Ways Investment Advisers Can Limit Regulatory Investigations Risk

3 Ways Investment Advisers Can Limit Exposure to Regulatory Investigations

Investment advisers face considerable regulation and should follow best practices for best execution.

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By Rich Fachet, vice president of financial institutions at Argo Pro

Investment advisers help secure the future of their clients, and they work under a significant amount of regulation. And while the cost of operating in a regulated environment is already high, there’s another potential cost on top of that: regulatory investigations.

If an adviser is subject to a regulatory investigation and lacks sufficient coverage, he or she can suffer financial loss – and reputational damage.

A July 2018 risk alert from the Office of Compliance Inspections and Examinations (OCIE) of the U.S. Securities and Exchange Commission gave numerous examples of issues found during examinations of advisers’ compliance with their best execution obligations. To promote compliance, the OCIE encourages advisers to scrutinize their own adviser compliance programs and revise them where necessary.

Here are three things investment advisers can to do limit exposure to regulatory investigations.

1. Set clear policies and procedures at all levels.

This is essential, not only for in-house operations but also for third-party service providers. But it’s not enough to simply set policies and procedures; they must be monitored and enforced to minimize errors that can lead to claims.

Investment advisers should:

  • Use due diligence in the selection of third-party service providers or broker-dealers. This includes regularly checking the execution quality of transactions handled by these providers.
  • Perform best execution reviews of broker-dealers, paying attention to their financial responsibility, execution capability and responsiveness to the adviser.
  • Seek and review input from traders and portfolio managers.

2. Be transparent with your investors.

In a word, disclose. In the spirit of transparency, be up front. This will strengthen your investors’ confidence in you and encourage open communication. One area the SEC is focused on is fee disclosure, including:

  • Making sure all fee arrangements are properly disclosed.
  • Fully disclosing best execution practices to ensure fair pricing.
  • Disclosing soft-dollar arrangements as well as any proprietary fee arrangements.

3. Obtain comprehensive insurance coverage.

Although following policies and procedures helps to eliminate errors, it isn’t fail-safe. That’s why investment advisers should give themselves the added protection of insurance coverage for situations they believe could lead to a claim. The following are some of the essentials for today’s environment – and all are available with Argo Pro’s new Asset Management PROtectSM.

  • Pre-claim defense coverage gives advisers an opportunity to proactively engage with their insurance carrier earlier in the claims process by giving notice of a potential claim before it occurs. This kind of pre-claim coverage can offer additional expense coverage prior to a formal regulatory investigation.
  • Third-party cyber coverage is essential in today’s world. After all, cybersecurity is the top compliance challenge for registered investment advisers, according to a 2018 Investment Adviser Association survey.
  • Built-in cost of corrections coverage, or trade error coverage, provides investment advisers with added protection against reputational harm from an accidental trade error.
  • A specialty claims team that includes attorneys who can provide expert advice in-house is part of an efficient solution for advisers.

Investment advisers continue to face evolving challenges. Having the right coverage in place and the right resources available – and following the best practices above – will go a long way toward managing the weight of organizational risk.