The Division’s Securities Examiners
visit and review state registered investment advisers who reside in or
maintain offices in Alaska. The Division conducts routine
exams and may also initiate examinations for cause.
A for cause examination is conducted where the division has reason to
believe a firm may have violated securities laws. Most exams are conducted
on a routine basis.
If you or your firm are to be examined,
the Division will generally schedule a date and time with you prior
to the exam. The exam may last a day or longer, and the examiner will review
books and records to determine if the rules and regulations pertaining
to state registered Investment Advisers are being followed.
These are some of the books and records we review:
Record keeping compliance issues may
be uncovered during our exam. Potential compliance issues include
record keeping, outdated disclosures on Form ADV, inadequate supervisory
procedures, and outdated or incorrect account information. Other
compliance issues may arise because investment adviser regulations are
now divided between state and federal authorities. Our examiners will
the State investment adviser’s operations to determine whether the
investment adviser is properly registered at the state level or whether
the adviser should instead be registered with the Securities and Exchange
Commission. Generally, this depends on the value of the assets the investment adviser has under management.
The exam may also uncover sales practice
compliance issues such as misrepresentation to clients, inflated performance
claims, lack of suitability of investments offered to clients, inadvertent
custody of client funds and securities, and engaging in investment adviser related activities without being licensed.
Discovery of such problems might result in
the State Investment Adviser receiving a warning letter, a follow-up exam,
an administrative order, or monetary penalties.
The following information covers the most common
compliance issues found in examinations of State Investment Advisers:
If you have further questions about these areas,
you can reach the Division at (907) 465-2521.
Securities examiners review records for the
purpose of determining whether there is adequate disclosure to investment
advisory clients on the following topics:
What services are being provided and who is
providing the advisory services are questions that may arise where the
investment adviser only introduces the clients to one or more other advisers.
These questions also arise in connection with wrap fee programs, where
a third party firm may provide advisory services. The investment advisory
agreement should answer these questions, as should the State investment adviser ’s brochure and/or Part II of Form ADV. Securities examiners
review the investment advisory contract and compares the contract with the activity conducted at the firm and with the contents of Form ADV. After 2001, all new and renewal filings by investment advisers registered or notice filed in Alaska are required to submit filings through the Investment Adviser Registration Depository (IARD), which includes the form ADV Parts I and II. The IARD is an electronic gateway that investment advisers use to update filing information, add or delete investment adviser representatives they employee, and provide disclosure information to existing and potential clients. To check on continuing information
on the IARD and Form ADV, go to www.sec.gov/iard/.
Securities examiners also check to see if investment
advisory clients are given adequate disclosure of any conflicts
of interest the state investment adviser may have. The examiners also
review investment advisory agreements to make sure they do not contain "hedge" clauses in which the state investment adviser disclaims liability
for losses occasioned by any negligence of the investment adviser. The
Securities and Exchange Commission has taken the position, and the
Division agrees, that "hedge" clauses are unenforceable and
therefore their inclusion in an advisory agreement is misleading to clients.
Securities examiners look for conflicts of
interest when they examine state investment advisers. Different kinds of
conflicts of interest arise depending on the number of roles the investment adviser and its affiliates play with regard to the customer. The investment adviser is a fiduciary who must put the customer’s interest before
his own. These are some of the situations involving conflicts of interest
an examiner looks for:
In all conflicts situations, the key issue
is the effect of the conflict on the customer. Has the customer been
of the conflict? Has the customer consented to the transaction despite
the disclosed conflict? If the customer consented, was the customer
a position to evaluate the effect of the conflict on the customer’s
interest? The more vulnerable or unsophisticated the customer, the greater
the burden is on the investment adviser to show that the customer has
knowingly consented to the conflict. Disclosure and customer consent
not always be sufficient remedies for conflicts of interest.
