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News September 5, 2005 Issue

What Are We Supposed to Be Doing? (The expanded version)

Remember that list of sample "to-dos" published in IM Insight on July 4, 2005?

As promised, hereís an expanded list, based on many helpful comments from industry participants. Use it to jog your memory, spark ideas, and/or give you a sense of what other firms are up to.

Many of these to-dos are not explicitly required by law and are more in the nature of industry best practices. This is not a comprehensive list. And no, CCOs, youíre not expected to do all of this yourselves. Delegate!

Portfolio Management

  • Confirm client investment objectives ("conservative growth"), mandates ("no more than 10 percent foreign"), and restrictions ("no tobacco") (initially for new clients and annually thereafter for all existing clients).
  • Identify other restrictions on the management of clientsí accounts, such as regulations tied to the nature of the client (ERISA, mutual fund), disclosures in Form ADV or prospectuses, or representations in advisory contracts (initially and annually thereafter).
  • Confirm that the investment objective/mandate selected for each client is suitable, given the clientís risk tolerance, investment horizon, and goals (initially and annually thereafter).
  • Update clientsí investment objectives/mandates/restrictions (as necessary).
  • Provide portfolio managers with reference lists of client-specific investment objectives/mandates/restrictions, and keep those lists updated (ongoing). Test the listsí accuracy (at least annually).
  • As your firm grows, consider implementing a front-end order management and compliance system to prevent violations of objectives/mandates/restrictions.
  • Conduct account audits to confirm compliance with investment objectives/mandates/restrictions (at least annually, preferably quarterly). This check should be performed by someone other than the accountís portfolio manager.
  • Review portfolio turnover rates, and trends in those rates, to identify churning or window dressing or other inappropriate levels of trading (quarterly).
  • If your firm invests in IPOs, confirm clientsí eligibility under NASD Rule 2790 to participate in "new equity issues" (initially for new clients and annually thereafter for all existing clients). The initial confirmation must be a positive affirmation by clients, subsequent annual confirmations may be done via negative consent (see Rule 2790).


  • Review trading activity for anything that looks out of the ordinary (ideally, daily). Portfolio managers should review trade records to confirm that trades were executed as intended. Someone removed from the portfolio management function should eyeball trades to identify unusual activity. Note: Some firms electronically reconcile trading instructions against executed trades (i.e., the transactions appearing in the custodial account) on a daily basis.
  • Hold periodic best execution meetings (ideally, within 45 days of quarter-end). As part of that meeting, review broker commission reports and client commission reports and identify outliers. Also consider whether to review commission recapture reports on behalf of clients.
  • Assess brokerage relationships for actual or potential conflicts of interest (initially and during the best execution meetings).
  • Compare the receipt of gifts versus the trading done with "gift givers" to evaluate for conflicts and actual or apparent quid-pro quo arrangements (during the best execution meetings).
  • Track soft dollar expenditures (monthly or quarterly).
  • Review proposed soft dollar products/services and approve if appropriate (ongoing).
  • Review any bunched trades that are reallocated from the allocation determined at the initial placement of the order (as necessary). See the SMC Capital no-action letter.
  • Review client-directed brokerage arrangements and notify any client whose selected broker appears to be performing poorly or who is charging excessive commissions (quarterly). See the SECís May 2003 case against Jamison, Eaton & Wood.
  • Review and document any cross/principal trades; confirm that appropriate notice has been given and consent obtained (as necessary).
  • Log and resolve trade errors (as necessary).
  • Confirm that your firmís ADV and contract disclosure about trading practices comports with actual practice (annually and as necessary due to the development of new trading practices/policies).
  • Confirm that order tickets meet the requirements in Rule 204-2(a)(3) (any time the format of the order ticket information is altered).
  • Review trading and soft dollar policy and procedures (at least annually). Update as business changes.


