Nov 16, 2022

The SEC recently released some interesting enforcement actions that should make advisors and broker-dealers think long and hard about permitting employees to contribute to most, if not all, political candidates without incurring significant risks to their business. This is particularly true if your firm manages any assets for public entities ─ the risks are simply not worth it. Compliance and finance professionals need to be aware of the risks here ─ in my opinion, they’re draconian.

Political contributions: How should firms address the issue?

  • Ensure that all employees know the risks involved and the damage an improper political contribution can do to the firm
  • Have a modern conflict-of-interest system (preferably with AI) to sort through the litany of different electronic communications methods, including encrypted ones
  • Be sure the system checks (or compliance manually checks) the various databases to make sure that employees are following your policies
  • Require quarterly certifications by all employees, because a quarterly (rather than annual) certification will serve to better remind employees of the requirements

Electronic communications: What you need to know

Broadly speaking, the second area of the SEC’s enforcement action targets electronic communications. Firms must look at not only their employees’ emails, but also any other type of communications (interpret broadly here) to validate that employees are not conducting illegal activities. While it might seem harsh to think that employees could be doing something illegal, the fact remains that it occurs with too much frequency. A look at the SEC web page of all the enforcement and administrative actions against both companies and individuals will reveal that this, sadly, happens all too often. So, let’s look at how firms should address this issue.

  • Firms need to review their overall policy, particularly their procedure to demonstrate that they reflect not only the business reality, but also have considered if the scope of electronic communications oversight is as broad as it needs to be.
  • Compliance professionals should consider quarterly certifications from the staff to ensure that employees have not used personal emails, texts, and chats to communicate with clients or prospects. The implication here (which got some of the banking-affiliated brokers and advisors sanctioned) is that nefarious activity could be taking place outside the purview of compliance. Although certifications provide limited protection for a firm, they’re better than nothing and also put employees on notice that these activities are prohibited.
  • At minimum, Cutter strongly recommends conducting annual training in this area. Be forewarned: If the SEC determines that employees have not followed this policy, they may subject their “personal” communication devices to the intense review by government regulators.

Find additional information on the SEC’s electronic communications rules here:

Proposed rule: Oversight of service providers

The SEC recently released a new proposed requirement for all advisors that outsource services for almost anything relating to their investment business. While it does not include administrative or ministerial, the proposed requirement is otherwise very broad. For mutual fund sponsors, this is very similar to the Compliance Rule.

As part of the proposed rule, firms must demonstrate that they exhibited due diligence in the selection of their various outsourced services. They need to establish policies and procedures to describe the general selection process for their selection as well as processes for ongoing oversight. This is not a one-and-done process. Firms need to practice some continuous level of oversight. Cutter recommends that this be in addition to some type of regular oversight in the mutual fund arena, where most firms hold a quarterly meeting with their vendors and then a deeper dive on an annual basis.

Here is the link to the proposed rule on outsourcing by investment advisors:

For firms struggling with these SEC requirements, Cutter has a strong practice for the selection and oversight of various vendors. Connect with us at [email protected] for more information.