Branch Office Supervision in Light of OCIE Guidance

On Monday, OCIE released a Risk Alert focused on their recent observations from focused examinations of investment advisers that operate out of multiple locations or branch offices. I provided a summary of that guidance here.

So what does this mean for investment advisers who operate multiple offices or branch offices? Advisers should review their policies and procedures and determine whether they sufficiently address business being conducted at these offices. Firms should consider the following:

Code of Ethics

  • Are “access persons” at these offices subject to the firm’s Code of Ethics?
  • Do employees prepare and submit initial holdings reports, quarterly transaction reports, and annual holdings reports?
  • Do employees at these offices report their gifts and entertainment appropriately?
  • Does the office have sufficient policies and procedures to prevent insider trading?
  • Is the business aware of and does it understand all outside business activities engaged in by employees?
  • Is the business tracking political contributions of branch office employees?

Advertising and Communications with the Public

  • Does the business treat advertisements and marketing activity consistently across branch offices?
  • Is social media use and review comparable across branch offices?
  • Are advertisements reviewed and approved in a similar manner?
  • Are performance presentations reviewed by the headquarters? Are backtested performance presentations being used without knowledge?
  • Are third-party rankings or awards being used in advertisements without approval?
  • How are client complaints handled at branch offices?
  • Are electronic communications (both internal and external) handled similarly?

Custody Related Issues

  • Does the business have policies and procedures to identify instances where a branch office activity could deem the business to have custody under Rule 206(4)-2?
    • Most commonly, I see issues in:
      • identifying “related persons” that may be deemed to have custody under the rule;
      • not identifying employees that have agreed to serve as trustee or executor for non-familial clients;
      • serving as a general partner or manager of a private investment vehicle;
      • receiving checks that are inadvertently made payable to the business or receiving stock certificates from clients;
      • obtaining check writing authority from clients;
      • obtaining login credentials to a client’s bank or brokerage account that provides the employee with ability to transfer assets; and
      • maintaining authority over a client’s managed account that provides broad disbursement authority without compliance with no-action guidance issued by the Staff.
  • If the branch office is deemed to have custody, does the business have policies and procedures to comply with Rule 206(4)-2?
    • Are client funds or securities maintained with a qualified custodian?
    • If you open an account with a qualified custodian on your client’s behalf, either under the client’s name or under your name as agent, do you notify the client in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, promptly when the account is opened and following any changes to this information?
    • Do you have a reasonable basis, after due inquiry, for believing that the qualified custodian sends an account statement, at least quarterly, to each of your clients for which it maintains funds or securities, identifying the amount of funds and of each security in the account at the end of the period and setting forth all transactions in the account during that period?
    • Are the client funds and securities subject to an actual examination annually by an independent public accountant (or do you rely on the limited partnership audit exception)?

Investment Advice, Disciplinary Histories, and Litigation Risks

  • Do you have policies to identify and document instances of disciplinary or litigation events?
  • Do you have procedures to closely monitor individuals with disciplinary or litigation histories with a view towards how they render advice?
  • Have clients been notified of employee disciplinary events requiring disclosure under Form ADV Part 2B?
  • Especially when representatives serve as portfolio manager, but in all instances, have clients received appropriate disclosure of the strategy being managed by their portfolio manager?
  • Does the firm disclose all material conflicts of interest associated with rendering of investment advice at branch offices?
    • Are representatives at branch offices recommending investments where they have a material ownership interest or business relationship?
    • Are representatives receiving any type of kick-back or revenue sharing for recommending an investment?
    • Are representatives selecting or recommending non-optimal securities for a client (such as more expensive share classes)?
    • Are disclosures regarding wrap fee programs accurate? Has the business disclosed additional fees and expenses, including potential trade away fees?
  • Does the business automatically rebalance client accounts, and if so, does the business take steps to avoid paying short-term redemption fees?

Administrative and Billing Issues

  • Does the business supervise billing performed by branch offices?
  • Does the business review advisory agreements entered into by branch offices to ensure that clients are being charged the appropriate fee?
  • Are credits and reimbursements being applied consistently?

Recommendations from the Staff

  • The Staff suggested that businesses with “centralized processes mitigated instances in which supervised persons or branch offices had independent billing options or fee arrangements that deviated from client agreements or disclosures.”
  • The Staff hinted that advisers that automate and/or centralize their review and approval of personal transaction activity and educate employees on their code of ethics and personal trading policies were better positioned for compliance.
  • The Staff intimated that uniform portfolio management and centralized trading was favorable.
  • The Staff favorably highlighted compliance testing and periodic reviews of essential activities at branch offices and focused on portfolio management, monitoring trading and management activities, and supervision that did not focus exclusively on self-reporting.

This is not intended to be a verbatim recitation of the Staff’s guidance and serves to highlight some of the key points raised by the Staff. Compliance officers and legal counsel should review the Staff’s guidance and review their policies and procedures in light of this guidance.

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