"You should maintain a strong compliance communication system—it shows clients that you run your business in a careful, organized and honest manner."

Policing Your Practice

By John Bowen

If you're like most advisors, you entered this business because you enjoy helping people reach their financial goals. I can safely say that very few of you became advisors because you love dealing with securities regulations. Unfortunately, building a successful firm requires that you manage compliance issues efficiently and effectively.

In fact, the need to comply with federal and state rules is more critical than ever these days, thanks to the large number of new regulations that have followed in the wake of scandals at financial services firms. It's absolutely vital that you implement an effective system for staying compliant. If you don't, you expose your firm to fines, risk your reputation and could even threaten your firm's existence.

But compliance is about more than just avoiding big problems. A strong system will also help keep your business organized and efficient—making your firm look more appealing to potential buyers—and enable you to provide better client service. Here's how to build a great compliance system.

EFFECTIVE RECORDKEEPING

There are 17 types of records that the SEC requires you to keep—more if you hold custody, provide supervisory or management services, or vote proxies. Maintain a file for each of the items, even those that may not be relevant for your firm; it shows an auditor that you know your duties. Many of these forms are self-explanatory, but three types of records deserve discussion:

Written supervisory procedures. Your WSP serve as your firm's internal operating handbook. Even if you're a solo operation, you need to keep a written record of the procedures at your office. WSP cover aspects of your business such as the chain of command, restrictions on insider trading, your portfolio management process (how you ensure that clients' portfolios are consistent with their objectives, for example), trading execution policies, custody requirements, safeguards to protect clients' assets and privacy and business-continuity plans.

Regulatory rules aren't the only reason to maintain a proper WSP document. Your WSP also act as the working guide to your entire business—a road map for how to handle situations as they arise. As such, the document helps ensure that your entire organization—including employees to whom you delegate duties and any outsourcing companies you might work with—takes a consistent approach to meeting client needs and providing quality service. Such a document is highly valuable to a potential buyer looking to purchase a well-run firm.

You're required to review your WSP every year to ensure continuing compliance with changing rules. Also, whenever you make a big change to your business—forming a revenue-sharing partnership, for example—you should review your WSP.

Code of ethics. A code of ethics is required as part of the Investment Advisors Act. You can include your code of ethics in your WSP or create a separate document. Regardless, your code of ethics should cover issues such as compliance with federal securities laws, protection of material nonpublic information, policies and procedures for personal securities trading, recordkeeping and educating your employees about the code.

Form ADV. Whereas your WSP detail your internal systems, your Form ADV acts as the external face of the business by summing up your firm for regulators and clients. Your ADV can help you market your firm and differentiate yourself from the competition.

Form ADV has two parts. The first, an electronic filing, registers your practice with regulators. The second, the full disclosure brochure, describes your firm's service offerings for clients and prospects. This is the section in which you disclose your services, fees, potential conflicts of interest and your conditions for managing an account. This shows clients what to expect when they work with you—if you charge fees and/or commissions, provide certain advice or have discretionary authority.

Another part of the second section gives you the opportunity to write about your business in your own words and explain in more detail the disclosures you made earlier. This is where you can do some marketing by highlighting your unique attributes. Keep in mind, though, that this isn't your marketing brochure. Try to make this part at least four pages to satisfy regulators, but no longer than 12 pages so you don't come across as rambling.

COMPLIANCE CALENDAR

How can you put the pieces of your compliance puzzle together to ensure that your firm runs the way it should? The answer is a compliance calendar.

Most of your duties are carried out on a monthly, quarterly or annual basis. Simply tracking each of those duties on a calendar will give you the ability to follow the rules consistently. And, a calendar gives you a written record of the actions you have taken—proof to an auditor that you did all you could to stay compliant. Finally, a compliance calendar can reassure clients that your firm is on top of its responsibilities.

Creating such a calendar can be as easy as using a spreadsheet for all the various monthly, quarterly and annual duties, and initialing and dating each box when a task is finished. The timing for each job will depend on the particulars of your firm. A small practice, for example, might review trade ticket execution quarterly instead of monthly, while large firms often review broker-dealer best execution once a quarter instead of once a year.

In addition to this calendar, you need a way to ensure that you've given the necessary paperwork to clients at the right time, and that completed documents have been returned. Make and maintain a client checklist that includes each document you must present to each client. Then indicate when it was presented and when the completed form was returned.

CLIENT COMMUNICATIONS

You should maintain a strong compliance communication system—it shows clients that you run your business in a careful, organized and honest manner. It might even help you uncover ways to provide better service. The tools that will help you effectively communicate with clients on these issues include:

New account form. Don't rely on a third-party broker-dealer's form (unless you're an agent of a broker-dealer)-the arbitration clause will not apply to you, and other details may not be applicable to your firm. Instead, create your own form that accurately details your specific advisor-client relationship.

Investment policy statement. As a fiduciary, you must invest according to your clients' best interests at all times by managing accounts based on their financial situations and objectives as well as any reasonable restrictions. The IPS is the document that will spell out your clients' expectations, goals, limits and risk tolerance.

Form ADV Part II. Once a year, you're required to send each client a letter offering them your Form ADV Part II. As part of that letter, you can include marketing efforts such as reminding clients to set up appointments to update their plans.

Privacy note. You must give clients a copy of your privacy letter once a year.

Request for updated information. Get in touch with clients at least annually to find out if there have been any changes to their financial situation or investment objectives, and whether they want to impose any reasonable restrictions on the management of the account. At least quarterly, notify clients in writing to contact you about any of these issues. This shows that you provide individualized advice and helps ensure that you do not need to register under the Investment Company Act as a mutual fund.
Clearly, compliance is a complicated and detailed process—and it's one that never ends. By taking a systematic approach to your compliance efforts, you'll considerably ease your burden and ensure that you're doing what needs to be done.

Reprinted from: FINANCIAL PLANNING