This is What Investment Advisor Audit Requirements Look Like

Image of Folded white puzzles elements and one red with text AUDIT.How's that for a post title. I bet it has you salivating to read it. After all, doesn't everyone want to know about the investment advisor audit requirements? Haha! Of course, they don't.

Let me tell you why I'm writing this post. A couple of weeks ago, my investment advisory firm, Leamnson Capital, got audited by the Commonwealth of Virginia, not the SEC (Securities and Exchange Commission)

The SEC's bases its registration requirement on the value of the assets a firm manages. A firm that manages $100 million or more registers with the SEC. Those under $100 million register with their state. It's a non-traditional way of qualifying firms. To me, assets under management indicate a company is good at gathering assets. Not sure what that has to do with taking care of clients.

Anyway, the day of my audit, I read a post by another blogger that rubbed me the wrong way. He was pontificating about the best type of financial advisor. He had strong opinions on how they should get paid. That included the standards they should adopt. Then it occurred to me. Financial bloggers can say anything they want with no accountability to anyone.

So I wrote about it (some would say spouted off) in a recent blog post. I challenged the arrogance of some of my fellow personal finance bloggers. For the most part, the response was positive. Those that took issue did it respectfully. There were some exceptions, as you might expect.

Who should read this?

I'm writing this post to reach two audiences.

  • Bloggers in the personal finance space – I hope to encourage bloggers to take seriously what they write. If you're writing about investing, retirement planning, early retirement, insurance or any other financial topic, do your research. If you're not an expert in it, don't write about it. Just because something worked for you, doesn't mean it applies to everyone. Acknowledge that more when you write. Understand that people are looking to you for advice. They look to you as an authority. Most bloggers I know take that seriously. But I'm troubled by the group-think in many blogs.
  • Readers who seek education about their finances – Most of the personal finance bloggers do not have training in personal finance. They're speaking out of their own experience and highlight their successes. The vast majority of these bloggers are Millennials and Gen Xers. Keep that in mind when you're reading. Find out who these folks are before taking their advice. Look at their about pages. Do they have particular expertise? What's their focus. What's their day job?

Before the haters come after me about the Millennial comment, let me be very clear. I have the utmost respect for the Millennial bloggers I've come to know. It's a great community. As a whole, I find them genuinely interested in wanting to help people. The ones I consider friends are humble and helpful.

I've written a Mea Culpa to Millennials to confess my sin of buying into the stereotypes.

What's the point?

As a financial advisor, I'm proud of the work I do for my clients. I also have to listen to and endure the worn out views many personal finance bloggers have toward my profession.

Admittedly, the industry has done much to earn their bad reputation. But it grates on me how many bloggers lump all of us into the same pot of bad apples. Many of these bloggers have had bad experiences personally with advisors. Fair enough. That doesn't make us all bad.

A good friend of mine calls this type of homogenizing a group making an incident an indictment. In other words, we let a bad experience or two with individuals cause us to indict an entire group of people. And if we're bloggers, we write about it to try and convince our readers to feel the same way.

This bashing of advisors gets old.

Unsupervised?

I'm sharing what's involved with an advisor audit to challenge those who feel our industry has no supervision. It's just not the case. We are a regulated industry. That means we are accountable to those who set the rules for how we operate. An audit assures that we are following those rules and guidelines. Why? To protect the public and the clients we serve.

Though I don't enjoy these audits, I'm glad I'm part of a system of checks and balances. It's a system of accountability to monitor a firm's practices. The audit is to make sure I'm operating in an ethical manner that complies with the standards I agreed to uphold.

I'm not a fan of overregulation. But I sometimes wish there were some minimum standards and qualifications that personal finance bloggers had to meet.

With that, let's look at what I had to do for the audit my firm just completed.

Related:
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Audit requirements

There are four major areas where I had to provide documents.

  • General recordkeeping
  • Portfolio management
  • Financial planning
  • Private equity or hedge funds

Each section included numerous requests for documents. I'll list them separately to give you an idea what's involved.

General recordkeeping

There are nineteen areas (not items) listed with specific documents under each section. Here's a partial list to give you a flavor.

