RIA Compliance Blog
A new Risk Alert released by the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) reminds advisers of the added compliance obligations that arise when hiring representatives carrying the baggage of reportable disciplinary histories. While by no means exhorting advisers not to hire such persons, the Risk Alert nonetheless encourages advisers to properly consider the obvious compliance risks presented by such hiring practices, and, in turn, to adopt prudent policies and procedures to address those risks.
We follow OCIE’s periodic Risk Alerts closely as they not only provide insights regarding the focus of recent OCIE examinations, but also provide insights as to what OCIE management will be directing the staff to focus on in the future. This particular Risk Alert is a read-out of the results of a recent series of OCIE exams from 2017 specifically targeting advisory firms that (i) previously employed, or currently employ, any individual with a history of disciplinary events and (ii) for the most part serve retail clients. Indeed, OCIE makes special notation of its “focus on protecting retail investors” as a genesis for both the targeted exam initiative (the “Initiative”) as well as this new Risk Alert. Accordingly, advisers with a large retail customer base should pay especially close attention to the new Risk Alert.
In conducting the Initiative, OCIE’s staff focused on three areas of interest: (i) the compliance policies and procedures put into place to specifically cover the activities of previously-disciplined individuals; (ii) the disclosures relating to previously-disciplined individuals required to be made in filings and other public documents (including advertising); and (iii) conflicts of interest implicated by the hiring of previously-disciplined individuals. With this roadmap in place, the Initiative identified a variety of observed deficiencies across a range of topics, including:
- Firms failing to provide full and fair disclosure regarding disciplinary events. This came in the form of firms omitting material disclosures regarding disciplinary histories, in some cases because the firms solely relied on supervised persons to self-report disciplinary events. Additionally, some firms provided incomplete, confusing, or misleading information regarding disciplinary events, or failed to properly update disclosure documents to reflect mandated disclosures.
- Firms failing to adopt and implement sufficient policies and procedures to address the risks associated with hiring previously-disciplined individuals. For example, some advisers did not have processes reasonably designed to identify whether an individual’s self-attestations regarding disciplinary events completely and accurately described those events.
- Firms failing to adequately supervise or set appropriate standards of business conduct for their supervised persons. Notably, the staff found that some firms did not include, as part of their monitoring activities, review of the activities of supervised persons with disciplinary histories that were working from remote locations.
On the other hand, in the course of conducting the Initiative, examiners observed certain policies and procedures that OCIE states “may help other firms address the weaknesses discussed above.” According to the Risk Alert, advisers that hire or employ supervised persons with disciplinary histories may want to consider, among other things:
- Adopting policies that specifically address what procedures (such as a formal investigation) must occur prior to hiring a previously-disciplined individual.
- Enhancing due diligence practices associated with the general hiring of all supervised persons in order to identify undisclosed disciplinary events. Such practices could potentially include third-party background checks, internet and social media searches, fingerprinting personnel, contacting personal references, and verifying educational claims. Additionally, advisers could review their new hires’ Form U5 filings 30 or more days after they are hired in order to identify termination notices that the new hire did not properly disclose that were later filed after the firm’s hiring decision was made.
- Establishing formal heightened supervisory practices for overseeing supervised persons with more serious disciplinary histories (such as misappropriation, unauthorized trading, forgery, bribery, and making unsuitable recommendations).
- Adopting policies and procedures to deal with future client complaints related to previously-disciplined individuals.
- Establishing heightened oversight of previously-disciplined individuals located in branch or remote offices.
We encourage advisory compliance personnel to read through this latest Risk Alert with an eye towards reassessing their current procedures with respect to the hiring and supervision of previously-disciplined individuals. As noted earlier, to the extent that the adviser generally serves a retail customer base, this reassessment should be all the more urgent. Indeed, even for advisers that have a blanket prohibition on hiring previously-disciplined individuals, the Risk Alert suggests a number of best practices covering general human resource due diligence that will minimize the possibility that a reportable event will go unnoticed—only to emerge as a compliance liability at a later date.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Investment Adviser Practice Group page for more information.