Federally licensed investment advisors often grouse about the heavy hand of government regulation. But the good news is the Securities and Exchange Commission each year gives its licensees a heads up in terms of its enforcement priorities. If you pay attention, an SEC action should never take you by surprise.

To that end, the agency in early February 2018 released its examination priorities for the year. Among them are protecting Main Street investors; further tightening cybersecurity; making sure investment advisors comply with anti-money laundering regulations; assuring that FINRA and MSRB operate effectively; and making sure clearing agencies, securities exchanges, and transfer agents support the capital markets.

According to the SEC’s Office of Compliance Inspections and Examinations (OCIE), the agency’s work stands on four regulatory pillars: promoting compliance, preventing fraud, identifying and monitoring risk, and informing policies. Its 2018 priorities document is designed to provide transparency into its “thinking on issues and areas that we believe constitute an appropriate focus for us in the upcoming year and which entail the most effective use of examination resources . . . .”

The SEC’s enforcement document spells out its concerns in great detail. Five areas will receive the majority of its attention in 2018:

  • Retail investors, including seniors and those saving for retirement. The SEC says protecting Main Street investors will continue to be a concern in 2018. Look for the agency to address the disclosure and calculation of fees, expenses, and other charges; firm supervision of their investment advisor representatives; and the execution of customer orders in the fixed-income securities arena. In addition, OCIE will continue to keep a close eye on the growth of cryptocurrencies and initial coin offerings to make sure investors receive sufficient risk disclosures.
  • Cyber-security. Concerned that cyber-risks to the industry are increasing dramatically, OCIE says it will prioritize cyber-security governance, risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response.
  • Anti-money laundering programs. The SEC’s examiners will review licensee efforts to comply with all anti-money laundering requirements, including establishing written programs to identify their customers, performing client due diligence, and monitoring accounts for suspicious activity. If they spot such activity, they are required to file Suspicious Activity Reports (SARs) with the Financial Crimes Enforcement Network. In 2018, the OCIE will focus on making sure licensees are taking reasonable steps to understand the nature and purpose of customer relationships and to properly address risks. They will also assess wither RIAs are filing timely, complete, and accurate SARs.
  • FINRA and MSRB. Similarly, SEC’s OCIE will train its microscope on FINRA to make sure it is operating effectively and providing adequate oversight of broker-dealers and municipal advisors. The agency will also focus on the Municipal Securities Rulemaking Board’s (MSRB) internal policies, procedures, and controls.
  • Compliance and risks in critical market infrastructure. Finally, SEC’s OCIE will evaluate all entities that provide critical services to America’s capital markets, including clearing agencies, national securities exchanges, and transfer agencies.

You can find further information about these initiatives in the SEC document, 2018 National Exam Program Examination Priorities. If you have specific questions about how these priorities might affect your firm, please check with your registered investment advisor and/or with a consulting firm that specializes in investment-advisor compliance. Good luck!

Are you a new registered investment advisor (RIA)? Then you know the process of setting up an investment-advisory firm is no simple matter. Whether you’re licensed with the Securities and Exchange Commission (SEC) or with a state securities administrator, establishing a firm that complies with federal or state regulations can be a daunting challenge. Then there are the tasks of deciding on the legal entity of your firm as well as designing its operational procedures.  And let’s not forget the crucial chore of purchasing investment-planning software, along with other financial applications, and the hardware necessary to run all these tools.

Given all this, it’s understandable that some new RIAs put E&O insurance at the bottom of their task list . . . or maybe even decide not to buy it.

As a new RIA, you might rightly assume your assets under management (AUM) will be limited for the first few years as your client list grows, creating only nominal E&O exposures. You might also be doing business with friends, relatives, and other people who you believe would be unlikely to sue you (at least, in theory). And you might take comfort from the fact that your regulatory agency does not require you to buy E&O insurance. How crucial can it be if it’s not required? Finally, you might decide that the cost/benefit ratio of buying E&O insurance is skewed too far toward the cost side of the equation.

