RIA SEC Compliance: Frequently Asked Questions

Various SEC compliance rules and regulations govern Registered Investment Advisors (RIAs), and several amendments have been introduced for existing RIA rules and regulations to adapt to changing circumstances. This article will provide answers to frequently asked questions about RIA compliance requirements, including SEC’s electronic record-keeping requirements, new marketing, and custody rules.

Frequently Asked Questions (FAQ)

What is the SEC rule 206(4)-7? 

The SEC rule 206(4)-7 (Compliance Programs for Investment Companies and Investment Advisors) requires RIAs to satisfy the following three requirements:

1. Establish Policies and Procedures – The SEC’s new rule 206(4)-7 under the Advisers Act and new rule 38a-1 under the Investment Company Act require each ria to adopt and implement written policies and procedures to prevent violations of SEC compliance rules. Failure to maintain adequate compliance policies and procedures is deemed a compliance violation. 
2. Perform an Annual Review – RIAs must conduct an annual review of established policies and procedures and assess the adequacy and effectiveness of those implementations.
3. Appoint a Chief Compliance Officer (CCO) – According to Rule 38a-1, RIAs must appoint a CCO to administer the policies and procedures implemented in 1. The SEC compliance officer should have the required knowledge of federal securities laws and the full responsibility and authority to develop and enforce appropriate policies and procedures. 

What is SEC Rule 204-2? 

The SEC has amended rules related to electronic recordkeeping by registered investment companies and advisers. Under revised rules 31a-2 and 204-2, they can maintain records electronically if they satisfy the following requirements.

1. Protect the records from alterations, destruction, or loss.
2. Establish access controls by only allowing authorized personnel to access them.
3. The electronic copies of non-electronic originals must be complete, true, and legible.

This amendment includes all records that must be maintained and preserved by any rule under the Investment Company or Advisers Acts. Thus, if RIAs keep records electronically, they must comply with the above conditions.

What are the amendments introduced to the SEC’s Custody Rule? 

An RIA has custody if the company keeps client funds or securities or can directly or indirectly possess such assets. Such RIAs must comply with the amendments introduced to the SEC’s custody rule. The Custody rules require RIAs who keep custody of client assets to ensure the following:

1. A qualified custodian is employed to maintain the client’s assets
2. Written notification should be sent to the client when the investment adviser at a qualified custodian opens an account on a client’s behalf
3. Have a valid assumption that the qualified custodian sends quarterly account statements to the clients
4. Ensure client funds and securities are verified using at least a yearly examination per a written agreement between the investment adviser and an independent public accountant. The examination must be held without prior notice to the investment adviser.

The purpose of custody rules is to prevent the misuse of client assets by their investment adviser. Thus, RIAs should never keep client funds or securities without implementing proper procedures to comply with the rules and regulations of the SEC custody rule.

What is the SEC’s new Marketing Rule (206(4)-1)? 

The SEC modernized the rules governing investment adviser advertisements and payments to solicitors by creating a single marketing rule (Rule 206(4)-1), replacing the existing advertising and cash solicitation rules. Following are the highlights of the amendments they have made.

1. Amendments to the Definition of Advertisement.
2. General Prohibitions
3. Testimonials and Endorsements – Using testimonials and endorsements in an advertisement is prohibited without satisfying disclosure, oversight, and disqualification provisions.
4. Third-Party Ratings – Including third-party advertising ratings is prohibited unless certain criteria are satisfied and related disclosures are provided.
5. Prohibitions on including performance information – Including gross performance without net performance, performance results unless they are provided for specific periods, hypothetical performance without satisfaction criteria, etc. 
6. Amendments to Books and Records – RIAs must comply with the books and records rules, including filing an amended Form ADV about their marketing practices and keeping true, accurate, and current copies of advertisements and disclosures.

Which firms are subject to the SEC’s new marketing rule?

The SEC’s new marketing rule applies to all registered investment advisers or investment advisors required to be registered with the SEC. It does not apply to the following types of investment advisors.

• Exempt reporting advisers (ERAs)
• Investment advisors who are not required to register with the SEC
• Marketing of registered investment companies
• Marketing of business development companies

How has the definition of “advertisement” changed under the SEC’s new marketing rule?

The definition includes any direct or indirect communication RIA makes that offers investment advisory services or new investment advisory services. This excludes most one-on-one communications and contains certain other exclusions. The definition also includes any endorsement or testimonial for which an adviser provides cash and non-cash compensation directly or indirectly.

What are the “general prohibitions” under the SEC’s new marketing rule?

• Making an untrue statement of a material fact or omitting a material fact necessary to make the statement made, in light of the circumstances under which it was made, is not misleading;

• Making a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the SEC;

• Including information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the adviser;

• Discussing any potential benefits without providing fair and balanced treatment of any associated material risks or limitations;

• Referencing specific investment advice provided by the adviser that is not presented in a fair and balanced manner;

• Including or excluding performance results or presenting performance periods in a manner that is not fair and balanced; and

• Including information that is otherwise materially misleading.

Under the SEC’s new marketing rule, what is the “performance information” prohibited?

1. Gross performance, without net performance
2. Approved statements or reviewed performance results by the commission
3. Including performance results 

• If they are not provided for specific periods

• If they are from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered in the advertisement, with limited exceptions

• If they are a subset of investments extracted from a portfolio, unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio;

  4. Including hypothetical performance, 

• if the adviser does not adopt and implement policies and procedures to ensure that it is relevant to the likely financial situation and investment objectives of the intended audience, 
• If the adviser does not provide the required information on the hypothetical performance

5. Predecessor performance

How can LeapXpert help with SEC RIA compliance?

LeapXperts’ new RIA solution enables you to easily archive client conversations over WhatsApp, iMessage, and SMS and comply with investment advisor compliance regulations. It is a fast and flexible SaaS solution developed with RIAs and their needs in mind. It is easy to enroll, has no obligation on a minimum number of seats, and onboarding only takes minutes. When all messages are archived with the LeapXpert messaging solution, RIA firms can maintain the RIA standards and reap the benefits of compliant mobile messaging with their clients.