When Policies, Procedures and Testing Protocols Aren’t Enough…

The Compliance Program Rule continues to be a powerful tool for SEC enforcement, recently used by the SEC to address trading away in wrap accounts, misappropriation of retail client assets, and the misuse of an omnibus account. Advisory firms had written policies and procedures and testing protocols, but they were not good enough; are yours?

In the wrap account case, the registered investment adviser, which was the sponsor of wrap programs, failed to timely gather and disclose all material facts relating to “trading away.” Even though the RIA performed manager and trading reviews, had a best execution committee, and had recently improved its due diligence and disclosure processes relating to the wrap accounts and transaction cost analysis, the SEC demanded more.

In the misappropriation of retail client assets case, the dual registrant failed to catch five employees who were stealing money from client accounts. The dual registrant had a supervisory framework in place to oversee its representatives, and had automated and manual controls, but with the volume of transactions and client activity, the framework failed.

In the omnibus account case, an investment adviser representative made trades for himself and clients in an omnibus account set up for block trading, allocated shares late in the day after watching changes in price, and placed a greater proportion of profitable trades to his and other favored accounts. The firm had policies and procedures which required that allocations be based on average price and be fair and equitable to all clients. But, these were not effectively implemented, and pre-trade documentation was insufficient.

In each of these cases, the firm had an established compliance program, with written policies and procedures and testing. Nonetheless, the Commission found the respondents violated the Compliance Program Rule due to their respective failure to adopt and/or implement policies, procedures, and controls that were reasonably designed to prevent and detect the wrongdoing.

So, when is your testing enough to prevent wrongdoing, or at least prevent enforcement proceedings?

For advisers who have wrap accounts, the Settlement Order provided relatively rare detail, and we recommend you read this in full and test your processes against this detail. We can assist with the testing. We also have a more detailed write-up of this case in our regular SEC enforcement and news alert Compliance Matters, to which you can subscribe. Contact our sales department or your Ascendant consultant.

For other topics, while a Compliance Program cannot necessarily stop every rogue actor, there are missteps that a Compliance Program can catch, which is why we regularly address these details in a risk assessment or annual review and stress adherence to process. For example, the dual registrant missed other red flags, including using personal email addresses for client communications, using improper account forms, and engaging in unauthorized outside business activities. If not representative of fraud or wrongdoing, they at least show lack of compliance care, and should have put the firm on notice to further monitor certain tasks and/or employees. Further, a good Compliance Program has both automated and manual controls and reviews. But, proprietary tools and automated systems must be assessed regularly, for technical issues and to address weaknesses that may not be keeping up with demands.

Regarding the unfair allocation case, we stress the importance of pre-trade documentation, and we recommend TradeSentryTM, our trading surveillance platform. And, finally, we regularly see the benefits of third-party compliance consultants; we are another set of eyes to review and test, and we can give you additional industry perspective to stay in line with your peers and the SEC’s expectations.

Post written by Eugenie Warner


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CSS frequently publishes blog posts which are written by our team from their observations in the field, at conferences and through experiences with compliance professionals. These posts are designed to further knowledge and share industry best practices. Topics run the gamut, including Form ADV, cybersecurity, MiFID II, position limit monitoring, technology challenges and more. Complete and submit the brief form below to receive notifications when we publish new content.

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