Policies Are Not Evergreen: Items to Consider for Review in 2024
Main Contributor: Gretchen Sturdivan, CSCP, Compliance Manager & Creative Director
Background
Par for the course with any SEC exam will be a request for the adviser’s policies and procedures that were in place during the examination period. They will ask to see each version along with documentation to support the changes made. Knowing this will be part of any routine exam, it would be prudent to include a review of your firm’s policies and procedures as part of your annual review and whenever material changes are made to the firm’s processes or structure. However, you may not know exactly where to start and what you are even looking for each year.
As a result, we put together a list of items for your consideration during 2024’s annual review. We generate these additions or changes based on our experiences during SEC examinations, reading newly published risk alerts and rules.
The Private Fund Rule
As of the date of this article, we are holding off on generating policies to address the private fund rule, as it has been vacated by the courts and we are not sure yet if or how the SEC will push back. That being said, we do expect the SEC to focus on the contents of this rule during exams and perhaps pull pieces out as best practices.
If you are a private fund adviser, you will want to ensure your policies are in line with the applicable items outlined in the rule. While you are no longer required to develop policies around adviser-led secondaries, you may still want to incorporate their guidance from the rule as a best practice. Likewise, if you have side letters in place, you may want to ensure you maintain the appropriate disclosures in line with the rule.
T+1 Settlement Policies
As of May 28, 2024, the main element for investment advisers to consider with the shortening of the securities transaction settlement cycle from T+2 to T+1 is to make and keep records of each confirmation received, and of any allocation and each affirmation sent or received, with a date and time stamp for each indicating when it was sent or received. Rule 15c6-1 includes all securities with the exception of a contract for an exempted security, government security, municipal securities, commercial paper, bankers’ acceptances, or commercial paper. Advisers can rely on the custodian for the required records but must maintain the records in their system in line with their policies and procedures.
If your firm trades in securities that are applicable to this rule, ensure your policies and books and records matrix are updated to reflect your process for the retention of the required records. Ensure that the staff responsible for keeping and maintaining the records have been trained and informed of the new requirements.
Generative AI Policies
While Generative AI can be a fun way to create a cartoon of your cat, in terms of investing and compliance, the use of Generative AI is unwieldy at best and hard to wrap your arms around, especially as an employer. To mitigate the risks associated with potential misinformation, to protect client data, and to ensure compliance with SEC regulations, SCS recommends that firms include a policy in their manual outlining the usage restrictions, for example:
Generative AI may not be used for making investment decisions, offering investment advice, or any other client-facing communications without prior approval.
Employees shall not use generative AI to generate or simulate any regulatory or compliance-related documentation.
The policies should also include how you will train employees and protect client data. For example, sensitive client data and proprietary information should never be entered into public-facing generative AI platforms due to the cyber and confidentiality risks. The firm should include disclosures to clients whenever generative AI played a role in generating the content or data presented to them and should ensure that records are maintained of any AI interactions. This includes storing the raw outputs from the AI, input data, and any subsequent edits or validations made by employees.
Ensure employees acknowledge the policies and conduct periodic audits to assess compliance with the policy. Any violations should be documented. Continue to update this policy in your manual as the technology changes. Generative AI is the perfect example to drive home the point that policies are not evergreen and must be updated with the regulatory and technological wind.
Off-Channel Communications
Clients text advisers. This is a common occurrence and one that is challenging to monitor and communicate the importance of to advisers. Unfortunately, these off-channel communications can become a required record that was not properly retained. The SEC’s enforcement division has been actively looking at issues around employees using personal devices to communicate – whether that be personal cell phones, email, etc., and they are levying heavy fines on firms for off-channel communications that are not retained. In 2024 the SEC fined Senvest Management LLC $6.5 million for communicating internally and externally using personal texting platforms and required that they implement improvements to their compliance policies and procedures.
SCS recommends generating or updating an electronic communications policy to provide that e-mail, instant messaging, and other electronic communications are treated as written communications and that such communications must always be professional in nature. All firm and client-related electronic communications must be on the firm’s systems or approved devices and must be archived to meet books and records requirements. For any business-related communications, both internal and external, employees should only use their firm-issued email address. If an adviser receives a business-related message that is not able to be archived, they must screenshot the message and forward it to their firm-issued email address. They can tell the client that they are not able to communicate in this manner and continue the conversation with the client using approved forms of communication. Messages that are personal in nature, such as confirming an appointment time, do not need to be archived. Ultimately, the firm must be able to maintain documentation of all client- or firm-related communication.
Continuing Education Requirements for IARs
While this isn’t a new topic for all advisers, it’s only just started to apply to some investment adviser representatives (“IARs”) this year, as new states adopt the model rule developed by NASAA. As this continually evolves, SCS recommends that each firm evaluate whether or not it applies to their IARs and adopt policies outlining the requirements and timeframes. Any IAR registered in one of the effective states needs to complete the continuing education requirements on an annual basis. The education requirements are two-pronged, with a) an ethics component of 6 credits, and b) a products and practices component of 6 credits. We have more detailed information about these requirements on our Resources page.
ESG Policies
In light of recent SEC exams, SCS recommends developing a comprehensive set of ESG policies for your firm, if it’s applicable. Specifically, consider the following:
Provide the internal definition of any terms that relate to ESG and are used in marketing materials
Outline all of the ESG criteria that are used (i.e., environmental, social, governance, etc.)
Describe the application of ESG criteria to the investment process and the scoring methodology
Describe the firm’s adherence to ESG frameworks or standards (i.e., UN Principles for Responsible Investment)
Document the service providers used for providing screening information or due diligence services in connection with the use of ESG criteria during the securities investment process, including proxy voting
Document the process for divestment recommendations
ESG template policies are not one-size-fits-all, as each firm has their own unique considerations and policies, so ensure your policies are aligned with your firm’s ESG practices.
Form N-PX
Though the first filing for investment advisers will be due August 31, 2024, we still find that some advisers are not fully versed in the Form N-PX requirements and what the filing will entail. Let’s break it down here.
This is the first year in which firms who are subject to 13F filings will be subject to annual Form N-PX filings. Whether or not you vote proxies for your clients will determine if you must simply notice file to indicate you do not vote proxies or complete a full filing with your proxy voting records on 14a Executive Compensation votes. The time period for filing will cover July 1st of the previous year through June 30th of the current year.
If you are subject to Form N-PX filings, SCS recommends ensuring that you have incorporated policies this year to address the new requirement. Include details around whether or not you are using a third party to tabulate the results and/or file Form N-PX.
Conclusion
More often than we would like, we find advisers who have practices in place that are not captured in their policies. Maybe they are reviewing marketing materials with the new rule in mind, but they have not developed the policies to outline their procedures and ensure employees affirm their understanding. As a reminder, every investment adviser registered with the SEC is required to establish and maintain policies and procedures reasonably designed to prevent violations of the Investment Advisers Act of 1940 and rules and regulations related to that Act as well as to detect and correct violations that occur. It makes it challenging to prevent violations when policies are not in place.
This is an essential request that is part of any routine SEC exam and should be an action item to incorporate as part of your firm’s annual review so as to avoid deficiencies in this area.