An examiner will review any written policy
of the investment adviser on conflicts of interest and will consider conflicts
issues throughout the review of books and records. An examiner might spot
a conflict through review of customer correspondence, complaints, and
statement of accounts or by operational review of the investment adviser itself and interviews of its employees or customers. Once an examiner
has spotted a conflict, the examiner will generally ask the principals
of the investment adviser for an explanation and may seek further evidence
to confirm the extent of the conflict of interest.
Conflicts of interest may involve serious securities
law violations, such as sale of unregistered securities, fraud in connection
with the purchase or sale of securities, and unlawful acts of a person
advising another. Some of the most serious conflict problems arise when
the investment adviser is also an issuer or is an affiliate of an issuer.
If there is an apparent conflict of interest, the investment adviser has
a greater burden of showing that the investment recommendation was suitable
for the customer.
The examiner will review the investment adviser’s
advertising files containing a copy of all advertisements (pamphlets,
circulars, solicitation letters, etc.) the adviser uses to solicit
business and maintain current clients. All advertisements should be dated
and initialed by a principal (or designated supervisor) of the adviser
prior to or immediately after distribution to ensure that the advertisement
falls within applicable guidelines.
Common compliance issues include:
During the review of advertisement files, the
examiner may examine software and other programs the adviser uses to
record and retain client data and the examiner may verify performance
claims compliance with AIMR standards.
Definition of custody
On October 1, 1999, Alaska adopted a definition
of "custody of client funds or securities" at 3 AAC 08.950 (22)
which states that custody, "means for a state investment adviser,
the state investment adviser directly or indirectly holds client funds
or securities, has authority to obtain possession of client funds or securities,
or has the ability to appropriate the client funds or securities, except
a state investment adviser is not considered as having constructive custody
of a client’s funds or securities, if such possession is for the
sole purpose of immediately forwarding those funds or securities to a
third party at the request of the client;"[.]
However, until the recent adoption of this
definition, the term "custody" had not been defined under most State Securities
laws or the Investment Adviser’s Act of 1940. As a result, court
cases involving custody, along with SEC interpretations and no-action
letters, have established fairly broad parameters and deem an adviser
to have "custody" of client assets if it has any direct or indirect access
to them. This body of interpretive information will still be applicable
in the course of our examinations. For instance, an investment adviser may be deemed to have custody of client funds if it sends the bills for
its services directly to the custodian, who then automatically pays the
adviser. However, the SEC has established guidelines
that establish strict procedures to follow so that this situation would
not be considered constructive custody of client funds. The SEC
has allowed automatic payment of advisory fees where:
The Division also holds to this position regarding
automatic payment of advisory fees and, in general, rules consistently
with the established SEC "no action" positions on matters
IAs who are issuers
An adviser who is also an issuer of securities
is deemed to have custody unless an independent custodian is utilized
and the custodial agreement(s) include provisions that define the method
by which the adviser receives payment and withdraws funds (via an independent
Requirements for IAs with "custody"
Additional financial and books and records
requirements (3 AAC 08.025 and .040(b)) are imposed on advisers that
have custody or possession of client securities or funds, which include:
IAs having custody of client
funds or securities must have a $35,000 surety bond and maintain
a positive net worth at all times;
Securities of each client must be
segregated, marked to identify
the particular client
having the beneficial interest
in the security, and held in safekeeping in
a place reasonably free from risk of destruction or other loss;
The SIA must deposit all client
funds in one or more bank accounts that contain only client funds
and the account or accounts must be maintained in the name of the SIA as
agent or trustee for the clients;
The SIA, immediately after accepting
custody of funds or securities from any client, must notify the client
in writing of the place and the manner in which the funds and securities
will be maintained, and thereafter immediately notify the client in
writing of any changes in the place or the manner in which the funds
or securities are maintained;
The SIA must maintain a separate record
for each client’s bank account that shows the name and address
of the bank where the account is maintained, the dates
and amounts of deposits to and withdrawals from the account, and the
exact amount of each client’s beneficial interest in the account;
The SIA, at the end of every three
months, must send each client an itemized statement showing the funds
and securities in the state investment adviser's custody and all debits,
credits, and transactions in the client’s account during the
At least once every calendar year,
an independent certified public accountant or public accountant must verify
all client funds and securities by actual examination at a time chosen
by the accountant without prior notice to the SIA, and the accountant must
issue a report stating that the accountant has made an examination
of all client funds and securities and describing the nature and extent
of the examination, and the report is filed with the administrator promptly
after each examination.
