Advisors Falling Short On Client Suitability Documentation

The books and records category of advisor compliance remains the top area of concern, with client suitability information most frequently cited as being deficient. That's according to a report issued by the North American Securities Administrators Association (NASAA).

“It just kind of blows our minds that we still see the No. 1 books and records issue is client suitability documentation,” said Michael Huggs, director of Mississippi Securities Division and head of the Investment Advisor Operations Project Group committee for NASAA.

Since most future disputes will likely come from clients, not regulators, it’s incumbent on advisors to keep their books up to date and squeaky clean, he said.

“We implore the advisor to document the discussions with the client about risk tolerance, goals, needs and financial status” that go into the investment recommendations to clients, Huggs added.

The report showed an increase of about 10 percent in the number of advisors with at least one deficiency in the books and records category between 2013 and 2015. Examiners counted 1515 individual deficiencies. The percentage of advisors with at least one deficiency rose to 74.8 percent in 2015.

“Maintaining sound books and records is the best way for investment advisors to protect themselves and their clients,” William Beatty, NASAA president and Washington Securities Director, said in a news release.

The number of deficiencies among investment advisors has declined 30 percent from two years ago. However, the percentage of exams noting at least one deficiency rose in many categories, according to the results of the biannual state-coordinated investment advisor examinations.

The 1,170 reported state examinations uncovered 4,983 deficiencies in 22 compliance areas. This was down 30 percent from the 6,482 deficiencies in 20 compliance areas reported in 2013, the NASAA reported.

At the same time, the percentage of exams noting at least one deficiency in 2015 compared with 2013 rose in each of the following categories: books and records, contracts, privacy, fees, custody, advertising, brochure delivery, supervision and financials.

Only the registration category recorded a decline over the two-year period.

“I’d like to see that go back down, but we’re quite pleased that the total number out there is going down,” Huggs said.

The report compares category deficiencies across advisors with varying levels of assets under management (AUM) and among investment advisors of differing sizes. The findings offer an industry snapshot of where advisors are falling short in compliance.

Huggs gave two main reasons that overall deficiencies declined over the two-year period. One reason was because advisors were more familiar with the compliance responsibilities expected of them. The other reason was that regulators and examiners were doing a better job of teaching advisors what they need to know.

Increases in the number of deficiencies in individual categories may have to do with myriad regulatory changes that advisors sometimes have trouble keeping up with, Huggs added.

In the contracts category, the report found 633 individual deficiencies. The percentage of advisors with at least one deficiency rose to 49.5 percent in 2015, from about 40 percent in 2013.

The report also found many deficiencies surrounding fee reporting.

In the fees category, examiners found 166 individual deficiencies — amounting to deficiencies in 21.2 percent of advisors. Fees that didn’t match contracts or fees that were not consistent with what was reported on ADV Forms occurred in 54.8 percent of those deficiencies, examiners found.

In the custody category, 166 individual deficiencies also were found — amounting to deficiencies affecting 20.1 percent of advisors. Discrepancies surrounding fee deductions and proper client invoicing occurred in 48.8 percent of those deficiencies.

Advisors need to make sure their documents are up-to-date, consistent and in writing not to please examiners but to protect advisors themselves, Huggs said. Best practices guides are available through the NASAA.

The 2015 sample examination data was provided by 42 jurisdictions between January and June 2015, NASAA reported.

State securities regulators have regulatory oversight responsibility for investment advisors with AUM of less than $100 million.

Of the 823 investment advisors included in this year’s coordinated examinations, 232 had AUM of between of $30 million and $100 million and 591 had AUM of less than $30 million.

Under the Dodd-Frank Act, about 2,100 midsized investment advisors with AUM between $30 million and $100 million switched from federal to state oversight in 2013.

InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].