Skipping Your Annual Client Review? The SEC May Be Watching

Taking your eyes off firm-wide client compliance requirements can come back and bite you in a big way.

Tom Dupree, founder of Lexington, Kent.-based Dupree Financial Group, found out the hard way.

On Oct. 5, the Securities and Exchange Commission hit Dupree with a $25,000 fine, and censured the company for its failure to conduct mandatory compliance reviews over a four-year period.

“It is unlawful for a registered investment adviser to provide investment advice to clients unless the adviser completes annual reviews of the adequacy of its compliance policies and procedures and the effectiveness of their implementation,” the SEC wrote.

“From the time Dupree Financial registered with the Commission in June 2010 through 2014, it failed to perform annual compliance reviews.”

Dupree has developed a “strong culture of compliance” that stood up well in the registered investment advisor community, Dupree said.

"We were simply unaware of a certain requirement. It's that simple,” he added. "I made every effort to comply with everything that I felt I needed to comply with. One of the things that didn't happen is we didn't do an annual compliance meeting the way they wanted it done and documented. We were doing everything else around compliance.”

Regulation Environment to Continue

Even if you’re 90 percent of the way there on SEC-approved compliance practices, firms like Dupree’s should have seen this one coming, Wall Street insiders say.

“The complexity of regulations will only grow as the regulating bodies continue to crack down on financial services firms,” said Frank Engelbert, a principal systems engineer at Software AG, based in Phoenix.

The best thing for RIAs and financial planning firms to do is plan ahead, Englebert advised.

"They need the right tools to identify and flag potential compliance issues, so they can sense and respond to violations quickly,” he explained. “As laws and regulations continue to evolve and change on an even more regular basis, firms must adapt faster and create synergies by overlapping regulatory requirements.”

Proper compliance preparation “really comes down to the off-the-shelf reactive compliance programs most RIAs have,” said Braden Perry, an attorney at Kennyhertz Perry in Kansas City and a former federal enforcement attorney specializing government compliance.

“You’ve got to have best practices,” Perry said. “Company leadership should devote adequate resources to the compliance program, which will greatly increase the chance of catching and fixing any errors, including annual meetings/requirements that may occur.

“Second, a senior-management-level chief compliance officer should send regular reports to top-level staff,” he added. “That is vital to ensure the proper oversight of the compliance functions - this should fit into the annual compliance calendar.”

Being proactive heads the list of challenges, Perry said.

“Many regulated companies are reactive, meaning that they do not anticipate issues but wait for issues to arise and then act or react,” he said. “Success in a reactive organization, by contrast, is an uphill battle. These organizations are likely resistant to change.”

Stay Prepared for Anything

Other investment compliance experts warn RIA firm leaders to expect federal regulators to keep the heat on, and to prepare accordingly.

The expectation is that firms will have compliance management systems and processes for a variety of activities such as customer due diligence, training plans, financial operations and independent audits, said Laura Goldzung, a compliance specialist at AML Audit Services.

For investment advisors, the SEC would expect written policies and procedures with supervisory controls for monitoring and surveillance, recordkeeping, investigations and audits, gifts and entertainment, employee disclosure and personal trading, she added.

“This list is long and it is burdensome,” Goldzung said. “However, if you want to be a financial services firm, compliance requirements come with the turf.”

Even if you bring in professional backstops, don’t expect to shed any accountability.

“Frequently, firms will engage a third party to provide oversight over the moving parts of compliance and sometimes they will outsource the whole process,” Goldzung noted. “Even when outsourced though, the firm owns the responsibility - that is never transferred away.”

There are a multitude of compliance systems that will assist financial advisory firms in managing the compliance function.

“Not everyone is compliance educated and the compliance function requires skill and the interest in regulation and compliance,” she said. “Not everyone possesses that skill, so if you don’t have the resources, hire them."

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms, including CBS News, The Street.com, and Bloomberg. Brian may be contacted at [email protected].

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