  • Confirm that illiquid stocks and bonds, and other securities where market value is not readily available, have been appropriately valued (ideally, immediately prior to valuing assets for purposes of client reporting, billing, or calculating performance).
  • Maintain adequate documentation to support any fair valuations (each time a fair valuation determination is made).
  • Conduct post-transaction reviews on the sale of hard-to-value investments to see whether the valuation assigned by your firm was fair, reasonable, and close to the price ultimately received on the sale of the investment (as necessary).
  • Immediately review any price overrides (instances where firm personnel over-rode the price provided by the firmís custodian) (as necessary).
  • Confirm that any pricing decisions made by portfolio management staff are reviewed by personnel independent of the portfolio management function (e.g., compliance or operations).
  • Review valuation policy and procedures (at least annually). Update as business changes.


  • Reconcile account positions noted by custodian against the firmís internal records (monthly).
  • If your firm has custody (for example, because it is authorized to deduct fees directly from client accounts), confirm (initially at account set-up and at least annually for all clients) that:
    • qualified custodians are being used;
    • proper notice has been provided to clients as required by Rule 206(4)-2 (at adviserís opening of custodial account and upon any change in the custodianís name, address, or manner in which the client funds or securities are being held); and
    • quarterly account statements are being sent to clients (or their independent representatives) by the qualified custodian (your firm must have "reasonable belief" that those statements are being sent ó consider requesting a duplicate copy from the custodian to confirm). If the custodian is not sending statements, your firm must do so and undergo an annual surprise verification.
  • Confirm that any funds or securities inadvertently received by your firm are returned within three business days to the sender (as necessary). Forwarding funds or securities to someone other than the sender could cause your firm to violate the custody rule.
  • If your firm is a manager to a private fund, confirm that the fund sends annual audited financials to all investors in the private fund within the required time period (120 days from the end of the fundís fiscal year for most private funds; 180 days for fund-of-funds) OR a qualified custodian is sending quarterly account statements directly to the fundís investors OR your firm sends quarterly account statements to the investors and undergoes an annual surprise verification.
  • If a surprise verification is required, confirm that it is done annually, on a truly "surprise" basis, and that the accountant has filed a Form ADV-E within 30 days of completing the verification.
  • Review custody policy and procedures (at least annually). Update as business changes.


  • Confirm that actual proxy practices conform to proxy policy and contract and ADV disclosures (at least annually).
  • Test to confirm that appropriate documentation is maintained (documents material to making a voting decision or that memorialize the basis for a decision) (at least annually).
  • Log and respond to requests for proxy information (ongoing).
  • Review for conflicts in the proxy voting process (at least annually).
  • Review proxy voting policy and procedures (at least annually). Update as business changes.

Anti-Money Laundering

  • Check clients and investments against the OFAC list (initially at account set-up or first investment and at least annually thereafter).
  • Consider developing an anti-money laundering policy. Consider whether to finalize and adopt it OR to keep in draft form. While the adoption of a formal AML policy and procedures is not yet required for most SEC-registered advisers, having a draft policy on hand will allow firms to provide something in response to examinersí requests about having an AML policy.
  • For advisers that are currently subject to AML regulations (i.e., advisers to offshore private investment funds), monitor and review the firmís AML policies and procedures, as well as those of any third-party service providers to which AML functions have been outsourced (at least annually).

Advisory Fees

  • Confirm that advisory fees are being calculated correctly (ideally, immediately before fees are assessed). When are assets valued? When is the fee deducted from the account? Was the correct fee rate used? Were performance fees calculated correctly? Were breakpoints honored? Were clients double-billed? Were any necessary credits or rebates applied to avoid double dipping?
  • Confirm that clients paying performance fees are "qualified clients" under Rule 205-3 (each time a client enters into a performance fee contract).
  • Identify any clients with "most-favored-nation" clauses and confirm that they were charged the correct management fee (at least annually).
  • Confirm that advisory fees collected in advance are returned to clients upon account termination (as necessary).

