On November 9, 2020, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) announced the results of its examination of nearly 40 SEC-registered investment advisers that operate multiple branch offices (the “Risk Alert”). Most of the firms examined conducted their advisory business out of at least 10 branch offices. OCIE observed a wide range of deficiencies across the advisers it examined, largely stemming from failures to implement policies and procedures designed to ensure compliance with the Advisers Act at branch offices. The Risk Alert serves as a warning, and reminder, to firms operating multiple branches of the need for careful attention to the unique risks posed by this model.
The multi-branch office model involves inherent heightened risks for supervision and compliance, as geographically dispersed personnel develop different practices or disparate ways of communicating and running their day-to-day business. The Risk Alert reported that the firms examined failed to account for and mitigate these heightened risks, as OCIE determined that almost every firm examined failed to adhere to at least one aspect the Compliance Rule. The Compliance Rule issues frequently concerned advisers’ failure to recognize that they had custody of clients’ assets, failure to adequately implement and oversee their fee billing practices, or both. Specific shortcomings highlighted in the Risk Alert included:
- lack of policies and procedures that limit the ability of supervised persons to process withdrawals and deposits in client accounts, change client addresses of record, or do both;
- lack of policies and procedures to help identify and remediate instances where undisclosed or inaccurate fees were charged to clients;
- supervision deficiencies regarding the failure to disclose material information, portfolio management, and trading and best execution, particularly when advisers oversaw branch office personnel with higher-risk profiles;
- deficiencies related to advertising, especially regarding materials prepared by supervised persons located in branch offices not operating with the primary name of the adviser firm; and
- deficiencies related to the code of ethics, including failure to comply with reporting requirements, to identify access persons, to review transactions and holdings reports, or having comprehensive codes of ethics.
OCIE also reviewed the provision of investment advice by advisers to clients and found that more than half of the advisers examined had deficiencies related to portfolio management advice. The deficiencies most often related to oversight of investment decisions occurring within branch offices, disclosure of conflicts of interest, and trading allocation decisions. The specific issues highlighted in the Risk Alert report included:
- deficiencies related to oversight of investment recommendations, often related to mutual funds that charged 12b-1 fees, wrap fee programs, and automated rebalancing of accounts;
- issues related to conflicts of interest, such as expense allocation and failure to disclose financial incentives for advisers; and
- lack of documentation regarding analysis for best execution, completing principal transactions involving securities sold from the firms’ inventories without prior client consent, and inadequate monitoring of supervised persons’ trading.
To combat these concerns, the staff suggested that firms implement written policies and procedures that:
- are applicable to all office locations and all supervised persons;
- include unique aspects associated with individual branch offices; and
- specifically address compliance practices necessary for effective branch oversight.
The OCIE staff noted that uniform policies and procedures regarding compliance monitoring and oversight of branch offices can serve to mitigate the risks posed by the multi-branch office model, and additionally suggested annual compliance testing or periodic reviews of key activities at all branch offices.
The Risk Alert serves as an important reminder to advisers whose staff operate in multiple offices of the importance of regularly auditing their own policies and procedures to ensure compliance across offices. Indeed, the Risk Alert commends steps taken by several advisers to amend disclosures, revise compliance policies and procedures, and change other practices. Identifying, tracking, and following up to remediate gaps or issues following such reviews is a fundamental element of any effective compliance program. Doing so can also go a long way with responding to subsequent regulatory inquiries about the firm’s compliance program should any arise.
If you would like assistance in reviewing or revising your firm’s policies and procedures in light of the concerns published in the Risk Alert, please contact the authors of this article or anyone from the experienced McGuireWoods LLP Broker Dealer/Investment Adviser team.
 Advisers Act Rule 206(4)-7 requires SEC-registered advisers to adopt and implement written policies and procedures that are reasonably designed to prevent violations of the Advisers Act and rules thereunder by advisers and their supervised persons. Advisers Act Section 203(e)(6) highlights that establishing supervisory procedures reasonably designed to prevent and detect such violations and following them are important supervisory steps.