The SEC is still smarting from the criticism it received in the wake of the Bernard Madoff Ponzi scheme that went undetected during SEC exams. In an effort to ensure that a Madoff-type scheme does not go undetected, the SEC will soon introduce new features to its exam process for registered investment advisers and broker-dealers. The revamped SEC exam process will include interviews or other involvement with senior management and board members of the registrant.
The SEC's Office of Compliance Inspections and Examination (OCIE) is currently conducting a thorough review of its examination process. It expects to complete the review and implement new exam policies by the end of this calendar year. Earlier this year, OCIE reported on its new risk-based examination process, which requires the examiners to conduct extensive research of the registrant and its business before conducting the onsite examination.
During the pre-exam research process, the staff will focus on the following elements:
- The independence of legal and compliance departments and officers
- The adequacy and effectiveness of compliance and risk functions/processes and controls
- The level of senior management engagement in compliance and risk processes, and whether there is an appropriate compliance “tone” at the top of the firm
- Whether the board is engaged and focused on risk management
- The adequacy and independence of internal audits
OCIE now has a new centralized unit for risk assessment that will work with the SEC's Office of Market Intelligence to coordinate follow-up on tips and complaints received by the SEC. The data collected will be used by OCIE to help assess risk and determine which firms to examine. OCIE examiners, who will receive training once the new exam policies are complete, will focus on registrants and business practices where problems persist. For investment advisers, persistent problem areas found by the SEC during onsite examinations include conflicts of interest, portfolio evaluation, portfolio management, and whether the disclosures within Part II of Form ADV match up to the registrant's method of business.
Finally, OCIE is working with the SEC's Division of Risk, Strategy, and Financial Innovation and the Division of Investment Management to develop an exam program for hedge funds, which is to be in place by July 2011.