Client Disclosures / Form ADV

  • Fund IARD account (as necessary, typically annually).
  • Amend Form ADV (both Parts 1A and II) (see Form ADV Instruction 4 for what has to be done promptly and what can wait).
  • Update Form ADV on IARD (no later than 90 days after fiscal year end).
  • Replace paper copy of Part II kept in files (and electronic copy kept on firmís shared drive) with latest version of Part II (every time Part II is revised). Keep dated, historic versions of the Part II on file.
  • Provide current Part II of Form ADV (or brochure) to new clients (and for advisers with private funds, to new investors in those funds).
  • Mail updated Part II of Form ADV (or brochure) to all clients (and for advisers with private funds, investors in those funds) on an annual basis (note: while Rule 204-3(c) requires only an annual "offer," prudent practice is to mail the entire updated brochure to all clients).
  • If your firm requires prepayment of fees (more than $500 per client) six months or more in advance, provide a balance sheet to clients (annually). See Form ADV Part II Item 14 and Schedule G.
  • Confirm that all material information about the firmís precarious financial condition and past disciplinary history has been disclosed to clients, as required by Rule 206(4)-4 (see the February 2005 case of Colley Asset Management.)
  • Forget the Form ADV line items for a minute. Step back and ensure that all of the firmís material conflicts of interest have been disclosed.
  • Log and respond to requests for Part II of Form ADV (ongoing).

State Notice Filings

  • Determine the states in which your firm has to notice file (track locations of clients and your firmís office locations).
  • Make notice filings (annually).

IAR Registration

  • Determine who your firmís IARs are (first, see if they fit in Rule 203A-3(a), then look at the relevant statesí IAR definition).
  • File Form U-4 IAR registration (annually).
  • File Form U-5 IAR terminations (as necessary). Note that typically states require U-5s to be filed within 30 days of termination, however, some states impose shorter periods; see applicable state requirement(s).
  • Confirm that IARs have satisfied relevant state examination or experience requirements.

Codes of Ethics and Insider Trading

  • Develop a code of ethics and insider trading policy.
  • Determine who within your firm is an "access person" and who falls into any additional categories defined in your code.
  • Obtain holdings and transaction reports from access persons as required by Rule 204A-1 (initially, quarterly, and annually, see rule).
  • Review holdings and transaction reports (quarterly):
    • to confirm compliance with code of ethics;
    • for potential conflicts with client trades;
    • for indications of insider trading; and
    • to determine whether transactions involved securities on any restricted list maintained by your firm.
  • Compare preclearance forms submitted by employees to transaction reports (or brokerage statements/confirmations) (quarterly).
  • Obtain code of ethics certifications from employees (initially upon employment, and annually thereafter).
  • Determine if your firm should adopt a gift policy and keep a gift log.
  • Consider donating any and all business-related gifts received by the firm or its employees to a charity chosen by the firm (being careful not to take tax credit for doing so).
  • Log any instances of receipt of insider information under the insider trading policy (as necessary).

Compliance Program

  • Track regulatory developments (ongoing).
  • Track business developments (new lines of business, new geography, new types of clients) and assess any new compliance obligations resulting from those developments (ongoing).
  • Conduct conflicts assessment (ongoing, and on a formal basis, annually).
  • Conduct risk assessment and document "inventory of risks" (ongoing, and on a formal basis, annually).
  • Confirm competence, knowledge, and empowerment of CCO (annually).
  • Confirm that various departments in the firm have provided input in the development of policies and procedures affecting their area (at least annually).
  • Review the adequacy and effectiveness of the compliance program (ongoing, as part of the required annual review).
  • Determine whether there have been any patterns of compliance violations (repeated violations of the same type or by the same individuals or departments) (quarterly).
  • Document any material compliance issues (ongoing). Consider carefully how to memorialize this information and what is "material."
  • Consider whether compliance resources are adequate (annually).
  • Consider whether the firm has outgrown procedures established when the firmís business was smaller and/or simpler (annually).
  • Conduct internal or third-party mock audits of individual departments within the firm (as frequently as resources permit).
  • Confirm that issues raised in past SEC deficiency letters have been addressed and representations made in follow-up letters have been fulfilled (annually, or as necessary).
  • Review employee e-mails (periodic sampling or "smart testing") (as frequently as resources permit).
  • Identify supervisory responsibilities of firm personnel and confirm that the firmís top management and star performers are subject to adequate supervision (annually).
  • Train new employees on compliance requirements and provide them with copies of procedures (initially, upon hire).
  • Require all employees to certify that they have read and will comply with the firmís compliance policies and procedures and will come to the CCO (or designee) with any questions (initially, upon hire, and annually thereafter).
  • Provide employees with updated copies of compliance policies (as material changes occur).
  • Provide refresher compliance training to all employees (at least annually).
  • Follow up on compliance violations with sanctions, training, heightened review, or escalation (as necessary).
  • Log client complaints and/or threatened litigation, and document responses (ongoing).
  • Develop an exception policy. Who within the firm is authorized to grant exceptions from a stated policy or procedure? How must they be requested? How must they be granted (in writing)? How are exceptions tracked?
  • Confirm that your firm has "version control" over its policies and procedures and is keeping dated copies of policies and procedures previously in use.


