Walter & Shuffain - Certified Public Accountants & Business Advisors

Prepare your RIA firm for its next surprise audit

Registered Investment Advisors (RIAs) serve an important role in their client’s lives. They can often be financial custodians to their clients and hold great responsibility for the client’s financial situation. Due to past examples of mismanagement by RIAs in recent history, the Securities and Exchange Commission (SEC) began requiring annual surprise exams (surprise audits) of RIAs to detect fraud, misused, or misappropriated use of client assets managed by RIAs.  

Surprise audits are essential annual exams for RIA firms. Here is what you need to know to be prepared for your next surprise audit.  

Who is subject to a surprise audit? 

All RIA firms registered with the SEC that fit any of the following characteristics are subject to a surprise audit: 

  • Custody of any advisory client’s cash, bank accounts, or securities – If any inadvertent custody occurs, the RIA must return the funds or securities within three business days. Checks drawn and made payable to third party are not considered possession of client funds. 
  • Trustee or fiduciary of an account – Includes firms that act as both general partner and investment advisor to a limited partnership. 
  • Serves as power of attorney for a client – Includes signing checks on the client’s behalf, withdrawing funds or securities from a client account, or disposal of client funds or securities for any other purpose other than authorized trading. 
  • A related person or entity has custody of any advisory client’s cash, bank accounts, or securities. 
  • A related person or entity acts as qualified custodian for clients in connection with advisory services. 

What happens during a surprise audit?  

Your surprise audit must be conducted by an independent public accountant. As part of the examination, the auditor will:  

  • Request a list of the open, closed, and transferred client accounts subject to the custody requirements during a specified time period. 
  • Supply a template letter and ask you to prepare the confirmation letters for the clients selected. 
  • Provide you with a “to do” list of reports and other information needed detail for. 
  • Review your books and records as they relate to the RIA’s custody, confirm the information with the qualified custodian and client, and reconcile the confirmations with the provided records. 
  • Select a sample of transactions, request supporting documentation, and determine compliance with the Recordkeeping Rule. 
  • Ask you to supply a signed Management Representation letter (we will provide a template) stating you gave us all the information we requested. 
  • Upload the final audit opinion letters to the SEC. 

How can I prepare for my surprise audit? 

You will not know the exact date of your audit, but you can prepare your firm ahead of time with the following steps: 

  1. Proactively review all client/custodian contracts – You should know what accounts are in your custody. 
  2. Get a legal review of your contracts if you’re unclear whether custody is triggered. 
  3. Maintain an up-to-date account listing of accounts subject to exam including records supporting all transactions. 
  4. Ensure all contracts with clients/custodians are accessible and up to date with all amendments. 
  5. Update all contact information for clients/custodians and counterparties for privately offered securities. 
  6. Establish internal control documentation on systems and processes – Include information on key areas such as trading, reconciliation, and processes for evaluation. 
  7. Reconcile positions and transactions on a regular basis.  

How do I choose a firm for my audit? 

RIAs must file Form ADV with the SEC and include the name of the accounting firm engaged for the surprise audit. This year, those forms are due March 31, 2021.  

These surprise audits are important annual exams for each RIA firm, and meeting compliance is essential not only to appease the SEC, but to be able to show your clients that you are good stewards of their funds. Choosing the right independent accounting firm for your surprise audit is essential. You need more than check-the-box compliance: Getting insight on how you can improve can help alleviate any stress for the next audit as well as establish trust and goodwill with your clients. 

Walter & Shuffain has been performing surprise custody examinations for over 30 years and conducts approximately 20 per year. We understand your industry and the rapidly changing regulatory environment you face. Each examination is performed with the goal in mind of adding value to your compliance program. Contact us for more information and assistance.