealers just aren't getting the message. So in March of last year, it issued a staff bulletin on Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors and followed up with a second Q&A to clarify its expectations on conflicts of interest.
The bulletin provides examples of common conflicts and recommends how to manage them. Predictably, most conflicts are tied to “compensation, revenue or other benefits (financial or otherwise) that could incentivize a firm or financial professional to render advice that may not be in client’s best interest.”
The SEC makes it clear that all broker-dealers and investment advisers have conflicts of interest, that firms must have a process to identify, mitigate, or eliminate these conflicts, and that future SEC examiners will ask firms to produce the documentation supporting this process.
Our guidance
Create a policy to identify and address conflicts of interest. This policy can incorporate the firm's existing policies dealing with conflicts, including Code of Ethics and policies dealing with political contributions, best execution, gifts and entertainment, soft dollars, proxy voting, trade errors, pricing and valuation, principal and cross transactions, allocations and aggregation, and outside business activities.
- Develop a process to identify conflicts of interest. This process can be as simple as creating a spreadsheet that identifies known conflicts, such as revenue sharing, referral fees, trade allocation, personal or family accounts management, and compensation based on specific products. The spreadsheet should also include controls to mitigate the conflict and identify which client-facing documents disclose the conflict. The bulletin provides guidance on the disclosures required for proprietary products, receipt of third-party compensation, and wrap fee programs. Whenever a new investment product or business line is considered, conflicts should be identified as part of the discussion.
- Review conflicts periodically. In the bulletin, the SEC emphasized that identification and management of conflicts cannot be a "check the box" exercise. The SEC also re-emphasized the need for a culture of compliance. This means that the SEC expects firm management to be involved in the process. Consider creating a Conflicts Committee with high-level representatives from portfolio management, trading, operations, client service, and compliance. In addition to updating the conflicts spreadsheet, the committee could discuss compensation, new products, review disclosures for accuracy, and consider how changes to the business could raise new conflicts. Minutes of the meeting would evidence the firm’s commitment to dealing with conflicts.
- Follow the money. Money is at the heart of all conflicts, so the firm should look at its sources of revenue. Having someone outside the finance department review the firm’s general ledger can help uncover conflicts not previously identified. SEC examiners routinely review firm financials, and having a compliance officer review and ask questions beforehand may highlight potential conflicts or misclassifications of payments.
How we help
We can help you to navigate the evolving regulatory landscape while considering the complexity of your firm’s unique compliance requirements. Introducing ACA Signature, a scalable solution curated to suit your firm’s unique compliance needs. ACA Signature provides financial firms with scalable consulting solutions that can be paired with innovative technology and managed services for staying on top of regulatory and daily obligations. Our team of regulatory experts can build, enhance, or manage your compliance program, helping to mitigate risks and increase operational efficiency, while our ComplianceAlpha® regulatory technology platform can help you track conflicts of interest and more.
Designed by former regulators and compliance experts, ACA Signature provides services and solutions tailored to fulfill your firm’s ongoing compliance obligations. Our team includes former SEC, FINRA, FCA, NFA, CFTC, and state regulators along with former Chief Compliance Officers and senior compliance managers from prominent financial institutions in the industry. With over 20 years’ experience in the compliance industry, ACA is synonymous with quality compliance support.
Reach out to your ACA consultant, or contact us to find out how ACA Signature can help transform your firm’s compliance program.
Listen to our 2023 Regulatory Outlook webcast on demand
We recently hosted a webcast to review the regulatory changes that will likely have implications on compliance programs in 2023 and provide recommendations to prepare for these changes. Our experts discussed rule proposals and adoption, examination and enforcement trends, and regulatory guidance. Watch our webcast for more insights to help you prepare your compliance program for this year’s focus areas.