With the increase in authority granted by the Dodd-Frank Act to state regulators over registered investment advisers, there has been a noticeable uptick in the number and intensity of state examinations of IA firms. In a national survey coordinated by NASAA, and released this fall, 40 state RIA examiners were found to have uncovered 3,543 violations in examinations of 825 firms during the first half of this year, an average of over 4 violations per firm. The survey found that registration and books and records violations predominated, with violations related to unethical practices and supervision not far behind.
Well over half of the firms examined were cited for registration violations, and 45% for books and record violations. The examinations also found significant numbers of violations in the areas of advertising, compliance with privacy rules, financial disclosure, fees charged and custody of funds.
According to the NASAA report, smaller, independent advisers were significantly more likely to be found in violation than larger advisers and advisers affiliated with broker-dealers. The most common individual violations found involved inconsistencies between Parts 1 and 2 of the firms’ Form ADVs, missing, incomplete or inconsistent customer contracts, and missing or inconsistent suitability documentation.
Examiners found little difference between violations by hedge fund advisers and non-hedge fund advisers, except in the categories of custody and financial disclosure, where hedge fund adviser violations were about double that of other advisers. Hedge fund advisers that were examined by state regulators were cited for violations concerning their valuation of holdings, undisclosed conflicts of interest, cross-trading (not recording transactions that cancel each other out, often to hide a markup), preferential treatment, selling to nonaccredited investors, and selling unregistered securities without an appropriate exemption.
The Dodd-Frank changes are expected to add about 3,200 advisers currently registered with the SEC to state registration rolls. Many states have been adding examiners to their staffs, and NASAA has increased its already strong training program in the area. State regulators have expressed their commitment to substantially improve examination oversight of the mid-size firms coming under their jurisdiction, compared to recent SEC examination cycles.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds and issuers of securities, among others. Our regulatory practice group assists financial service providers with the complex issues that arise in the course of their businesses, including compliance with federal and state laws and rules.