What not to do during a state or SEC audit

It was the comic strip character, Pogo, who said, “We have met the enemy and he is us.” Although the creator of that comic, Walt Kelly, was not talking about investment advisers, the statement may also apply to advisory firms. Sometimes, investment advisers are their own worst enemy during a compliance examination.

No matter which securities regulator knocks on your door, compliance examinations are no laughing matter. Even though serious questions remain as to which entity will oversee registered investment advisers (“RIAs”), there are a number of rules you can follow in dealing with examiners. At a minimum, RIAs should avoid sabotaging their regulatory exam.

1. Check the confrontational attitude

On occasion, investment advisers take a confrontational approach with examiners. Instead of being cooperative and helpful, an adviser might make the mistake of debating compliance issues with examiners. Compliance examiners do not expect advisers to be argumentative like the couple in the Lockhorns comic strip.

When investment adviser representatives (“IARs”) are abrasive in their dealings with examiners, the outcome of the exam will not be pretty. The examination may become more adversarial, and examiners might dig more deeply than would otherwise be the case. Furthermore, when IARs are pushy or hostile in their dealings with regulators, examiners might wonder if they are equally aggressive with clients. If there are client complaints against the RIA or IARs, examiners will be much more inclined to believe them. In addition, examiners may be less likely to give the benefit of the doubt to the RIA.

See: Elizabeth witnesses a mock audit first hand and feels the advisor’s pain.

2. Don’t bring up the last exam or other advisors’ practices

Advisers sometimes argue that the last examiner did not point out a particular deficiency during a prior regulatory exam, so it should not be a problem now. The fact that a problem was overlooked during a prior exam does not mean you are in compliance with applicable rules and regulations. Similarly, the fact that another adviser is engaging in the same conduct does not make it compliant. For example, you won’t help your cause by showing examiners other RIA websites that are just as noncompliant as yours is.

3. Don’t be condescending toward your clients

Some IARs demonstrate a condescending attitude toward current and prospective clients, and examiners will pick up on that vibe. After being criticized that his marketing materials won’t be understood by unsophisticated investors, one IAR defended himself by saying that these individuals will never understand the firm’s investment strategy. He argued that if they understood investing, there would be no need to hire an advisory firm.

Examiners will not buy that argument and expect IARs to make a good faith effort to explain their strategies in terms that a layperson can understand. Furthermore, examiners might infer that if you are not explaining your strategies in plain English, you probably are not disclosing the risks in a meaningful way.

4. Don’t torture examiners

When examiners set up shop in your office for a few days or longer, treat them with the respect they deserve. They should be given a comfortable office or conference room to work in, not a tiny cubicle that looks like the one that Dilbert calls home in the comics. Make sure that coffee and other amenities are available.

One person, preferably the RIA’s chief compliance officer, should be the go-to person for all questions raised by examiners. If the examination team asks for documents and client files, the designated person should retrieve them. Otherwise, examiners might go wandering through the office asking questions and could observe other compliance issues that concern them. Ideally, your point person will be responsive and energetic, not egotistical and smug like Garfield, the comic strip cat that later became a big movie star. In fact, everyone at your firm should avoid comments or body language implying that they can’t be bothered and examiners are interfering with their work.

To avoid being your own worst enemy during an exam, make certain that examiners leave your office knowing that you and your staff are committed to compliance. Your actions and demeanor should assure them that your firm is working hard to be compliant and will correct any deficiencies found. No matter what the results are, you’ll at least know you did not sabotage the examination.

Les Abromovitz is a senior consultant with National Compliance Services, Inc. He wrote about the new ADV form a few months ago: Now, the SEC wants you to be a writer, too?. Les, an attorney, is the author of Growing Within the Lines: The Investment Adviser’s Advertising and Marketing Compliance Guide (Available on Amazon.com or through NationalUnderwriterStore.com). He can be reached at 561-330-7645, Ext. 213, or at LAbromovitz@ncsonline.com.