Ep.3: Basic Blocking and Tackling: The RIA Playbook for Compliance Tasks

Intro (00:00):

This is Adviser Intelligence, the podcast for investment advisers and financial institutions. In each episode, attorneys from your investment management and securities team break down compliance, regulation, and risk into practical insights that help you stay exam ready and ahead of what’s next. This podcast is brought to you by Stark & Stark.

Joseph Antonakakis, Esq. (00:28):

Hello. Welcome to Adviser Intelligence. My name is Joseph Antonakakis.

Ronald Minsky, Esq. (00:34):

Ron Minsky.

Jeffrey Lang, Esq. (00:35):

And I’m Jeff Lang.

Joseph Antonakakis, Esq. (00:37):

And today we’re talking about what we’re calling basic blocking and tackling. In other words, the tasks that advisers need to do on sort of a daily, weekly, monthly, quarterly, annual basis is part of their compliance program. And these are tasks that folks outsource to us. We have an annual compliance program where people can outsource a lot of these tasks to us, and it’s a fairly large program. And we’re going to talk about a number of those tasks. And I’d like to start with some of the easier ones, and then we’ll sort of get a little more complex as we go. Number one, Form ADV. We talked about it a little bit on our last episode, but Ron, if you could give us an idea of when Form ADV needs to be filed for investment advisers.

Ronald Minsky, Esq. (01:25):

So the main time that Form ADV needs to be filed is your annual amendment. And that is essentially at the end of your fiscal year, December 31st. So after December 31st, you produce your annual amendment, and that annual amendment is due to be filed on March 31st.

Joseph Antonakakis, Esq. (01:54):

Yeah. Or like within 90 days

Ronald Minsky, Esq. (01:56):

Within 90 days of the firm’s fiscal year. The firm’s fiscal year end. And then it is deliverable to your clients within 120 days.

Joseph Antonakakis, Esq. (02:05):

Of the fiscal

Ronald Minsky, Esq. (02:06):

Fiscal year

Joseph Antonakakis, Esq. (02:06):

End. And so you have the annual amendment. And then in addition to that, if there’s any sort of material change, you also have … People call it different things. There’s the interim amendment or the other than annual amendment. What are some instances in which that might need to be filed?

Ronald Minsky, Esq. (02:24):

So the other than annual amendment, as Joe mentioned, is filed when you have a material change. Certain material changes might be a change in management, a change in ownership, maybe a change in your fee structure, a change in the services that you’re offering.

Joseph Antonakakis, Esq. (02:43):

Change in disciplinary history, Which we see sometimes.

Ronald Minsky, Esq. (02:45):

History, absolutely. So these are material changes which require you to file your other annual amendment promptly. There’s no set definition for the term promptly, but generally we recommend within 30 days of the material event that you file your other than annual amendment and deliver it to your clients.

Joseph Antonakakis, Esq. (03:11):

Yeah, precisely right. Sort of related to the ADV, I also wanted to talk about notice filings, or at least for SEC registered advisers, it’s called notice filings. If you’re a state registered adviser, we’re just talking about a registration. Jeff, when somebody needs to get notice filed, or how does somebody know when they need to get notice filed or registered in a state?

Jeffrey Lang, Esq. (03:33):

Well, for an SEC registered adviser, it’s going to boil down to where do I have client counts that are going to trigger state notice filings. Now, in most states, we’re tracking to make sure when we have that sixth client. So in other words, more than five, when we get that sixth person, that’s going to trigger notice filing. And so what you want to be doing is monitoring very closely to make sure that if you cross over that threshold, you’re notice filing accordingly and you’re not caught in a situation where you’ve gotten that sixth client, they’ve been on your platform for a while and you’ve yet to notice file. So great to be tracking that information. There are four states that trigger notice filing with the first client. Those states are Nebraska, New Hampshire, Louisiana, and Texas. Client number one will leave you needing to notice file in any of those four states.

Joseph Antonakakis, Esq. (04:34):

Exactly right. And the same goes for registration. If you’re a state registered adviser, right? It’s not called notice filing in that instance. It’s a registration. And once you hit what the regulators call the de minimis, that minimum number of clients in that state you’re required to get registered as an investment adviser. And then you’re … If you’re a state registered adviser, you have to sort of go through the registration process.

Jeffrey Lang, Esq. (04:57):

State by state.

