What problems? Violations in NASAA sweep exams fall dramatically

A roundup Monday of coordinated state investment advisor examinations so far in 2023 found that surprisingly, violations have plummeted over two years.

Compared with exams in mid-2021, the North American Securities Administrators Association found that across categories such as registration, books and records, and supervision and compliance, the incidences of violations were down by half or more.

An announcement published alongside the report didn’t offer an explanation for the sharp decline in investment advisor violations, but some of the improvement could stem from advisors having addressed issues from prior routine exams, said Alisa Goldberg, chair of the investment advisor operations project group at NASAA and director of the Florida Division of Securities.

“We cannot know for sure — however, NASAA and the state regulators have been working very hard with the state-registered investment advisors to take them into compliance. A number of these exams were second-time exams,” Goldberg said. “We would hope that they would be more compliant, based on previous interactions with them.”

For the 2021 report, 24% of the investment advisors were examined by their states for the first time. That figure increased this year to 34%, with 232 of the 683 routine exams in the report being the first that firms had faced.

This year, for example, nearly 23% of firms had exams that turned up violations related to registration, down from just over 44% in 2021. The second most common violation area — books and records, largely related to client suitability — saw the incidence drop from 42% to 17%. And in supervision and compliance, the rate fell from 29.5% to over 16%.

The decline was even more dramatic regarding contract violations, which fell from 30.5% to over 12%. And while 19% of exams turned up fee-related violations in 2021, that was just 6.4% this year. One of the biggest drops was in custody violations, which fell from nearly 19% to less than 3%, according to NASAA. Similar declines followed in the financial matters and advertising categories.

The organization's 2021 report showed that instances of violations on routine exams dropped compared with those in 2019, but not to the same degree as what the new data show. For example, registration violations declined slightly from 2019 to 2021 from just under 50% to about 44%, while books and records problems went from nearly 60% to about 42%. And contract issues dropped from about 44% to 31%, but issues around supervision and compliance as well as advertising increased.

Regardless of the improved results, Goldberg cautioned investment advisors to stay on top of their Form ADV filings.

“That’s a major concern, mostly from an updating standpoint,” she said. Additionally, customer contracts with inaccurate information or those that include hedge clauses that seek to limit liability are also issues that states are watching, she noted.

This year, states have found a significant number of issues around client suitability and protections for vulnerable investors. On the latter, 37 exams showed investment advisors not having any policies for addressing financial abuse, for example.

“Unfortunately, there were a number of deficiencies related to state investment advisers not having policies and procedures for suspected financial exploitation,” Goldberg said in an announcement of the findings. “Our hope is that this data will result in changes that increase investors’ confidence in their advisers and better protect them from investment fraud.”