SEC Examinations and Enforcement Update for Registered Investment Advisers: Transparency for SEC Exams, Marketing Rule Sweep, and More Custody Scrutiny

A series of recent actions by the Securities and Exchange Commission (SEC) and its staff should prompt registered investment advisers (RIAs) to reassess their risk tolerance for some relatively common RIA marketing, custody, and other business practices. On August 21st, the SEC announced its first enforcement action against an RIA, Titan Global Capital Management USA LLC, for violations of the Marketing Rule, Rule 206(4)-1 under the Investment Advisers Act of 1940 (the “Advisers Act”).[1] On September 5th, the SEC announced settled enforcement actions against five RIAs for violations of the Custody Rule, Rule 206(4)-2 under the Advisers Act and/or Form ADV disclosures relating to their custody practices.[2] On September 6th, the SEC’s Division of Examinations (“EXAMs”) published a risk alert (the “Alert”) providing insight into EXAMs’ risk-based approach for selecting RIAs for examination and the initial scope of such examinations.[3] Finally, on September 11th, the SEC announced settled enforcement actions against nine RIAs for Marketing Rule violations, indicating the continuation of an ongoing Marketing Rule sweep.[4] We explore these developments and provide key takeaways below.

Examinations Risk Alert

In a welcome act of transparency, EXAMs published the Alert to explain how it may select an RIA for an examination. The Alert outlines EXAMs’ risk-based selection process, which broadly considers whether an RIA engages in any practices that the staff believes may present a heightened compliance risk. Specifically, the Alert notes that the staff may consider:

(1) prior examination observations and conduct, significant fee- and expense-related issues, and significant compliance program concerns;

(2) supervisory concerns, such as disciplinary history of associated individuals or affiliates;

(3) tips, complaints, or referrals involving the RIA;

(4) business activities of the firm or its personnel that may create conflicts of interest, such as outside business activities and the conflicts associated with RIAs dually registered as, or affiliated with, brokers;

(5) the length of time since the RIA’s registration or last examination;

(6) material changes in an RIA’s leadership or other personnel;

(7) indications that the RIA might be vulnerable to financial or market stresses;

(8) news reports that may involve or impact the RIA;

(9) data provided by certain third-party data services;

(10) the disclosure history of the RIA; and

(11) whether the RIA has access to client and investor assets and/or presents certain gatekeeper or service provider compliance risks.

Additionally, the Alert includes an attachment that identifies typical records and information EXAMs staff will initially request in an examination. This typical request list outlines many required records that should be familiar to RIAs in light of their recordkeeping obligations pursuant to Rule 204-2 under the Advisers Act (e.g., financial records, trade blotters, policies and procedures, advertisements, and disclosure documents). However, the request list also identifies other more nuanced areas of risk-based focus, for example: (i) remote office and/or independent advisory contractor oversight process; (ii) electronic access controls; and (iii) composite account performance information, including current and terminated composites and composite returns. RIAs that wish to fully prepare for SEC examinations should identify and organize their records and other information that pertain to these focus areas (if relevant to their business) to make them readily accessible.

Marketing Rule Enforcement Actions

As we reported last year, the SEC signaled its intent to promptly examine RIAs for compliance with the recently adopted Marketing Rule. Such examinations have now culminated in a series of enforcement actions.[5] The SEC’s settled order against Titan Global Capital Management USA LLC alleged that this RIA used hypothetical performance metrics in advertisements that were misleading because the advertisements failed to disclose certain assumptions, risks, and limitations of these metrics, among other compliance violations. The SEC assessed approximately $1 million in civil penalties and disgorgement. In the nine other settled Marketing Rule enforcement actions, the SEC alleged that the RIAs in question presented hypothetical performance (as defined in Advisers Act Rule 206(4)-1(e)(8)) to the general public on their websites[6] without adopting and implementing policies and procedures reasonably designed to ensure that the performance was relevant to the likely financial situation and investment objectives of the intended audience, as required by the Marketing Rule.[7] Importantly, while the Marketing Rule does not expressly prohibit the dissemination of hypothetical performance to the general public, the SEC effectively took this position in the Rule’s adopting release, noting that “advisers generally would not be able to include hypothetical performance in advertisements directed to a mass audience or intended for general circulation.”[8] In addition, in two of the settled orders, the SEC alleged that the RIAs failed to maintain copies of each advertisement as required under Advisers Act Rule 204-2(a)(11). In one order, the RIA was reprimanded because it was unable to produce records of each version of its website that it had published during the examination period.[9] In the other, the RIA was unable to produce required records because it had failed to ensure that its advertisements had been archived by an outside service provider.[10]

