Some advisers need to plan for SEC registration

By Charles Lerner, June 13, 2010 –Investment News

Investment managers who are not currently subject to oversight by the Securities and Exchange Commission may be required to register with the SEC as the result of financial reform legislation currently working its way through Congress.

Right now, advisers with fewer than 15 clients who do not hold themselves out to the public as investment advisers don't have to register with the SEC.

Although subject to change during the reconciliation process, both the House and Senate versions of the reform bill would remove the exemption under which certain advisers are not required to register. The legislation would require an advisory firm to register with the SEC even if it has only one client, as long as it has assets under management of more than $100 million in the Senate bill, or $150 million in the House bill. (The final legislation may provide a carve out for advisers to private-equity funds and venture capital funds, family offices, and foreign advisers that have fewer than 15 clients and manage less than $25 million in assets for U.S. clients.)

Although the proposals provide a one-year grace period to register and become compliant with the Investment Advisers Act of 1940, advisers should begin to prepare for registration with the SEC by adopting a compliance program. There are four basic steps to building a regulatory compliance program that advisers should take now.

The adviser should designate a lead person to be responsible for the regulatory compliance program. Once registered with the SEC, this person or someone else should be designated as a chief compliance officer.

For smaller firms, it is not unusual to designate the chief operating officer or the chief financial officer as the CCO. No matter who fills this role, the SEC expects that the CCO will be competent to fulfill the compliance oversight role. Moreover, he or she should have the ability, stature and the authority within the firm to develop and operate the compliance program.

If the designated lead compliance person is not familiar with the regulatory requirements, he or she should begin the education process. The SEC's website provides valuable information
( In addition, many law firms provide guidance and regular updates on regulatory requirements. The designated person or CCO might also want to attend one of the industry-sponsored compliance conferences to obtain an overview of compliance requirements and developments.

A registered adviser will be required to adopt a code of ethics that:

• Sets forth the standards of ethical conduct expected by the adviser and its employees.

• Requires personnel to report their personal securities holdings.

• Requires that certain employees designated as “access persons” (due to their access to and involvement in the investment decision-making) obtain pre-approval for the purchase of securities from an initial public offering or private placement (such as the purchase of hedge funds).

• Requires the internal reporting of violations of the code of ethics.

• Requires each employee to acknowledge in writing the receipt of the code of ethics.

The adviser needs to have written policies and procedures designed to prevent, detect and correct violations of the Advisers Act. They should be specifically crafted to fit the particular adviser, but should generally cover:

• The portfolio management process.

• Disclosures made to investors and clients.

• Personal trading activities of the firm's personnel.

• Custody of clients' assets.

• The making and maintenance of books and records.

• Confidentiality of information; trading practices, including best execution, “soft dollar arrangements” and allocations of trades among clients.

• Valuation of assets.

• Business continuity.

Although off-the-shelf compliance manuals are available, the adviser should ensure that the policies that are crafted fulfill its business and compliance needs. Policies for an adviser with few employees and a smaller amount of dollars under management, where the adviser does not engage in frequent trading, will differ from those of a large, multioffice, active-trading firm.

The CCO periodically should monitor and test the adviser's business operations to detect non-compliance and ensure that the compliance policies and procedures are being followed. Such test
areas should include portfolio management and trade allocation, brokerage arrangements and execution, personal trading, valuation, marketing and performance advertising.

The CCO should also ensure that the investment guidelines for client accounts are being followed and that traders do not engage in manipulative or other improper trading activity. In addition, the CCO should make sure that the other practices required of advisers, as set forth in the adviser's compliance policies and procedures, are followed.

The adviser may need to acquire systems as add-ons to its current system to enable the compliance review of the adviser's securities trading and positions.

Finally, once the compliance program is in place and the adviser is prepared for a possible SEC review, the adviser can register with the SEC by electronically filing Form ADV I. This filing sets forth factual information, listing the adviser's name and address, number of employees, types and number of clients, dollar amount of assets under management, identification of persons that control and manage the adviser, regulatory or disciplinary actions by regulators, etc.

The adviser must also prepare (but is not required at this time to file with the SEC) an informational brochure called Form ADV II, which includes more descriptive information about including such practices as the guidelines used for proxy voting, a description of the investment decision-making process, the fees charged by the adviser, and the firm's requirements in the code of ethics. This second document must be made available to the adviser's clients.

Advisers who will be required to register with the SEC as a result of the pending legislation need to prepare now, as developing and implementing the required compliance program takes time.

Charles Lerner is the founder and principal of Fiduciary Compliance Associates LLC, which provides compliance consulting to investment advisers. For further information visit