  • Confirm that advertisements comply with SEC rules/no-action positions and internal firm policies (ongoing).
  • Subject all advertisements to review and approval by the firmís legal or compliance department prior to first use (ongoing).
  • Confirm that published advertisements did, in fact, receive pre-approval (annually).
  • For composite performance, review account inclusion/exclusion policy (annually).
  • Keep copies of ads as required by Rule 204-2(a)(7) (ongoing).
  • Confirm that performance backup is being maintained as required by Rule 204-2(a)(16) (annually).
  • Update performance statistics on marketing brochures (at least quarterly). Consider what additional disclosures are necessary to make performance not misleading (i.e., in light of significant market events).
  • Develop a process for responding to RFPs and tracking those responses.
  • If AIMR compliance is claimed, ensure compliance with AIMR Standards (note: AIMR-PPS is changing to GIPs on January 1, 2006).


  • Confirm that any solicitors used are not disqualified (initially, and annually thereafter).
  • Enter into written solicitation agreements with solicitors.
  • Confirm that unaffiliated solicitors are delivering the required disclosure document (at least annually).
  • Obtain acknowledgements from solicited clients (and for advisers with private funds, solicited investors in those funds) (as necessary).
  • Keep copies of the solicitation agreement, solicitor disclosure documents, and client/investor acknowledgements (as necessary).
  • Document your bona fide effort to ensure that solicitors are complying with the terms of their solicitor agreement.
  • Document which clients were obtained through a solicitor, and which solicitor was used for each such client (initially, at account set-up).


  • Review and update privacy policy and related disclosures (annually).
  • Provide privacy notices as required by Reg. S-P (initially, at account set-up, and annually thereafter).
  • Maintain a list of clients who have opted-out.
  • Confirm that information about clients who have opted-out is not being conveyed to unaffiliated third parties (except for the purpose of effecting client transactions, etc.) (annually, or whenever marketing information is provided to third-party sources).

Books and Records

  • Confirm that required books and records are being maintained for the time periods and in the manner required by Rule 204-2 (annually).
  • Confirm that required books and records are not being inadvertently destroyed (particularly those retained in electronic form) (ongoing). For example, test samples of records bound for destruction.

Safeguarding / Disposal of Customer Information

  • Develop written safeguarding procedures (see the SECís December 2004 release #34-50781).
  • Confirm compliance with new SEC disposal procedures (annually).
  • Conduct intrusion testing to evaluate potential gaps and breaches (annually).

Business Continuity Plan

  • Develop a business continuity plan, including specific emergency response procedures (phone trees, etc.) and data recovery plans. Update as necessary.
  • Provide updated copies of plan to employees.
  • Test business continuity plan and document the results of such testing (at least annually).

13 Gs, Ds, and Fs

  • File Form 13G if 5 percent beneficial ownership or more is triggered (within 45 days after year-end and then promptly for material changes, unless more than 10 percent is owned, see the form for instructions). If not eligible to file Form 13G, file Form 13D.
  • File Form 13F (if firm has investment discretion over $100 million or more of certain 13f securities) (45 days after the end of any year in which the firm triggers the Form 13F filing requirement, and then 45 days after the end of each of the next three calendar quarters).