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Compliance & Risk

Investment adviser ‘side hustles’ can present compliance challenges

Jason Wallace  Senior Editor / Thomson Reuters Regulatory Intelligence

Jason Wallace  Senior Editor / Thomson Reuters Regulatory Intelligence

Investment advisory representatives that have a second job or offer additional investment-related services may present compliance challenges to the financial services firms that employ them

For the most part, what advisory representatives and employees do outside the office on their own time is their own business, but if the activity conflicts with the adviser’s professional obligations it could exponentially raise the firm’s regulatory risk and account for client confusion.

Investment-related services are often an attempt to provide clients a more comprehensive approach to financial management. For example, a representative may offer accounting or insurance services — not covered by an adviser’s client protections — in addition to asset management to clients.

Intensifying the risk, many advisory representatives have adopted a hybrid work schedule in which they are supervised remotely and away from the usual risk-mitigation safeguards inherent in physical office branches. Further, investment-related compensation and the potential for conflicts of interest are key regulatory concerns.

Therefore, an adviser firm that employs outside business activity (OBA) policies and procedures, ensures proper disclosure, and trains its representatives can be better prepared for the conflict or interest risks associated with OBAs.

Outside business activities

Outside or other business activity is generally defined as any outside investment-related business in which a supervised person (i.e., officers, directors, partners, investment adviser representatives, and employees) participates and which involves a substantial amount of time or pay.

OBAs can also include non-compensated leadership positions, such as a president or treasurer of a non-profit board of trustees. And, according to the Securities and Exchange Commission (SEC), substantial time is defined as an OBA that encompasses 10% or more of the supervised person’s total time and/or pay.

Typical investment-related OBAs of advisory representatives may include roles as insurance agents, accountants, or registered representatives of a broker-dealer. However, a non-investment related OBA may also need to be disclosed if the other business activity or activities provide a substantial source of the supervised person’s income or involve a substantial amount of the supervised person’s time.

Policies & procedures

A firm’s policies should include procedures regarding the collection, supervision, and disclosure of the outside business activities.

To support the written policy, a firm can institute a representative questionnaire or OBA-request form. The questionnaire or request form will give the representative the opportunity to request approval and self-report outside or other business activities.

On an ongoing basis, a Chief Compliance Officer can spot-check the individual’s outside business by searching the internet or website to see if the information confirms or contradicts the firm’s records. Additionally, OBAs can be a topic for email and communications reviews for all employees.

OBA disclosure

OBA disclosures are found in the adviser’s Form ADV and the individual’s Form U4. The ADV Part 1 has some standard questions that apply to outside business and inherent conflicts of interests, although the primary method of disclosure is done via the firm’s ADV Part 2 and Form U4.

ADV Part 2A has certain questions that cover outside business activities. Items 5 and 10 ask about the fees and other financial industry activities and affiliations of the firm and its associated persons. In Part 2A, the SEC lists 11 different individual affiliations that require disclosure; they range from broker-dealer and municipal securities dealer to pension consultant and real estate broker.

The ADV Part 2B supplement requires detailed information about each individual or supervised person (or persons) providing advisory services to individual clients. Like a resume, the supplemental information includes educational background, business experience, and other business activities, along with the disciplinary history of the individual. Additionally, the supplement requires the OBA disclosure to dictate whether it’s investment-related or not. The verbiage is specific to any other business activity that involves a substantial amount of time or pay.

However, the SEC’s primary request concerns investment-related compensation. An individual must disclose compensation from bonuses and non-cash compensation, compensation based on the sales of securities or other investment products, as well as an explanation of the incentives this type of compensation creates. Both portions of Form ADV 2 require the firm to determine whether the OBA creates a material conflict, to describe the existing conflict, and generally say how the firm addresses it.

The Form U4 requires information about the representative’s other or outside business as well. Item 13 of the U4 requires detailed information such as the name of the business, title, whether investment-related or not, relationship with the other business, duties required, and approximate number of hours per month devoted to the other business. Like the supplement, the Form U4 requires the listing of non-investment related activity, unless it’s exclusively charitable, civic, religious, or fraternal and is recognized as tax exempt.

Lastly, the Form CRS covers conflicts of interest as well, and it may have further disclosure requirements based on the specifics of the outside business.

Training

In addition to initial and annual questionnaires or OBA request forms, a firm can host periodic compliance meetings and publish intermittent compliance bulletins highlighting the topic of OBAs.

An individual’s training should include what constitutes an OBA that must be reported, and steps taken to receive approval by the firm’s compliance department.

Additionally, a firm should include what type of activities are prohibited by the firm. For example, a firm may prohibit an OBA that includes custody of client assets, some political activities, or outside activities that require more than a certain percentage of the advisory representative’s time.

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