Senior SEC officials recently outlined the agency's criteria used when it selects registered investment advisers (RIAs) for examination.
The SEC initiated its “risk-based” approach in 2010 to determine which firms to examine and which parts of a firm's business it will want to more closely scrutinize during the examination. Factors that may dictate which firms to examine include tips, complaints, and referrals from other governmental agencies received by the SEC. In addition, the selections are often made by the risk areas identified by the SEC through a review of the firm's Form ADV, results of previous examinations of the firm, information from third parties, business activities of affiliates, amount of assets under management, private fund advisory activities, disciplinary history, and the time that has elapsed since the last examination was conducted.
If your firm has never been the subject of an SEC examination or it has been several years since the SEC's last visit, you should expect to be notified by the SEC in the near future. Generally, the SEC sends a written notice to the RIA stating that it will arrive at the RIA's principal place of business on a certain date and, in order to facilitate the examination, will request a list of information to be provided to the staff prior to the examination. The pre-examination review of such required information, according to the staff, is intended to make their actual onsite time more efficient and focused.
Once the firm is selected and requested pre-examination information from the firm has been reviewed by the examiners, the SEC staff conducts the onsite examination, which can take anywhere from several days to several weeks. Generally, the examination team will consist of at least two examiners, but often includes five or more. While at the firm, the examiners target certain areas such as conflicts of interest, valuation of complex investment instruments, private funds, allocation of trades (especially where the RIA manages side-by-side incentive fee and non-incentive fee clients), advertising and performance presentations, and custody of assets issues.
As part of the examination process, the staff will especially review the firm's supervisory and control focus. As part of that review, the staff will look for signs as to whether senior management and the board of directors are setting the appropriate compliance tone within the firm from top to bottom. John Walsh, Chief Counsel of the SEC's Office of Compliance Inspections and Examinations, recently stated that RIAs, while gearing up for the inevitable SEC examination, should ensure employees understand their obligations; have an effective compliance program with a chief compliance officer who possesses the authority to implement and enforce the compliance program; engage senior management and the board of directors in compliance matters; and conduct, at least annually, compliance risk assessments, and effect changes in the compliance program where the risk assessment indicates weaknesses.
Apparently, the SEC has geared up its risk analysis and surveillance personnel so that its examination program can target the high-risk firms and areas of concern. In addition, the SEC has organized working groups specialized in certain areas such as new and structured products, valuation, and fixed income securities. The SEC has looked to employ persons for its examination program who have specific industry experience in the areas targeted by SEC for examination.