Bates Research | 12-11-20

Multi-Branch Office Supervision and Compliance – OCIE Details Deficiencies

Last month, OCIE released a Risk Alert urging SEC-registered investment advisers to consider the “unique risks and challenges presented by “employing a business model that includes numerous branch offices and business operations that are geographically dispersed.” The OCIE observations stem from a December 2016 initiative (“Multi-Branch Initiative”) examining advisers that conduct business out of ten or more branch offices. The advisers continue to be an area of focus to date because they “often serve retail customers” and “have unique risks and challenges related to design and implementation of their compliance programs and oversight of advisory services provided through remote offices.” Although COVID-19 was not the basis for the alert—the data and observations came from the initiative, which ended in 2018 (see fn. 2 in the alert)—the pandemic undeniably added urgency to issues around remote supervision and compliance. This pushed the topic higher on the list of areas OCIE is continuing to monitor, including “telework conducted from dispersed remote locations.” OCIE “will provide its observations to its colleagues in the Division of Investment Management.”

Last week, Bates focused on OCIE recommendations based on observed deficiencies concerning adviser obligations required under the Compliance Rule. Consistent with that emphasis, OCIE issued this separate alert to highlight main office oversight of (i) branch office compliance programs and practices (applicable to, for example, rules on custody or ethics) and fiduciary obligations related to fees, expenses and advertising; and (ii) supervision of branch office personnel that provide investment advice to clients (including the formulation of recommendations and conflicts disclosures).

Here’s a closer look at OCIE’s findings and and warnings to firms overseeing multi-branch office compliance.

Compliance

OCIE found multiple deficiencies in branch office compliance programs and practices, and in the fiduciary obligations of advisers. Here are some of the findings:

Custody Issues – Advisers violated the “Custody Rule” by, among other things, failing to have adequate policies and procedures that limited the ability of supervised persons to process transactions in client accounts and to ensure consistent application of rules across the firm.
Fees and expenses – Advisers failed to have branch office policies and procedures to remediate overcharges or to consistently apply fees.
Supervision – Advisers failed to adequately supervise branch office personnel leading to multiple compliance deficiencies related to material disclosures, best interest recommendations on mutual fund share classes, best execution and trading, and documentation of disciplinary events for personnel with higher-risk profiles.
Advertising – Advisers failed to adequately address issues arising from branch offices operating under a different name (i.e. D/B/A) and by supervised persons located in branch offices. These included presentations which omitted material information, disclosures of inaccurate credentials and other unsupported claims.
Code of Ethics – Advisers breached their Code of Ethics, with failures affecting transaction reporting and proper review, identification of access persons, and procedural omissions which allowed supervised persons to invest inappropriately in limited or private offerings.

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Supervision of Advisory Activities Across Multi-Branch Offices

OCIE found multiple deficiencies in branch office portfolio management. Generally, these related to ineffective oversight of investment decisions, failures to disclose conflicts, and inadequate supervision of decisions on trading allocations. Specifically, OCIE highlighted deficiencies associated with oversight and disclosures on mutual fund share class selection recommendations (the subject of a successful SEC enforcement initiative - see Bates alert) and wrap fee programs. Observed failures involved inadequate best interest assessments, erroneously charged commissions, inadequate disclosures, insufficient oversight of “trading away practices,” and poor monitoring practices.

In addition, OCIE identified deficiencies related to “automated account rebalancing” which prompted redemption fees from mutual funds and failures to disclose fees associated with automated processes. OCIE also identified conflicts of interest related to “expense allocations that appeared to benefit proprietary fund clients over non-proprietary fund clients.” Finally, OCIE raised issues concerning adviser compliance failures on trading and allocation practices. These deficiencies highlighted insufficient documentation (including failures to provide any analysis that would satisfy best execution requirements), client consent and associated monitoring failures.

OCIE Recommendations

OCIE offered several recommendations that could assist advisers in designing and implementing policies and procedures under the Compliance Rule. These include the adoption of written compliance practices and procedures applicable to all office locations and all supervised persons, and tailored compliance practices necessary for effective branch office oversight, among others.

Best practice recommendations included the development of uniform policies and practices on advertising, client fee billing, portfolio management and monitoring, as well as requiring approval for personal trading activities for all supervised persons located in all office locations. OCIE also recommended compliance testing and periodic compliance reviews of key activities at all branch offices. Consistent with earlier recommendations, OCIE suggested further that advisers establish hiring practices that include “disciplinary event” checks and ensuring the accuracy of disclosure of such information. Finally, OCIE emphasized the importance of periodic compliance training for branch office employees.

Conclusion

While OCIE’s previous Compliance Rule alert covered a broad range of adviser compliance concerns, this Multi-Branch alert is, in some ways, a reminder that some of the greatest compliance weaknesses come from the geographic separation of remote offices and the “unique” complexity of supervising personnel in those offices. While the alert is based on pre-COVID data, the fundamental issues it raises are well known. The urgency for firms to tighten their compliance regimes across multi-branch business operations has grown. As a result, expect future examinations to likely focus on these weaknesses.

About Bates Compliance:

Bates Compliance delivers guidance and tailored compliance consulting solutions to our broker-dealer, investment adviser and hybrid firm clients on an as-needed or ongoing basis. Our team—made up of experienced senior compliance, legal and former regulatory professionals—drafts and tests policies, procedures, and supervisory and compliance processes, recommending and implementing changes based on leading practices to enhance compliance and supervisory systems and to remediate regulatory, litigation and internal audit findings. Bates Compliance consultants prepare clients for branch exams and conduct mock SEC reviews.