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Compliance Programs of State-Registered Investment Advisers 
in the Wake of New Federal Requirements

New SEC Rule 206(4)-7

By October 5, 2004, all investment advisers registered with the Securities and Exchange Commission ("SEC") must comply with new Rule 206(4)-7 under the Investment Advisers Act of 1940 (the "Advisers Act") (Final Rule: Compliance Programs of Investment Companies and Investment Advisers; Release No. IA-2204, File No. S7-03-03, 12/17/03). The new rule was promulgated under Section 206(4) of the Advisers Act, which prohibits any act, practice or course of business that is fraudulent, deceptive or manipulative. Rule 206(4)-7 requires SEC-registered investment advisers to: 1) adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules by the investment adviser and its supervised persons; 2) at least annually, review the adequacies of those policies and procedures and the effectiveness of their implementation; and 3) designate an individual, who must be a supervised person, to be responsible for administering the policies and procedures.

Correspondingly, SEC Rule 204-2, concerning the maintenance of books and records by federally registered investment advisers, was amended to require firms to maintain 1) copies of all policies and procedures formulated under Rule 206(4)-7 that are in effect or were in effect over the previous five years; and 2) any records documenting the investment adviser's annual review of those policies and procedures as required by Rule 204(6)-7(b).

Connecticut's Response

The Division has received several inquiries concerning how the SEC's new compliance procedure requirement would affect investment advisers registered with the department under the Connecticut Uniform Securities Act ("CUSA").

Given Connecticut's existing regulatory structure, the department is not promulgating an additional regulation to mirror new SEC Rule 206(4)-7 at this time. State-registered investment advisers are reminded, however, that the implementation of comprehensive supervisory procedures goes a long way toward minimizing business risks and preventing dishonest or unethical practices, including material conflicts of interest and the misappropriation of client assets.

Section 36b-31-6f(b) of the Regulations under CUSA provides that: "Each registered . . . investment adviser shall establish, enforce and maintain a system for supervising the activities of its . . . investment adviser agents and Connecticut office operations that is reasonably designed to achieve compliance with applicable securities laws and regulations."

Section 36b-31-6f of the Regulations requires that, at a minimum, the supervisory system provide for the following:

1.    The establishment, implementation and maintenance of written supervisory procedures containing:
  • The supervisory system established by the investment adviser
  • The titles, registration status and location of required supervisory personnel
  • The locations of required supervisory personnel
  • The responsibilities of each supervisory person as they relate to the type of business in which the investment adviser is engaged
  • An internal record containing the names of all persons designated as supervisory personnel and the dates on which such designation is or was effective
  • Consideration of whether investment adviser agents at the location engage in retail sales or other activities involving regular contact with public customers or clients
  • Consideration of whether a substantial number of investment adviser agents conduct activities at or are otherwise supervised from the location
  • Consideration of whether the investment adviser agents are geographically dispersed
  • Consideration of whether the securities or investment advisory activities are diverse, complex or both.
2.    Designation of a manager with authority to carry out supervisory responsibilities for each type of business in which the investment adviser engages and for which investment adviser registration is required
 
3.  Designation of an on-site, full-time manager for each Connecticut branch office and principal place of business to be responsible for the day-to-day operation and supervision of the office
 
4.  Assignment of each investment adviser agent to a supervising manager
 
5.  Reasonable efforts to determine that all supervisory personnel have the experience or training to carry out their assigned responsibilities
 
6.  Participation, at least annually, by each investment adviser agent, either individually or collectively, in an interview or meeting conducted by persons the investment adviser designates. During this interview or meeting, compliance matters relevant to the adviser agent's activities must be discussed. The meeting or interview may occur in conjunction with a discussion of other matters and may be conducted at a central or regional location or at the investment adviser agent's place of business
 
7. Designation of one or more managers to review the supervisory system, procedures and inspections implemented by the investment adviser and take or recommend to senior management appropriate action reasonably designed to achieve compliance with CUSA and its Regulations. Unlike Rule 206(4)-7, there is no express requirement in the Connecticut regulations that this review occur at a specified time (i.e. at least annually)

In addition, Section 36b-31-6f obligates each investment adviser to amend its written supervisory procedures as appropriate within a reasonable time after changes occur in 1) applicable securities laws and regulations; and 2) the investment adviser's supervisory system. The adviser must also communicate the amendments through its organization.

The failure of an investment adviser to supervise its investment adviser agents is a basis for revoking, suspending or restricting an investment advisory registration under Section 36b-15(a)(2)(K) of CUSA. State-registered investment advisers should also bear in mind that the implementation of comprehensive supervisory procedures helps to minimize business risks. For small advisers in particular, business continuity planning covering contingencies such as an adviser's incapacity or death is important. In addition, procedures should provide safeguards against dishonest or unethical practices, including material conflicts of interest and the misappropriation of client assets.

In conducting examinations of investment advisory books and records, the Division will review the investment adviser's compliance manual, among other records. For additional guidance on the examination process, including required books and records, see Investment Adviser Examination Program.

February 2005

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