Rule 206(4)-7 requires SEC-registered investment advisers to undertake an annual review of its policies and procedures. Advisers were required to adopt and implement written policies and procedures by October 2004. The goal of adopting policies and procedures was, and is, to effectively ensure compliance with the Investment Advisers Act of 1940 (“Advisers Act”). Following their adoption, advisers were given eighteen months to conduct a first annual review of the polices and procedures ensuring the goal of preventing violation of the Advisers Act was being achieved. Assuming Advisers waited until the October 5, 2004, deadline to implement their policies and procedures, the first annual review deadline is April 5, 2006. For many reasons, both regulatory and policy, it is the Chief Compliance Officer (“CCO”) who shoulders the burden of the review. Though the CCO may delegate certain responsibilities of the review, it is recommended that the CCO have intimate knowledge of the firm’s operations in order to effectively manage and implement the review process.
The goal of the annual review should be twofold. First, a CCO wants to review the policies and procedures for effectiveness in fulfilling their goal of Advisers Act compliance. Following confidence that given the adviser’s business operations the policies and procedures continue to effectively reflect the latest regulatory environment, the second goal of the CCO should be to ensure the office mirrors the written policies and procedures that are in place, and vice versa. The CCO should document all steps of the review process.
First, determine the effectiveness of the adviser’s written policies and procedures. The goal is to ensure they generally address the minimum areas of concern the SEC outlined and that any area specific to the adviser’s business is addressed. Minimally, confirm the following are addressed:
1) Portfolio management process, including allocation of investment opportunities among clients and consistency of portfolios with clients’ investment objectives, disclosures by the adviser, and applicable regulatory restrictions;
2) Trading practices, including procedures by which the adviser satisfies its best execution obligation, uses client brokerage to obtain research and other services (“soft dollar arrangements”), an allocates aggregated trades among clients;
3) Proprietary trading of the adviser and personal trading activities of supervised persons;
4) The accuracy of disclosures made to investors, clients, and regulators, including account statements and advertisements;
5) Safeguarding of client assets from conversion or inappropriate use by advisory personnel, including related custody issues;
6) The accurate creation of required records and their maintenance in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction;
7) Marketing advisory services, including the use of solicitors;
8) Processes to value client holdings and assess fees based on those valuations;
9) Safeguards for the privacy protection of client records and information; and
10) Business continuity plans.
After confirming the written policies and procedures adequately address these areas, the CCO should ensure that each section specifically focuses and explores the areas of the advisers business that are particularly implicated and, thus, require further attention. The CCO should go through each of these sections and ask, “Is our business particularly concerned by this section,” or, “Has our firm entered a new line of business that requires a particular section be expanded to discuss the particular procedural safeguards the firm has put in place to address the particular regulatory concern encompassed by such business.” Thus, for example, does the adviser’s written policies and procedures of an adviser whose business aggregates trades, comprehensively discuss the procedures in place for the proper allocation of those trades?
Second, the adviser wants to ensure the firm’s day-to-day business mirrors the written policies and procedures. This is accomplished by incorporating safeguards in each area of regulatory concern that physically demonstrates the adviser is cognizant of its regulatory duties as it performs its advisory business on a day-to-day basis. Mirroring the written policies and procedures with the firm business can include simple checklists in place to ensure an area of the written policies and procedures manual is actually being addressed in practice, or it can include an audit of a particular area of the business to ensure that compliance is occurring. Whatever the process in place, the CCO should record the actual process and include the particular “check” within the manual. For example, if it is a checklist, on a regular basis the CCO should review the checklist and include copies of the checklist or signoffs in the manual. Or, if it is an audit that is required, include a written audit summary in the manual following its occurrence. Continuing with our example above, where we confirmed that an adviser whose business aggregates trades has addressed the procedures in the manual for the proper allocation of those trades, the adviser should mirror the manual with a specific process documenting that the proper allocation of trades has been incorporated. This can include any review process, checklist, etc. These internal processes ensure the regulatory language of the manual has a physical presence to capture the relevant regulatory concern. In addition, it provides a simple process with which to perform the annual review. In this way the CCO can review a particular area of the written policies and procedures once every couple of weeks, and thus spread out the annual review process over the course of a year.
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