The Securities and Exchange Commission has laid down various rules and regulations for registered investment advisors (RIA.s), to prevent fraud and unlawful activities. One of the activities that a RIA must undertake to ensure that they comply with all of SEC’s requirements is an internal risk assessment of their firm.
The Importance of Risk Assessment for RIAs
Risk assessment for R.I.As helps them identify the different types of risks based on their business model, conflicts of interests, and affiliations. While conducting a risk assessment, they might discover operational and compliance risks related to their firm, and thus be able to remedy it.
Investment advisory firms are prone to some common errors such as incorrect filing of form ADV, making wrong fee calculations, and also a lack of organization of records and books.
Let’s take an in-depth look at the importance of risk assessment for RIAs and how firms can conduct it.
What is an RIA?
A registered investment advisor is a person or firm, that helps institutional investors and affluent individuals manage their wealth and investment portfolios.
All investment advisors must register either with the SEC (Securities and Exchange Commission) or state securities administrators. The latter is usually a government or regulatory agency, or official, overseeing and enforcing state-level regulations and rules regarding securities transactions.
Apart from managing assets for their clients, RIAs also create portfolios by using bonds, mutual funds, and individual stocks. They may also use a mix of individual issues and funds or only funds for streamlining asset allocation and cutting down on commission costs.
Registered investment advisors must follow the fiduciary standard. This means they must always keep the interest of their clients at the forefront. They receive compensation from their clients for their investment advice.
What is Risk Assessment?
The purpose of risk assessment is twofold: to assess risks to the investment firm and assess potential risks to its clients. They must carefully assess and prioritize operational issues, procedure, and vulnerability in their organisation. Ultimately, they must try to mitigate and minimize risks.
Purpose of Risk Assessment
The best way to detect and prevent regulatory violations is having written policies and procedures. This is usually the responsibility of the Chief Compliance Officer (CCO).
Firms should conduct an annual audit for all their processes. This helps them:
- Understand the risks their organization may be exposed to
- Assess of they have the right processes and procedures in place to mitigate risks
- Customize processes and procedures to be able to mitigate newly identified risks
Risk assessment serves as a timely shot in the arm to help firms know if their organizational policies and procedures are sufficient to manage risks. Identifying potential compliance slip ups can help them avoid penalties in the future.
Issues That Risk Assessment Should Address
Risk assessment for RIAs begins with identifying all conflicts and compliance factors that may create risk exposure for the firm and its clients. Then, they must design policies and procedures that address those risks. It is expected that the policies and procedures should address the following (but not limited to) issues:
- Safeguarding records and information of clients
- Preventing fraud and incorrect usage of client assets by employees for the from
- Accurately storing and maintaining records, so they cannot be modified or altered unauthorized
- Ensuring full disclosure of statements and advertisements to clients, regulators;# and investors.
- Portfolio management processes
- Fair trading practices
- Business continuity plans
Identifying Risks for RIAs
There are many types of risks that may harm the interests of a firm and its clients. Take a look:
- Strategic risks arise from inadequate business decisions.
- Operational risks arise from the inadequate operations systems, mismanagement of information systems, and transaction processing. These risks can result in unforeseen losses.
- Being unable to meet the financial obligations counts as a financial risk.
- Compliance risks arise from the possibility that a breach of internal policies or procedures may impact negatively or disrupt the firm’s condition or operations.
- Finally, reputation risks arise from the possibility that inappropriate management or employee actions may cause the public or press to form a negative opinion of the firm or its products and services.
An individual or a risk committee may identify these risks or any other risks by brainstorming about possible threats to the interests of the firm and its clients.
When identifying the risks, it is important for the advisers to think outside the box. After successfully identifying the risks, the individual or the risk committee should assign a person or team to examine a firm’s policies, day-to-day business processes, procedures, and systems surrounding the risks. Then, they must ascertain the level of risk, and propose reasonable compliance solutions for eliminating or decreasing the risk.
Risk assessment is an essential responsibility for a registered investment advisor. It allows them to safeguard their clients against potential harm, and also ensures their firm complies with the necessary regulations and laws.
If you’re an RIA looking for a better way to assess and manage risks, take a look at the governance and legal compliance solutions provided by VComply.