Custody Rule and Form ADV Enforcement Actions

In the SEC’s recent enforcement actions relating to custody, the SEC alleged that certain of the RIAs failed to distribute annual audited financial statements prepared in accordance with GAAP to investors in certain private funds that it advised within 120 days of the fund’s fiscal year, as required by Rule 206(4)-2(b)(4).[11] The SEC also alleged that certain of the RIAs failed to update a response to their Form ADVs regarding the status of their Custody Rule financial statement audits. Section 7.B.23(h) of Form ADV requires an investment adviser to state whether all of the audit reports prepared by the auditing firm for each of its advised funds, since the adviser’s last annual updating amendment, contained unqualified audit opinions. The private fund investment adviser must state “Yes,” “No,” or “Report Not Yet Received.” Form ADV also states that “[i]f you check ‘Report Not Yet Received,’ you must promptly file an amendment to your Form ADV to update your response when the report is available.” In the orders, the SEC alleged that the RIAs violated Rule 204-1(a) under the Advisers Act because they did not file a Form ADV amendment to update the response to Section 7.B.23(h) until roughly a year after receiving the audit opinion. The SEC brought enforcement actions against numerous RIAs last year for similar violations, indicating that the staff is actively monitoring Form ADV filings for these issues.[12]

Key Takeaways

• RIAs should familiarize themselves with the document request list attached to the Alert and maintain the identified information organized and easily accessible. RIAs should consider themselves on notice that EXAMs staff will expect RIAs to have these records available for prompt production (i.e., within 24 hours of a document request).[13] The EXAMs staff may be less willing to grant document production extensions, especially with respect to the types of information identified in the Alert.
• The SEC has provided numerous warnings to RIAs regarding the new Marketing Rule. Since the SEC characterizes the Marketing Rule examination sweep as ongoing, RIAs should immediately assess the state of their Marketing Rule compliance and be prepared for examination.
• The SEC and its staff have long viewed hypothetical performance with skepticism. RIAs should expect that the new Marketing Rule will encourage SEC staff to further scrutinize these matters. RIAs that include such performance in advertisements should, at a minimum, avoid presenting hypothetical performance to a general audience and develop extensive controls and disclosures.
• As noted above, the Custody Rule is a top priority for SEC staff. RIAs relying on any exceptions from self-custody restrictions—such as the private fund GAAP audit approach—should refresh their processes and make certain these are accurately reflected in Form ADV filings.

[1] See In the Matter of Titan Global Capital Management USA LLC, Rel. No. IA-6380 (Aug. 21, 2023).

[2] See SEC Charges Five Advisory Firms for Custody Rule Violations (Sept. 5, 2023).

[3] See Investment Advisers: Assessing Risks, Scoping Examinations, and Requesting Documents, SEC Division of Examinations Risk Alert (Sept. 6, 2023).

[4] See SEC Sweep into Marketing Rule Violations Results in Charges Against Nine Investment Advisers (Sept. 11, 2023).

[5] See Marketing Rule Implementation – Are You Ready for November 4th? MoFo Client Alert (Sept. 23, 2022).

[6] Since RIAs must disclose all of their business websites on Form ADV Part 1, SEC staff is able to scan RIAs’ websites for certain items, including hypothetical performance, without necessarily opening an examination.

[7] See Advisers Act Rule 206(4)-1(d)(6)(i).

[8] See Investment Adviser Marketing, Rel. No. IA-5653 at 220 (Dec. 22, 2020).

[9] See In the Matter of Macroclimate LLC, Rel. No. IA-6409 (Sept. 11, 2023).

[10] See In the Matter of MRA Advisory Group, Rel. No. IA-6411 (Sept. 11, 2023).

[11] See Rule 206(4)-2(b)(4). This provision—the audit exemption—provides an alternative to complying with certain requirements of the Custody Rule for investment advisers to limited partnerships or other types of pooled investment vehicles.

[12] See SEC Charges Two Advisory Firms for Custody Rule Violations, One for Form ADV Violations, and Six for Both (Sept. 9, 2023).

[13] Rule 204-2(g)(2)(ii) requires that RIAs provide records to the SEC or its staff “promptly” upon request, which the SEC interprets as within 24 hours. EXAMs staff frequently provide more time to RIAs to produce records.