Joseph Antonakakis, Esq. (04:58):

State by state. Whereas with notice filing, oftentimes you’re just paying a fee and then the state is sort of just accepting you know, as notice filed in that jurisdiction.

Jeffrey Lang, Esq. (05:08):

That’s right.

Joseph Antonakakis, Esq. (05:09):

Sort of tangential to the ADV, we’re going to talk about U4 and U5. When are these required to be filed, Ron?

Ronald Minsky, Esq. (05:17):

The U4 is required to be filed prior to anybody providing investment management services to a client. So if you’re an investment adviser representative, you’re going to need to be U4ed prior to providing any investment advisory services to your clients. And on the flip side, the U5 is filed when you terminate providing services to investment management clients.

Joseph Antonakakis, Esq. (05:46):

Right. Yeah. The way I explain it to folks is if somebody’s coming into the firm, you’re getting them U4ed. If somebody is leaving the firm, you’re getting them U5ed. But that’s not the only instance where you file a U4 potentially. Jeff, if you want to maybe touch on if there’s some material change, what the filing requirements may

Jeffrey Lang, Esq. (06:04):

Look like. Sure. So the U4, as Ron was correctly indicating, is filed basically in relation to, okay, now I am going to conduct business. I’m going to provide investment advisory services in state X. I’m now going to get U4 in that state. So I can provide investment advisory services. I fill out my U4, it’s approved by the state or states where I conduct business and then off you go providing services. There are times when you might need to file amendments to your U4, and that can be, for example, when you have a name change, perhaps due to a marriage, or when you change your own personal address, or when you have an outside business that you need to declare.

Joseph Antonakakis, Esq. (06:52):

I was just going to touch on that actually. I’m glad you brought up the outside business activities. There’s a lot of questions that we get of like, what constitutes an outside business activity?

Jeffrey Lang, Esq. (07:02):

So it’s fairly broad in terms of when we receive compensation. So a lot of times, one that I frequently see, Joe, is rental property. People say, “Well, it’s not an investment advisory or it’s not related to my business.” Yes, but it’s a business that you conduct where you’re making a separate income. So for example, providing rentals, having rental businesses, or somebody is an adjunct professor teaching finance courses at the local university. That’s another activity I would declare. Anything like that where you’re actually doing something in that for- profit manner, you’re not doing something for a 50C3 charitable organization where you’re just a volunteer.

Joseph Antonakakis, Esq. (07:47):

Right. Like that’s one of the exceptions, right?

Jeffrey Lang, Esq. (07:49):

That’s one of the exceptions. That’s right. So those are the types of things where you might need to amend a U4. And of course, there might be a circumstance where somebody receives a complaint and depending upon the nature of that complaint, you might need to update the U4 for that as well.

Joseph Antonakakis, Esq. (08:05):

Yeah. Yeah. I don’t want to dive too deeply into that, but usually it’s like if it’s what they call a sales practice violation.

Jeffrey Lang, Esq. (08:11):

A sale practice violation.

Joseph Antonakakis, Esq. (08:11):

Usually has to go on the U4 as disciplinary history and that has sort of implications sometimes for the ADV part one, the form CRS.

Jeffrey Lang, Esq. (08:21):

That’s right.

Joseph Antonakakis, Esq. (08:23):

Since I mentioned the form CRS, now that I remember, I want to talk about it for a brief moment because a question we get a lot from state registered advisers is, “Do I have to file a form CRS?” Short answer is no. State registered investment advisers are not required to put together a form CRS. SEC registered investment advisers are required to file it with the regulators, provide it to their retail clients, at least on an annual basis and in various other circumstances. And that’s sort of also one of the tasks that folks are required to complete as well.

Ronald Minsky, Esq. (08:59):

Right. We should also mention that although state advisers do not have to file the form CRS, that their 2B must be filed.

Joseph Antonakakis, Esq. (09:10):

Yeah. To be or not to be is often the question that we get. And if you’re a state registered adviser, the answer is yes, 2B. You have to file that via IAPD. If you’re an SEC registered adviser, I see maybe 20% of our clients who are SEC registered actually file their form ADV part 2B in addition to their part 2A, even though they’re not required to.

Ronald Minsky, Esq. (09:36):

What I see a lot with our clients is that they may have their part 2A and part 2B in the same document. So when they file their 2A, they’re in essence filing their 2B as well. Precisely.

