SEC Rule 206(4)-7 requires investment advisers to review, no less frequently than annually, the adequacy of its written compliance policies and procedures and the effectiveness of their implementation. The SEC expects annual reviews to take into consideration any compliance matters that arose during the previous year, any changes in the business activities of the adviser or its affiliates, and any changes in the Investment Advisers Act or related rules that may impact the adviser’s policies and procedures. In addition, the SEC expects that an investment adviser will review its compliance policies and procedures on an interim basis in response to significant compliance issues, changes in business activities, and new regulation.
An investment adviser that does not adopt and implement written procedures exposes itself and its management personnel to significant disciplinary action for failure to supervise. Conversely, an investment adviser that adopts and implements written procedures greatly minimizes its exposure to failure-to-supervise liability. According to a safe harbor found in section 203(e) and (f) of the Advisers Act, a person cannot be deemed to have failed to reasonably supervise another person if:
- there have been established procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect, insofar as practicable, any such violation by such other person; and
- such person has reasonably discharged the duties and obligations incumbent upon him by reason of such procedures and systems without reasonable cause to believe that such procedures and system were not being complied with.
Considering the importance of having effective written procedures, Firms should conduct the annual review with the aim of verifying that its supervisory system is reasonably designed to afford it and its management personnel safe harbor protection from failure to supervise.
Firms should complete various reviews that are designed to detect matters of non-compliance. Material compliance matters, if any, should be described in the review that identified the compliance matter, including applicable corrective actions taken.
Firms should perform periodic compliance reviews throughout the year that are designed to identify material changes that would require the Firm to update its Form ADV or amend its written procedures. Material changes in business, if any, should be described in the documentation associated with the reviews, including any changes to procedures and/or supervision.
Firms must consider any applicable changes in the legal, regulatory, and business environment. To keep current on changes that could affect the Firm, the Chief Compliance Officer must receive and review communications and other helpful information from compliance professionals. These matters should be reviewed constantly and address matters prior to any changes taking effect. This way the firm can proactively take measures to implement new procedures and policies to mitigate risk. Firms’ policies and procedures should require the Chief Compliance Officer (“CCO”) to complete a risk matrix in conjunction with the annual review.