Compliance Considerations of Portfolio Management and Trading

Proper Portfolio Management and Trading are Regulatory Priorities:

In its 2019 Examinations Priorities Letter, the Securities and Exchange Commission (“SEC”), Office of Compliance Inspections and Examinations, listed Portfolio Management and Trading as SEC Examinations priorities.[1]  Many Firms are unaware of their Compliance requirements, putting those firms at risk for regulatory sanction.


The SEC intends to examine to ensure investment or trading strategies of advisers are: (1) suitable for and in the best interests of investors based on their investment objectives and risk tolerance; (2) contrary to, or have drifted from, disclosures to investors; (3) venturing into new, risky investments or products without adequate risk disclosure; and (4) appropriately monitored for attendant risks.

Registered Investment Advisers (“RIA” or the “Firm”) should take steps to review the current rules and their Policies and Procedures to ensure they are meeting their compliance requirements regarding Portfolio Management and Trading.

What are your Requirements?

The SEC’s article “Information for Newly-Registered Investment Advisers”[2] describes how RIAs are fiduciaries and have the fundamental obligation to act in the best interests of the RIAs clients.  The letter states:

“As an investment adviser, you are a “fiduciary” to your advisory clients. This means that you have a fundamental obligation to act in the best interests of your clients and to provide investment advice in your clients’ best interests. You owe your clients a duty of undivided loyalty and utmost good faith. You should not engage in any activity in conflict with the interest of any client, and you should take steps reasonably necessary to fulfill your obligations. You must employ reasonable care to avoid misleading clients and you must provide full and fair disclosure of all material facts to your clients and prospective clients. Generally, facts are “material” if a reasonable investor would consider them to be important. You must eliminate, or at least disclose, all conflicts of interest that might incline you — consciously or unconsciously — to render advice that is not disinterested. If you do not avoid a conflict of interest that could impact the impartiality of your advice, you must make full and frank disclosure of the conflict. You cannot use your clients’ assets for your own benefit or the benefit of other clients, at least without client consent. Departure from this fiduciary standard may constitute “fraud” upon your clients (under Section 206 of the Advisers Act).”

As described above, these fiduciary requirements extend themselves to Portfolio Management and Trading.  As an RIA, are your Portfolio Management decisions and trading practices designed with the best interests of the client as the primary goal?  Are you disclosing to your clients any conflicts of interest that may put the interests of your Firm in conflict with the interests of the client?  Have you taken steps to mitigate or eliminate those conflicts?

The SEC has taken enforcement action against Firms that did not meet their compliance and/or their fiduciary responsibilities when addressing Portfolio Management and Trading.  For example:

  • In the matter of Saxony Capital Management, LLC, September 30, 2019[3], among other actions, was required to pay disgorgement of $212,324.53 and prejudgment interest of $17,896.3 for inadequate disclosure of Mutual Fund Investments.
  • In the Matter of Lefavi Wealth Management, Inc., September 3, 2019[4], the Firm was required to pay disgorgement of $994,296.10 and prejudgment interest of $144,439.12, and a civil monetary penalty in the amount of $150,000 for among other violations, failure to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act, and the rules thereunder, in connection with its duty to seek best execution related to Alternative Investments.
  • In the matter of Putnam Investment Management, LLC and Zachary Harrison, September 27, 2018[5], among other actions, the Firm was required to pay a civil money penalty in the amount of $1,000,000 and respondent Harrison was required to pay a civil penalty of $50,000 for violating Section 206(2) of the Advisers Act, which prohibits any investment adviser from engaging in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client. Specifically, in its dealer interposed cross transactions, Putnam favored certain of its clients and did not seek to obtain best price and execution for certain of its clients in these cross-trades.

These are only a small sample of many enforcement actions brought by the SEC that involve Portfolio Management and Trading. In addition, the fact that Portfolio Management and Trading remain on the SEC’s Examinations Priorities Letter highlights the importance of this topic.

What should you do to Ensure Compliance?