Joseph Antonakakis, Esq. (09:51):

The other document I want to touch on, and it’s again something that we deal with pretty much every day with our clients, is updating the policies and procedures manual. The requirement is at least an annual review. Jeff, I see you want to say something.

Jeffrey Lang, Esq. (10:05):

Yeah. The key behind the compliance manual is making sure that it conforms to how you do what you do, and that’s very important. So to the extent that you have a compliance manual or you’ve received some form of off the shelf manual, you do need to make sure that you go through it and that you make sure it comports with how you do what you do in your day-to-day practice. And we can tell you from our vast experience in dealing with SEC and state level exams is that the examiners are very focused on reading that manual prior to or at the time they come in to visit you and they’re very familiar with it and they’re going to look at your practice in terms of what the manual says in it. That’s

Ronald Minsky, Esq. (10:51):

Probably the most frequent exam deficiency that I see when my clients go through an exam, is the deficiency where the examiner says, “Well, your manual says you do it this way, but in practice you actually do it that way.” And that’s probably the most common deficiency that I see in SEC exams.

Jeffrey Lang, Esq. (11:15):

A practical recommendation that I make to my clients is obviously the manual is a big document. It’s a lot to digest, but encourage folks on your team, if they specialize in a particular area, think your marketing person, your portfolio management person. Folks who have particular tasks with the firm should focus on those relevant areas of the manual to make sure that they comport with how they do their day-to-day work. So it’s important to focus particularly on your areas within the manual. And in addition, of course, to understanding the whole manual, but certain people like the marketing team or the portfolio management team may be in a better position to evaluate whether the manual is accurate to their practice.

Joseph Antonakakis, Esq. (12:04):

And in addition to that regular review and updating of the policy manual, the other thing I wanted to talk about is sort of what we do as part of our annual compliance program. And like we said, we work with a lot of clients, large and small. I mean, I’ve got a client in the program who’s a state registered adviser under 100 million. The majority of those clients as part of the program range from 100 or 200 million in assets to several billion in assets. And we do a lot of these tasks for them. So maybe we can go one by one and talk about some tasks that we complete. Jeff, if you want to go first.

Jeffrey Lang, Esq. (12:43):

Yeah. So I’ll talk about the basic battery of testing that we do. And of course this is customized to each relationship, but basic blocking and tackling, think personal securities transaction reviews, think email review, fee testing, best execution review, marketing review. These are all core items to a compliance program that every firm needs to be undertaking. So the SEC will, or the states will visit you and they will look to see that you are hitting these core requirements.

Joseph Antonakakis, Esq. (13:17):

Now, can I just pause you for a brief moment?

Jeffrey Lang, Esq. (13:20):

Sure.

Joseph Antonakakis, Esq. (13:20):

You mentioned personal securities transaction review. Can you give us an idea of like when an adviser is doing it internally or when we’re doing it for them, what are we looking for?

Jeffrey Lang, Esq. (13:30):

So what we’re looking for is we are gathering information on the trading that has been done by the access persons within the adviser’s firm versus what is set forth in the firm’s blotter and looking to see if there’s any situations where there might be inadvertent examples of front running or tailgating or any trading that just looks like it might stand out for some reason trading done by the access persons versus what has been done by the firm overall. So we’re comparing those trading patterns and we’re just looking for anything that might be concerning to the reviewer.

Joseph Antonakakis, Esq. (14:15):

Yeah. And then you also mentioned fee testing, reviewing client fee tests. Ron, I know you do a lot of these as well. Can you give us an idea of what we’re looking at when somebody’s doing fee testing on a quarterly basis or maybe a monthly basis, depending on how they do it?

Ronald Minsky, Esq. (14:30):

We’re looking to see that the fee that was actually charged to the client and deducted from the client’s account matches up with the actual calculation of what the fee should be and that the fee that’s being taken is being taken in accordance with the advisory agreement that you’ve signed with that particular client.

Joseph Antonakakis, Esq. (14:52):

Right. And we’re taking a look at two documents that you alluded to. Number one is the investment advisory agreement, which outlines what the client, that specific client’s fee is. And number two is their quarterly statement from a Schwab or a Fidelity or whomever that outlines the fee that was actually charged to that client for that quarter.

