Investment Adviser Examination Program
What Should I Expect During An Examination?
Common Deficiencies Found During Examinations
What If A Problem Is Discovered?
The Securities Division (the "Division") conducts examinations of state-registered investment advisers and of their offices both within Connecticut and outside of the state. We hope that this summary will provide investment advisers with an insight into our examination process and spotlight some of the issues the Division will review during an inspection.
Are Advisers Notified In Advance of Examinations?
If you or your firm are to be examined, Division staff will arrive at your place of business unannounced. The staff does not, as a normal course of business, schedule appointments. Examinations may last a day or longer and, if the location also serves as a broker-dealer main or branch office, the staff will examine the records of that entity as well.
What Should I Expect During An Examination?
During an examination, staff will review books and records to determine compliance with relevant laws and regulations and to detect any potential issues. As part of the examination process, staff may also interview individuals regarding the operations of the investment adviser.
What Records Are Reviewed?
The Division will review all records pertaining to an investment adviser's business during an examination, including certain of the following items:
|1.||Accounting journals and auxiliary records such as cash/check receipts and disbursement records;|
|2.||Checkbooks, bank statements, canceled checks and other bank documents;|
|3.||Unpaid and paid bills and documents pertaining to the expenses of the firm;|
|4.||Trial balances, financial statements and internal working papers;|
|5.||All incoming and outgoing correspondence including electronic mail messages;|
|7.||Advertising file including web sites, pamphlets and brochures;|
|8.||Client contracts, customer information documents, broker-dealer new account forms, trading authorizations, power-of-attorney forms (if applicable);|
|9.||Client brokerage statements;|
|12.||Client trade confirmations;|
|13.||List of names and positions of every employee, along with their business cards;|
|15.||Part II of Form ADV or the firm's "brochure" if used in lieu of ADV-II;|
|16.||Client file-order memoranda;|
|17.||Personal securities transactions; and|
|18.||Billing invoices sent to clients.|
Section 36b-31-14b of the Connecticut Uniform Securities Act Regulations and the Investment Advisers Act of 1940 should be consulted for further guidance regarding record keeping requirements for registered investment advisers.
Types Of Deficiencies Often Found
- Outdated or inaccurate Form ADV. Advisers are required to keep an updated copy of their Form ADV in their office for review. An examiner will request a copy of this form for his/her examination file.
- Failing to keep accurate records of client billing. All client-billing invoices must be maintained. All billing invoices should show how fees are calculated and indicate which specific periods bill cover. If the fee is deducted directly from the client's account, the adviser must follow procedures established by the Securities and Exchange Commission regarding custody.
- Lack of or missing client contracts. All clients should have an executed contract on file with the adviser for our review. The contract should have a description of the services offered, a fee schedule, and a non-assignment clause. If the adviser has a contract that contains a "hedge" clause, which tries to limit the adviser's liability if the adviser has acted in good faith or with no negligence, the adviser should be aware that it may still be held liable. Advisory contracts should not contain hedge clauses since they attempt to limit a client's rights under state and federal securities laws.
- Misleading business cards and letterhead. The use of professional designations (e.g., CLU, CFP, CIC) in the alphabet soup of the financial world can be confusing to the public. The use of the designation "RIA" is improper since it is not a designation approved by any professional organization. Also, affiliations with broker-dealer firms must properly be disclosed on the adviser's business cards and letterhead.
- Advertising file deficiencies. Investment advisers are prohibited from using testimonials. Further, advisers should not make reference to a past, specific, profitable recommendation without the advertisement setting out a list of all recommendations made by the adviser within the preceding period of not less than one year, and the advertisement must comply with other specific conditions.
- Missing documentation regarding discretionary authority over a client's account. An adviser should have the brokerage new account form and any related trading authorizations that show that the adviser has the authority to trade for the client. The adviser's contract should clearly show that the client has granted the adviser discretionary authority.
- Inadequate financial records. All advisers are required to maintain financial records for their business which includes journals for cash receipts, and disbursements, ledgers reflecting asset, liability, reserve, capital, income and expense accounts. These records should be maintained in a manner that can be produced in a written form for an examiner to review. All records should be kept in accordance with generally accepted accounting principles. Some sole proprietors may use their personal checkbook to record all of their advisory business' expenses and income. Under limited circumstances, the Division may allow this practice. The adviser should keep in mind, however, that the examiner(s) will review all entries made in the checkbook, including entries that have been made for the adviser's "personal" use.