What should Advisers do to maintain regulatory compliance regarding Portfolio Management and Trading? A good place to start is a review of your duties to your clients as a Registered Investment Adviser.

  • RIAs must perform a best efforts inquiry to obtain information regarding the client’s objectives, risk tolerance, time horizons, liquidity needs, and any special considerations. This information should be documented in some manner, with many firms relying on the use of an Investor Profile Form” which, when utilized, is typically completed with client input as part of the initial client intake process. Firms should verify that they have a methodology for gathering, documenting, and utilizing this information.
  • RIAs are required to provide clients with accurate disclosures of all material facts relating to the Investment Adviser-client relationship. These disclosures are typically provided through the use of Form ADV which must be provided to the client. In particular, Form ADV among other things, should accurately describe any conflicts of interest that may exist which may put the needs of the Firm in conflict with those of the client.  Firms should perform a conflict of interest inventory and verify that these conflicts are adequately disclosed and that steps are taken (and described in Form ADV) to mitigate or eliminate these conflicts.
  • When creating the client’s investment portfolio, RIAs must provide advice that is in the client’s best interest.  This includes performing adequate due diligence of the investments and ensuring the suitability of the investment itself.  For example, a particular investment may be highly rated and fit into a particular asset allocation, but it may not be suitable for a particular client due to the investment’s volatility. RIAs should perform due diligence of particular investments, and client portfolios should be reviewed by supervisory personnel when available, to verify the suitability and use of individual investments when deployed.
  • RIAs are also required to seek and obtain “Best Execution”.  This means the RIA is required to monitor the trade execution performance of the broker-dealers/custodians it uses to execute client trades. This is normally done by obtaining the “Best Execution Scorecard” for the broker-dealer/custodian used, and comparing it with the scorecards of other and similar broker-dealer/custodians to see if the execution quality of the chosen firm is performing in the best interests of the client. In evaluating Best Execution, the cost of trades is not the only factor taken into consideration. Factors such as quality and availability of client services, the range of other services offered by the Broker-Dealer/Custodian should also be considered.  This analysis should be performed on a periodic basis and memorialized in a “Best Execution Report”.
  • Once an investment portfolio has been created for a client, the RIA must monitor the portfolio on an ongoing basis and meet with clients at least annually to discuss the portfolio and any possible changes to the client’s status that may necessitate a change in their portfolio.

RIAs should perform a review of their Policies and Procedures Manual to ensure the above requirements are adequately and accurately addressed. If not, the Manual should be revised to include these steps and requirements.

Once, the Firm’s Policies and Procedures adequately address these requirements, Firms should include the testing of their Policies and Procedures designed to meet these requirements and document these tests as part of the Firm’s Annual Review.

In closing, Firms have a fiduciary duty to act in the best interests of their clients.  This requirement extends to Portfolio Management and Trading.  The SEC and other regulators take this duty seriously and have stated these are areas that will be considered during examinations.  Firms should take steps now to review their Portfolio Management and Trading procedures for adequacy.

Author: Core Compliance & Legal Services (“Core Compliance”). Core Compliance works extensively with investment advisers, broker-dealers, investment companies, hedge funds, private equity Firms and banks on regulatory compliance issues.


This article is for information purposes and does not contain or convey legal or tax advice. The information herein should not be relied upon in regard to any particular facts or circumstances without first consulting with a lawyer and/or tax professional.

[1] 2019 EXAMINATION PRIORITIES Office of Compliance Inspections and Examinations

[2] Information for Newly-Registered Investment Advisers, November 23, 2010

[3] INVESTMENT ADVISERS ACT OF 1940 Release No. 5385 / September 30, 2019 ADMINISTRATIVE PROCEEDING File No. 3-19552


File No. 3-19411

[5] INVESTMENT ADVISERS ACT OF 1940  Release No. 5050 / September 27, 2018 INVESTMENT COMPANY ACT OF 1940 Release No. 33257 / September 27, 2018 ADMINISTRATIVE PROCEEDING File No. 3-18844

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