Jeffrey Lang, Esq. (15:11):

And we’re actually looking at a third document, which is the statement that shows the amount upon which we build. So it’s really sort of matching all of that together. And a lot of times the input I’ll get from my clients is, “Hey, all of this information is already in my Black Diamond or my Orion tool or whatever automated technology they’re using to do fee billing.” So in other words, you might have sort of a set and forget billing system, but when we actually forensically look at the underlying documentation to make sure that everything is correct, we will often uncover mistakes just because the billing arrangement was changed, maybe it was renegotiated.

Joseph Antonakakis, Esq. (15:50):

Yeah, that is something I see incredibly often when I help with because-

Jeffrey Lang, Esq. (15:53):

Very often. Very often. And something we’ll remind our viewers is even if a fee change is in favor of the client because you lowered the fee, it is still a potential deficiency if it’s not documented.

Joseph Antonakakis, Esq. (16:11):

Yeah. And I’ve seen regulators point that out as a deficiency where, I mean, obviously if you’re charging a higher fee than what you agreed to, obvious deficiency, obvious problem. But I’ve seen regulators, state and federal regulators call out folks who are under billing. And like the question we ask is, “Well, this is in favor of the client. Why is this a bad thing?” It doesn’t matter. The regulators want, if you’re going to be billing someone, the fee has to be identical to what is indicated in their advisory agreement.

Ronald Minsky, Esq. (16:38):

It just shows inaccuracy in your process and in your practice.

Joseph Antonakakis, Esq. (16:43):

Yeah. It just could be a little sloppy. A couple more things I want to talk about, best execution review, which again, we do on a quarterly basis. We take a look at sort of securities that were purchased in a particular client account. We’re doing a comparison to some publicly available information to ensure that the purchase of that security aligns with the price that was outlined at the time that it was purchased. And the last thing I want to talk about is Edgar filings, which we touched on briefly in the ADV episode, but of course there are some filings that large traders need to file that’s the form 13H. If you have a certain number of assets under management on a discretionary basis in exchange traded equity securities or ETFs, you have to file the 13F, and there are some 13D and G filings as well for folks who have 5% or more of a particular company’s stock.

Ronald Minsky, Esq. (17:37):

The 13D filing I’d like to speak to in particular, because that’s a filing that’s often neglected by a lot of our clients.

Joseph Antonakakis, Esq. (17:46):

DNG. Yes. Yeah, for sure.

Ronald Minsky, Esq. (17:49):

Because maybe you haven’t realized that your client has crossed that threshold and is now responsible for filing a 13D.

Joseph Antonakakis, Esq. (17:58):

Yeah.

Ronald Minsky, Esq. (17:59):

And I’ve had that happen on several occasions where we had to catch up on a 13D filing because it just slipped through without them realizing that the client had crossed that threshold.

Joseph Antonakakis, Esq. (18:14):

Yeah. Instances where I see that the most is cases where the client is some sort of a C-suite executive or something like that at the company, at least that’s where I see it with our clients.

Ronald Minsky, Esq. (18:26):

It happens with the C-suite executives, but it also happens with heirs, with heirs to a C-suite executive or an heir to a founder of a company that has since become a publicly traded entity, and they don’t realize that they’ve inherited stock that crosses that threshold.

Joseph Antonakakis, Esq. (18:47):

Yeah. Well, I’ll tell you what, we talked about a lot of stuff. We talked about our robust annual compliance program, where we service, like we said, a lot of clients, and we do a lot of these quarterly tasks for them from email review to personal securities transactions review to best execution, to fee testing, and the whole slew of other tasks that we complete. And I’m glad that we had a chance to remind folks that you need to do these on a regular basis. It’s not just a set it and forget it. It’s not just a one time. It’s important to have a compliance calendar that outlines these tasks and when they need to be completed, so you can stay on top of your stuff. And if you don’t want to do it, if you do want to sort of set it and forget it, so to speak, you can work with a compliance attorney, for example, who you might be able to outsource it to.

(19:36):

So thanks, Jeff, and thanks, Ron, for your time. I appreciate it, and we look forward to seeing everyone on the next one.

Intro (19:45):

The Adviser Intelligence Podcast provides general information and commentary only. The content is not legal advice, nor does it create an attorney-client relationship. For more information about Stark & Stark services, please visit our website at stark-stark.com.