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Taking the Sting Out of an Audit

Here's how to get organized when the SEC or NASD or your broker-dealer visits.

By Janet C. Arrowood

My broker-dealer decided to take an interesting approach to the “Annual Face-to-Face Compliance Meeting” this year. He contracted with an independent firm to have an actual audit done in my office (and the offices of all the other registered representatives). So I thought I would share some information to help take the sting (and fear) out of a compliance (or an SEC or NASD) auditÉ

As registered representatives, we are subject to audits by a number of entities, including the SEC, the NASD and our broker-dealer. If you take a few minutes to review your contract, compliance manual and any other broker-dealer correspondence, you will find an audit much easier to prepare for and handle.

As a general rule, the goal of an audit is to look for discrepancies between your files and records and the requirements of your broker-dealer and the NASD/SEC. The auditor may also want to know if you understand normal procedures; consequently, you must be prepared for a number of questions. If your broker-dealer orders the audit, you will probably get to schedule it a few days in advance and then work frantically to get things in order. Should the SEC/NASD choose you, you may find the auditor or auditors at your door one day. If you are a registered investment advisor, you must keep even more records. However, this article does not address these additional requirements.
The most important files, in my opinion, are:

  • Compliance
  • Complaints
  • Customer records
  • Contracts
  • Incoming/outgoing correspondence
  • Advertising

In my compliance file, I keep copies of all my broker-dealer “OKs” for correspondence, articles (such as this one), presentations and advertising materials (including brochures). I also keep copies of anything else I receive from compliance. In addition, the file holds my compliance manual and copies of any checklists or other materials from compliance meetings. If I’m not sure where else to put something, this is the file in which it probably ends up!

You need a file labeled “customer complaints.” The auditor may ask you what you do if you receive a complaint. The answer to this question should be: I would immediately send a copy to my broker-dealer.

Customer records should contain a complete set of account statements. I usually keep three years worth of statements in the files and put older statements in storage. These files should also contain the original application(s) and new account form(s). I keep customer correspondence in a separate file. If you have more than one account for a given client, it doesn’t hurt to have subfolders inside the main folder for each account. Also, while you can commingle insurance and securities for a customer, I prefer to keep the stuff separate. If you receive change-of-address or other notices, keep them in here too.

I have all my securities and insurance contracts in a folder. Make sure you update them and throw away the old ones. This is a good place to have your broker-dealer contract. I also put my current U-4 and most recent U-5 in a sub-folder in this file.

You need to keep two correspondence files — one file for stuff you send out and the other for stuff you receive. Unless your broker-dealer says otherwise, make sure you send him copies of everything.

“Advertising” is everything you send to more than a certain number of people (check the limit with your broker-dealer) or put in front of the general public. This includes items such as articles, ads and brochures. The auditor may want to see the compliance “OK” on these items.

Here are some other items you should keep:

  • Copies of your commission statements
  • Copies of your business check statements (the auditor may want to reconcile the commission and bank statements to make sure there is no improper activity).
  • A trade blotter with the name of each client, the date the application was sent to your broker-dealer, the check number and investment details
  • Copies of email messages to and from clients (always cc your broker-dealer)
  • A copy of your errors and omissions coverage information
  • A copy of your insurance license(s)
  • A copy of any state-specific licenses for securities or insurance

Because I receive a lot of mutual fund account statements, many with duplicate information, I simply file them in an accordion folder by their last name. Then, when I receive the annual statements, I can make a major contribution to my local recycling center by just upending the folder into the bin.

Here are some additional things to keep in mind:

  • Your insurance files (both variable and traditional) are also subject to review.
  • You may have to produce one or more client files. Make sure the files are complete (application, annual statements, etc.).
  • If you work with qualified plans, you can expect the auditor to look closely at those files.
  • Don’t volunteer any information and don’t ask the auditor any questions.
  • You may believe you know more than the auditor, but it is advisable not to let that knowledge show!
  • Ask your broker-dealer if your office is a branch office. If it is, you must have the appropriate signage (Firm name and Member, NASD, SIPC, etc.).

Janet Arrowood is managing director of Denver-based Investment Decisions, Inc. She is a registered representative and can be reached at 303-567-0996 or by email at


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