Reasonable points, all. But we’d encourage you to consider these counter-points:

  • First, purchasers of financial- and investment-planning services today are not the same as those who purchased these services 15 or 20 years ago. They are much more knowledgeable about financial matters. They expect their advisors to know what they’re talking about and are much less forgiving when their advisors make mistakes.
  • Second, depending on your target market, you may quickly find yourself bringing on clients with seven-figure investment portfolios. They’ve been working for decades and now as baby-boomers are looking to move into retirement. Consequently, they can be sitting on substantial investment portfolios. Make a mistake in how you manage their hard-earned money or forget to do something important, and you will likely face an unhappy, litigious client.
  • Third, as baby-boomer portfolios have increased over the decades, a cottage industry of lawyers and law firms has formed to seek out financial-advisor clients who believe they’ve been wronged. In fact, a common marketing strategy of such firms is to get the names of advisors that FINRA or  the SEC have sanctioned and then blast them all over the Internet to recruit potential plaintiffs. Bottom line: the RIA marketplace has become much more legally treacherous over the last decade.
  • Fourth, RIAs often assume lawsuits will never happen to them because they’ve never been sued before. This is a cognitive bias called “the gambler’s fallacy.” Here, RIAs falsely believe the odds that something happened (or didn’t happen) in the past will determine the odds of it happening (or not happening) in the future. So if they never got sued, they never will. Clearly, this is a serious cognitive error that can have devastating financial consequences for a new RIA.
  • Fifth, as a new registered investment advisor, you may not be fully aware of the many ways an RIA can make mistakes, harming a client who then brings suit. You might breach your fiduciary duty, which is among the most frequent causes of RIA lawsuits, or recommend what turns out to be an unsuitable investment. Or you might innocently misrepresent the features or impact of an investment strategy or transaction, creating losses for your client. Then there are a host of negligence-related errors that can harm your new RIA firm. They might range from incorrectly executing a trade or falling for an Internet fraudster who wants you to wire your client’s money to him (who’s operating unbeknownst to you from an office in Nigeria). Then, as often happens, you might get sued just because a client is angry the stock market tanked, reducing her portfolio’s value.

Finally, depending on the nature of an RIA’s business, it’s not unlikely for clients to file six- and even seven-figure lawsuits against them. Being on the receiving end of a large legal action will quickly transform an RIA’s views on the costs vs. benefits of having errors-and-omissions insurance.

In short, even though you may be new to the RIA business, you’ll want to mitigate the financial risks of becoming embroiled in a client dispute. By putting a financial backstop in place before you get sued, you’ll be able to focus on working with your insurer-provided attorney and claims adjuster to mount a defense and hopefully achieve a positive outcome as quickly as possible. With your legal dispute behind you, you can then turn your attention to adding new clients and serving your existing ones, secure in the knowledge that if a problem arises with one of them in the future, your E&O insurance will be there for you.

As a Registered Investment Advisor (RIA), you know how important it is to differentiate your firm from its competitors. You also know that advertising is a great way to convey those differences to the marketplace. However, if you get too aggressive with your promotions, you can also get into hot water with the Securities and Exchange Commission (SEC). A recent SEC notice provides a cautionary tale.

According to a National Exam Program Risk Alert from the SEC’s Office of Compliance Inspections and Examinations, some RIAs are violating the SEC’s Advertising Rule (Rule 206[4]-1 of the Investment Advisers Act of 1940). According to recent field examinations and results from its “Touting Initiative,” RIAs are publishing, circulating, and/or distributing ads with untrue or misleading statements. This finding applies to advisors using online, print, or broadcast advertising or sending out promotions directly to clients.

The SEC risk alert identified 10 common RIA advertising violations, including:

  • Misleading prospects and clients about a firm’s investment performance by not deducting advisory fees from investment gains. This deceptively inflates performance.
  • Comparing firm performance to an investment benchmark without disclosing any limitations that might apply to that comparison.
  • Referring to an index whose composition does not relate to the RIA’s advertised investment approach.
  • Highlighting gross investment performance in one-on-one sales presentations without disclosing that client gains were in fact lower because of fees.
  • Making misleading claims of compliance with voluntary performance standards.
  • Touting high-performing individual stocks or investment strategies without mentioning the stocks or strategies that fared less positively.
  • Failing to maintain compliance policies and procedures to prevent deficient advertising practices.
  • Using third-party rankings or awards in a deceptive manner (i.e., without disclosing material facts).
  • Mentioning professional designations in a firm’s Form ADV Part 2B (brochure supplements) that have lapsed and/or failing to explain the minimum qualifications required to attain those designations.
  • Publishing client testimonials on firm websites, social media pages, and in third-party articles or pitch books, all of which are violations of the SEC’s Advertising Rule.