- Inadequate documentation of supervision. If the adviser has employees, the manager/principal will have supervisory duties over those individuals. Further, if the adviser is a one-person operation, it still will have compliance responsibilities. These duties and responsibilities should be documented in a written compliance/supervision manual. The manual should encompass all aspects of the business such as the review of incoming and outgoing correspondence, the review of customer financial plans, the review of new account documentation, the disclosure of any conflicts of interest, the review of personal securities transactions, and any other items that are necessary to have procedures that ensure compliance with the various securities laws.
- Records maintained in an electronic format. Records will be examined in the format in which they are maintained. Therefore, if the records are maintained on a personal computer, that computer's hard drive will be examined.
- Form DBA-1 not on file. If an adviser uses a trade name or a doing-business-as name other than what is on the form ADV, then a Form DBA-1 must be filed with the Division. There is no charge to file this form.
- Inadequate or outdated client information. The adviser should maintain a client information document that contains the client's age, annual income, net worth (exclusive of home, furnishings and automobiles), the client's investment objective, the name of the person that solicited the account, and the prior investment activity of the client. It is suggested that the above information be supplemented by other information such as client liabilities, expenses, financial goals, risk tolerance, marital status, number of dependents, health issues, and insurance coverage. All of this information should be kept current.
- Consistency of records. Examiners will compare the customer new account information, client contract, and customer information document with the services or advice actually provided to its clients. An adviser must maintain adequate information on its customers to document the suitability of the recommendations made. Examiners will also look thoroughly at the recommendations made where the client has granted discretionary authority to the investment adviser.
- Agent Not Registered. Registration is required for any person that receives any compensation or other remuneration, directly or indirectly, from the investment adviser in connection with the solicitation or referral of a client for the adviser and/or prepares or offers investment advice to a client.
Potential Problems Areas
- Use of a brochure. An examiner will request and review an investment adviser's brochure. The brochure must include everything contained in the Form ADV, Part II. All brochures and ADV's must be offered to a prospective client 48 hours before entering into any written contract or at the time of entering into any contract. The client has a right to terminate the contract without penalty within five business days after entering into the contract. Also, an adviser must offer or give its Form ADV Part II or brochure to its clients on a yearly basis. The adviser must keep some form of record to indicate when it was offered or given.
- Conflicts of interest. Generally, if an adviser is acting in more than one capacity more opportunity exists for conflicts of interest to arise. The investment adviser has a fiduciary duty to put the client's interest before their own.
- Custody. An adviser has custody if it directly or indirectly has authority to obtain possession of customer funds, or can appropriate customer funds. An investment adviser who is also an issuer of securities is deemed to have custody of client funds unless an independent custodian is utilized, and the custodial agreements include provisions that define the method by which the adviser receives payment and has access to withdraw funds. Further, if a client wishes for the adviser to become a trustee of a trust, it may trigger the requirements under the Act regarding "custody."
- Best execution. As a fiduciary, an adviser has an obligation to obtain "best execution" of clients' transactions. In meeting this obligation, an adviser must execute securities transactions for clients in such a manner that the clients' total cost or proceeds in each transaction is the most favorable under the circumstances. In assessing whether this standard is met, an adviser should consider the full range and quality of a broker's services when placing transactions, including, among other things, execution capability, commission rates, financial responsibility, responsiveness to the adviser, and the value of any research services provided.
- Recidivism. Examiners closely review the actions that advisers have taken to remedy deficiencies cited during previous examinations. Examiners have found instances where advisers have failed to correct violations cited during previous examinations, after the adviser represented to the Division, in writing, that the violations would be corrected.
Concluding An Examination
After completion of the examination, Division staff will usually sit down with the adviser and discuss any problems and issues that may have been uncovered. This is also an opportunity for the adviser to ask any questions of staff. After the examiner leaves, if deficiencies or potential problems were discovered, a follow-up letter will be sent to the adviser. This letter will require an adviser to respond to the department in writing stating how the deficiencies will be corrected. The adviser usually has a two-week period in which to respond. If no deficiencies or issues are noted during an examination, the Division will not issue a letter and the examination file will be closed.
What Happens If A Problem Is Discovered?
The resolution of problems discovered during an examination will be contingent on their severity. In some instances, an issue(s) may be corrected at the time of the examination and, in other cases, the Division may conduct a follow-up examination. As stated previously, an adviser will generally receive a letter from the Division in the event deficiencies or issues are noted during an examination. In a small number of cases where more severe violations have occurred, an adviser can be subject to administrative orders, fines and civil/criminal penalties.
This discussion of the Division's examination process has been provided as a courtesy to industry. It should not be considered a complete guide to the Division's regulatory program, nor should the information provided be considered a substitute for the official statutes and regulations that pertain to investment advisers. Do not rely solely upon this page for guidance! If you have specific questions, please call the Division at (860) 240-8230 or toll free at 1-800-831-7225. Thank you!