Investment adviser firms, their lawyers, and their consultants all report that the Securities and Exchange Commission’s examinations are becoming more demanding. Examiners are spending more time on the exams and are writing up more lengthy and detailed deficiency reports. The SEC is deferring less and less to firms’ explanations as to why supervision or compliance procedures were not in effect at the time of the examination, and seems to be taking a hard look at whether there are inconsistencies in what firms report and what they actually do in practice. Firms must prove that their compliance manuals are updated regularly and produce emails and other documents quickly. These developments are described in the October 26, 2009 Investment News article written by Jed Horowitz.
John Walsh, Acting Director of the SEC’s Office of Compliance, Inspection and Examinations, recently said at a National Society of Compliance Professionals national meeting in Philadelphia, “to put it bluntly, the world of compliance of 2008 is dead.” He added that the examination program was changing and will continue to change. In fact, the SEC is hiring more experienced personnel, focusing on the areas of trading and other investment areas. The result of this retooling is to permit the SEC to coordinate specialized sweeps and examinations. One of the goals is for the SEC to be able to get a cross-disciplinary view of the firm’s practices. The SEC will even reach out to the advisor’s clients and third party custodians to verify the existence of assets and the accuracy of trading data. Much of these changes, of course, are in response to the Madoff fiasco.
Kathleen Furey, a senior SEC attorney, recently outlined five areas of priority that will be the subject of focus for the examiners:
- Insuring custody of client assets and accuracy of evaluations;
- Assuring that required disclosures are made to customers, particularly those relating to trading conflicts;
- Reviewing marketing material, with a particular emphasis on accuracy of performance claims;
- Measuring the adequacy of compliance resources; and
- Focusing on any changes to a firm’s business or client base.
Firms are concerned that the new focus will be more costly in terms of preparation and follow up. There is even some concern that, either through legislation or rule-making, the cost of the exams may be passed on to firms. Regardless, smaller firms will be disproportionately affected by the more detailed and onerous exams. The shift in exam focus has also made it important for advisors to carefully consider how to prepare for exams and how to approach problems that may be disclosed during the examination.
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