If your firm has engaged in the above practices, now would be a good time to stop. Why? Because the last thing you need is an SEC black mark on your record or a client who thinks you lied and sues as a result. By competing fairly, your prospects will trust you more, your clients will be more satisfied and loyal, and you’ll have less need to use your E&O insurance in a legal dispute. Sounds like a winning strategy, right?

To review the SEC’s Advertising Rule, go here. To learn more about other ethics and compliance issues facing financial professionals, visit the EOforLess E&O HQ.

Do you have a business continuity plan for your firm? If so, are you confident it will get you back in business quickly after a major storm or other natural catastrophe? And once it does, will it protect you against storm-related E&O insurance claims?  If you don’t have a plan, do you know how to create one that your regulator(s) will deem sufficient?

The following resource list will help you answer all of these questions and more. And don’t forget to ask your RIA firm, broker-dealer, insurance FMO, custodial firm, and financial-product companies about backstop services they may provide to your clients. Good luck!

The Case for Business Continuity Planning

Advisers Have a Fiduciary Duty to Put Robust Business Continuity Plans in Place, Investment News, September 2, 2016

Advisers in Florida Brace for Hurricane Irma’s Wrath, Investment News, September 6, 2017

A Q&A with Insurance Industry Leader, Agility Recovery, August 17, 2015

Business Continuity Plans & Technology Help Businesses Weather Hurricane Harvey, Property-Casualty 360o, September 6, 2017

Financial Advisers in Harvey’s Path Ride Out the Texas Storm, Investment News, August 28, 2017

For Hurricane-Battered Advisors, Planning Is Key, ThinkAdvisor, September 1, 2017

Harvey Tests Whether Advisers Need More Emergency Planning, Investment News, August 28, 2017

Harvey’s Wrath Brings Out Resilience, Client Outreach From Texas Advisors, Financial Advisor, August 30, 2017

Hurricane Irma: Advisory Firms Close Offices, Activate Crisis Teams, Financial Planning, September 7, 2017

Why is Business Continuity Important?, Travelers Insurance


Business Continuity Planning Guides

Being There: An Insurance Professional’s Guide to Preparedness, Agility Recovery

Building a Strong Business Continuity Plan, Charles Schwab

Business Continuity Planning, FINRA

Business Continuity Planning Suite, Ready.Gov (Federal Emergency Management Agency)

FINRA’s Business Continuity Planning Template, FINRA (podcast)

Risk Control Bulletin: Business Continuity Planning Guide, CNA

Stay Open for Business: The Easy Way to Prepare Your Business for the Unexpected, Insurance Institute for Business & Home Safety


Business Continuity Planning Compliance Requirements


Adviser Business Continuity and Transition Plans, (Proposed, 2016), Securities and Exchange Commission

Business Continuity Planning for Investment Advisors, Lorna A. Schnase, Esq., September 25, 2013

Investment Advisors Act Rule 206(4)-7, Securities and Exchange Commission

Proposed SEC Rule Would Make Business Continuity and Transition Plan a Fiduciary Obligation, July 4, 2016, Michael Kitces Blog

SEC Examinations of Business Continuity Plans of Certain Advisers Following Operational Disruptions Caused by Weather-Related Events Last Year, National Exam Program Risk Alert, SEC, August 27, 2013

What the Proposed SEC Rule on Continuity Planning Means for Your RIA, Wealth Management, September 21, 2016


NASAA Model Rule on Business Continuity and Succession Planning, North American Securities Administrators Association, April 13, 2015


Emergency Preparedness Rule, FINRA Rule 4370

Guidance to Members Affected by Hurricane Harvey (and Irma), FINRA, Regulatory Notice 17-27


Business Continuity Plan Hardening

Five Easy Ways to Improve Your Disaster Recovery & Business Continuity Plan, Leverage Technology

How You Can Strengthen Your Business Continuity Plan, Steven Saslow, Information Technology Group, July 13, 2016

Ten Easy Ways to Improve Your Business Continuity Plan, Kenneth Howells, Continuity Central