On November 1, 2010, Carlo Di Florio, Director of the Office of Compliance Inspections and Examinations (OCIE), at the Annual Meeting of the National Society of Compliance Professionals held in Baltimore, Maryland, discussed recent reforms instituted by the U.S. Securities and Exchange Commission (SEC), including establishment of the Office of Market Intelligence, enhancements to the National Exam Program, and current exam priorities.

Office of Market Intelligence to Give TLC to 'TCRs'

Less than a year ago, the Division of Enforcement established the Office of Market Intelligence (OMI) to improve the handling of tips, complaints and referrals (TCRs). While a fair percentage of tips may, for various reasons, not be of practical use, taken as a whole they can establish a pattern, or at least indicate areas to investigate. OMI has started using a centralized database to collect all TCRs and combine that data with other confidential and publicly available information identified in the TCRs. With accurate centralized profiles of the universe of nationwide complaints, information can be shared freely across all SEC divisions and the SEC staff will be better able to see the “big picture” with regard to any given firm. The SEC also expects the recently-enacted whistleblower provisions of Dodd-Frank to increase the volume of TCRs dramatically. In the wake of recent scandals that went undetected, the SEC is taking the TCR process very seriously.

National Exam Program Enhanced and Refocused

The National Exam Program is now increasing its emphasis on making strategically risk-based assessments before commencing examinations. Given the substantial, but still limited, universe of resources available to the SEC, an increased risk-based focus should allow for better staff utilization. In general, the SEC plans to spend more of its examination time on the “front end,” before examiners even walk in the door of a firm. The SEC also hopes to better coordinate its oversight of investment advisers and broker-dealers in an effort to avoid failures that can come from separate examination silos.

Having said that, OCIE still lists its areas of focus for investment advisers and broker-dealers separately. OCIE is currently focusing on the following “hot topics” during examinations:

Investment Advisers

  1. Custody and Asset Verification. Examiners will continue to contact counter-parties and customers to verify the existence of assets. We have previously termed this phenomenon a response to the “Ponzi Scheme Presumption.”
  2. Valuation. Examiners will explore whether advisers have incentives to increase valuation (to make more money), decrease valuation (to avoid concentration limits) or hold values steady (to permit advisers to work out of troubled positions undetected).
  3. Conflicts of Interest. Examiners will consider conflicts broadly, including whether advisers are favoring certain accounts or affiliates, or failing to conduct due diligence as advertised.
  4. Portfolio Management. Examiners will explore whether advisers are following their disclosed strategies.
  5. Performance Calculation and Reporting. Examiners will look at performance outliers and question performance that is abnormally high, abnormally low, or “abnormally normal” (like Madoff).


  1. “Forest for the Trees” Exams. The examination staff will be looking at the big picture of how firms operate, seeking to identify problems in compliance, supervision, sales practices and risk management. This is a catch-all category designed to encompass the staff’s mission to detect and punish fraud in its many forms.
  2. Risky Products. Examiners will employ enhanced expertise and focus on complex or sophisticated products that bear significant risk, especially when sold to retail investors. The staff will focus on structured products (such as leveraged ETFs), oil and gas offerings, municipal securities, and pretty much anything sold to senior citizens that is not plain vanilla.
  3. Trading Practices. The examination staff will be turning its enhanced expertise to the issues raised by algorithmic and high frequency trading.
  4. Protection of Customer Assets and Information. The staff will continue to contact counter-parties (verifying up) and customers (verifying down) to ensure that assets actually exist and that transactions actually occurred. They will also focus on the security of customer information.
  5. Financial and Operations Issues. The staff will conduct a systemic scan of a firm’s system of checks and balances, risk management and governance processes.

Di Florio called on the industry to be “proactive” and root out problems before the examination staff does. Although this is a challenge in today’s economic climate, where firms are expecting compliance officers to do more with less, firms ignore “tone at the top” at their peril.