The SIA shall maintain a journal
or other record showing all purchases, sales, receipts and deliveries
of securities for all accounts and all other debits and credits to the
The SIA shall maintain a separate
ledger account for each client showing all purchases, sales, receipts
and deliveries of securities, the date and price of each purchase and
sale, and all debits and credits;
The SIA shall keep copies of confirmations
of all transactions effected by or for the account of any client; and
The SIA shall maintain a record
for each security in which a client has a position showing the name
of each client having an interest in the security, the amount or interest
of each client, and the location of the security.
procedure for SIAs with custody
In addition to an examination of all the books
and records required of state investment advisers (3 AAC 08.040) including
those listed above, additional tasks of the exam staff may include:
Determining whether the adviser
has any affiliation with the custodian; and
Obtaining information regarding
how instructions are conveyed to a custodian, who determines where the
client funds or securities are maintained, and, if the custodian is
a person other than a broker-dealer (such as a bank) how the transactions
Examiners review accounts for suitability issues by comparing account information with the services contracted for under the investment advisory agreement and with the advice given to the customer. State investment advisers need to maintain adequate information on their customers to document the suitability of the recommendations made. At a minimum, the investment adviser should maintain information on the customer’s annual income, net worth, and investment objectives. If the customer has specific objectives, for example, to retire in the year 2020 with a certain level of investment income, or to have funds available for their children’s future education, those objectives should be reflected in the customer’s file.
The examiner will pay special attention to
the suitability of recommendations where the investment adviser has discretion
over the customer’s account. However, the suitability of investment
recommendations is an issue relating to all investment advisory customers,
not only those who have given the investment adviser discretion over
or her account.
Investment Adviser Representative
During an exam, the issue of whether individuals, working at or for the SIA, should be registered as investment adviser representatives may arise. SIAs shall register individuals who
meet the definition of an investment adviser representative under the
As a rule of thumb, the SIA should register
individuals associated with the firm who:
Questions regarding registration can be directed
to the Division at (907) 465-2521.
To assist advisers in meeting your compliance
responsibilities, we have compiled and identified the most common issues
and problem areas found during state review of investment advisers:
Lack of a written customer contract. Advisers
must have a written contract with each client (AS 45.55.023(a)(16)),
even if the adviser is a fee only financial planner. The contract must disclose:
the services to be provided, the term of the contract, the advisory
fee, the formula for computing the fee, whether the fee is negotiable,
the amount of prepaid fee to be returned in the event of contract termination
or nonperformance, whether the contract grants discretionary power
the adviser, and that the contract will not be assigned by the investment adviser without the consent of the client. The contract may not include
a so-called "hold harmless" or "hedge" clause, which purports to require
clients to waive potential claims they may be entitled to bring under
state or federal statutes, or which seeks to hold the investment adviser to a lesser standard of care than is required by statute. Advisers are allowed
to include an arbitration clause in the contract.
Outdated Form ADV or brochure. Advisers are required
to update the Form ADV (and file the amendment with the Securities Division)
whenever information disclosed in the form changes in any material respect.
If brochures are used for providing required disclosures to clients,
they should be updated as required (at the same time the Form ADV is
updated) and filed with the Division. Part II of the qForm ADV or the brochure
must be furnished to prospective clients 48 hours before they sign a
contract, or at the time of signing the contract if the client can cancel
without penalty within five days after signing. In addition, every year
you must deliver to each client, or offer to deliver, a copy of the
updated ADV Part II or brochure. As always, a brochure must include
at least all information required by Part II of Form ADV. You need to
keep records of to whom the disclosure was offered or sent, and which
clients requested the update.