  • Business formation records – My firm is an LLC. That means I included the LLC agreement and filing records with the state, list of employees and job titles, and my CRD# (a FINRA identification)
  • Accounting records – Includes balance sheet, profit and loss statement, 12 months of bank and credit card statements, general ledgers, paid and unpaid bills at the time of the audit, and any loan agreements executed by the firm
  • ADV Part 2 – The ADV Part 2 is the “brochure” that lays out how the firm operates. States and the SEC all require member firms to update these documents annually to include any material changes in the firm's operations. If firms change things like fee structures, websites, addresses, personnel, they get counted as a material change. Firms have to offer to send the ADV Part 2 to anyone who requests it. We have to show where we offered it and who we sent it to.
  • Procedures manual – Separate from the public ADV documents, firms must keep a separate operations/compliance manual that describes procedures for staying in line with compliance requirements. Also, we must provide our disaster recovery plan, privacy policy and computer security systems (data protection).
  • Privacy policy  We must document that we've sent our privacy policy to all clients annually

Agreements and compliance

  • Advisory agreements –  A copy of the current advisory agreements we use with new and existing clients. They also want copies of all prior agreements. This includes investment advisory (discretionary and non-discretionary, and financial planning agreements
  • Complaint and litigation files –  If the firm must document any complaints or legal proceedings in the last year
  • Advertising file –  This included all websites the firm or its employees use or manage. All social media accounts (Twitter, Facebook, LinkedIn, Instagram, etc.). It also includes any print or internet advertising during the last 12 months. If the firm did any online advertising (Facebook, etc.) copies of those ads and who they targeted must be included.
  • Client communication –  That includes written communications and emails. Member firms must archive all client emails and turn them into the state for the last twelve months.

We're just getting warmed up here!

Portfolio management

Member firms must account for the number of clients for whom they manage money, the assets under management, and the type of client (discretionary vs. nondiscretionary).

We must provide a complete list of all trades and other transactions (deposits, withdrawals, etc.)  for the last 12 months. They want a complete list of securities held by clients, the positions held, and transactions in those securities for the last 12 months.

Client information

We must include the following documents for all clients:

  • All advisory and financial planning agreements (current and previous)'
  • Custodial account statements for each client account (Td Ameritrade in my case)
  • The latest performance reports (if applicable) for each client
  • The last billing statement for each client (each state has specific requirements they won't include on the billing statements)
  • A list of any clients terminated, either initiated by the firm or the client and the reason for the termination

Miscellaneous

Many firms use alternative investments like hedge funds or private equity (mine doesn't). Those that do have a long list of documents requested:

  • agreements with the funds
  • prospectuses
  • names and contact information for the funds used
  • amount of money raised by your firm for each fund
  • the most recent audited financial statements for each fund.

The firm must disclose whether it pays or receives referral commissions to or from individuals or other entities that refer clients to the firm. If the firm gets commissions for referring to others, it must document all agreements, and records of the compensation paid or received in the last 12 months.

Don't cry for me

I don't like having to put all of these documents together. But I'm glad to be in an industry that looks out for the clients their member firms serve.

In all, the total number of papers I submitted was somewhere in the neighborhood of 200 or so. Fortunately, I don't have several hundred clients and multiple advisors in my firm. Those that do have to do a lot more work to prepare for their audits.

The costs, in terms of time and loss of productivity, are pretty hard to measure. I spent the better part of a week getting all of these documents together. Larger firms would likely spend much more time and involve several people in their firms to obtain the requested information.

The size of the firm, the type of services they provide, and the results of any previous audits help determine how often a firm gets audited. In my case, the last examination was in 2015. The average time between reviews is from three to five years. So, the recent audit falls right in that time frame.

If a firm had significant deficiencies in a prior audit, it's likely they would get audited much sooner than the average time.

Final thoughts

I realize a post about an investment advisory firm's audit may seem tedious and unrelated to personal finance and blogging. To other registered investment advisors who educate via blogs and to me, it is relevant.

Most of us work hard to do the right thing for our clients. If we are state or SEC-registered (like Leamnson Capital) and not affiliated with a broker-dealer (think Merrill Lynch, UBS, etc.) we signed on to act as fiduciaries to our clients. That means we must operate in the best interest of our clients. In my case, when I left the brokerage firm that employed me, I left behind a pretty significant amount of income when I decided to not affiliate with a broker-dealer.

I don't judge anyone who is dually registered (RIA and securities licensed). I'm saying that many of us decided to register the way we did because we believe it's the best way to reduce conflicts and serve our clients better.

The community

I love the personal finance blogging community. It's much more of a community than the brokerage world, that's for sure. We advisors who blog are passionate about helping people understand personal finance, as are most personal finance bloggers. Here's the difference. We are held to a higher standard of compliance than unregistered bloggers. We have to account for what we say, to whom we say it, and how we care for our clients.

That doesn't make us better than those who aren't registered. I hope that bloggers who read this, especially those so vocally critical or our industry, will gain a better understanding of the rules we have to follow. I hope it causes them to be more careful and less dogmatic about the best way to accomplish financial independence or any other goals.

There are lots of roads that will get you where you want to go. In our work with clients, we advisors help them find the right road and walk with them on the journey. I encourage my blogging friends to keep writing great content. Keep educating people on the benefits of personal finance.

Do me a favor, will you? Lighten up on the advisory community. 😀

Now it's your turn. Do you agree or disagree about the lack of accountability for bloggers? Where did I go wrong with my views? I want to hear from you. 

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