Deficiency Letter

A deficiency letter is a letter, issued by the Securities and Exchange Commission (SEC), indicating a significant deficiency or omission in a registered statement or prospectus or, the case of an SEC examination, of deficiencies in an investment adviser’s regulatory compliance program. A deficiency letter should be dealt with promptly, and the SEC should be alerted of any actions taken to remedy the situation.

When issuing securities, a deficiency letter will usually disrupt the process. The letter will often halt the registration process, postponing the date of the issue. This prevents a company from receiving funds at an expected date. Furthermore, a stop order may be issued along with the deficiency letter. This will prevent any sale of the securities in the issue until the deficiency is handled.

When an investment adviser receives a deficiency letter regarding regulatory compliance deficiencies, he or she will need to address the letter by improving his or her regulatory compliance program in the ways advised by the letter. All SEC-regulated investment advisers must undergo periodic SEC examinations. Deficiency letters are issued following an SEC examination about 80 percent of the time. Usually, they are intended to highlight flaws in the adviser’s regulatory compliance or areas for improvement in his or her firm, rather than to call out unethical behavior.

Most deficiencies are minor, such as in the case of failing to maintain adequate advertising records or maintaining an inadequate business-continuity plan. Some common compliance deficiencies include:

• Failure to perform regular annual compliance policies and procedures, their implementation, and their effectiveness in the firm;
• Failure to amend form ADV at least once a year, or more often if required by the Form ADV instructions;
• Failure to file a Form PF; and
• Failure to meet the requirements of the Custody Rule.

Many advisers do not realize that they are failing to meet regulatory compliance requirements because they do not understand how regulations apply to their situations. For example, an adviser who has online access to a client’s account may not understand that he or she has custody of that account and must meet the requirements of the Custody Rule, including being open to surprise examinations from the SEC. Advisers often meet regulations to some extent but fall short of full compliance. Because regulations are so complex, the SEC typically allows advisers a reasonable amount of time to address deficiencies.