Inadequate or outdated client information.
Before recommending or executing an investment transaction on behalf
of a client, advisers must have reasonable grounds for believing the investment
transaction is suitable for the client. Advisers are required to make reasonable
efforts to obtain information concerning the client's financial status,
tax status, investment objectives, and other information necessary to
make a reasonable suitability determination. For an investment adviser,
merely asking for estimated net worth and income, and checking a box
for investment objective probably is not sufficient to establish suitability,
particularly if it must be established you have to establish it in an arbitration or court
action. A better practice is to obtain detailed information such as
a client's: assets, liabilities, income and expenses; existing investments,
financial goals and risk tolerance; marital status, dependents, family
obligations, age, health, and mortality issues; and insurance coverage.
Advisers may need to obtain documents such as tax returns, company benefit
(e.g., 401k) booklets, will and trust documents, and stock option agreements.
Since suitability will change over time as a client's family and financial
circumstances change, advisers need to update this information periodically.
The best practice is to update this information annually, and the Division
considers three year old information to be stale.
Misleading business cards, letterhead and
advertising. There can be some confusion about who can use the term "Registered (State) Investment Adviser. "If on Form ADV Part I, No.
8, the box for "A. Corporation," "B. Partnership," or "D. Other" has
been checked, then an entity is the registered investment adviser, and
persons employed by the entity and providing investment advice must
refer to themselves as "investment adviser representatives." While the Division requires that each investment adviser have a principal,
we do not technically "register" them.
Lack of documentation regarding discretionary
authority over client accounts. As stated in No. 1 above, this information
needs to be included in the client contract. In addition, advisers should
have a copy of the client's agreement with any brokerage firm at which
advisers are authorized to trade on the client's behalf.
Problems with invoices for fees. Advisers need
to keep a copy (electronic is okay) of each invoice sent to a client.
The invoice should show how the fee was calculated. In addition, if
fees are to be deducted directly from a client's brokerage account,
in order to avoid "inadvertent custody" of client funds: (1) the client
must authorize the arrangement in writing; (2) the invoice must be
to both the client and the custodian at the same time; (3) the invoice
must show the amount of the fee, how it was calculated, and the value
of the assets on which it is based; and (4) the custodian must notify
the client at least quarterly how much it has paid the adviser.
Misleading performance claims.
Other books and records issues.
Inadequate documentation of supervision.
If more than one person is employed by the investment adviser , then
the principal will have supervisory responsibilities. A compliance manual
(which even a sole proprietor should have) should be established and
maintained. There should be evidence that the principal is providing
supervision, such as reviewing and initialing incoming and outgoing
correspondence, order tickets, new client forms, and advertising.
Inadequate financial statements. Advisers are
required to maintain financial records for the business, such as
journals for cash receipts and disbursements, and ledgers reflecting
reserve, capital, income and expense accounts. These should be kept
in such a manner that the adviser can produce financial statements on a timely
basis in accordance with generally accepted accounting principles (i.e.,
on an accrual basis). The examiners will
also want to review your check register, so sole proprietors may want
to set up a separate business checking account so that business income
and expenses are segregated from personal (the examiners may still
to see a sole proprietor's personal account, however).
If the adviser has custody of, or discretion over,
client funds or securities, then you will need to have a surety bond
of $35,000 for custody and $10,000 for discretion. The adviser have discretion
even if all they can do is trade among a family of mutual funds. If needed,
a surety bond form can be obtained from the Division (see
forms page). A positive net worth must be maintained at all times,
not just at quarter or year end.
If you need assistance regarding these compliance
issues or other investment adviser matters, please contact the Division of Banking & Securities
at (907) 465-2521.