Retire Rich

April 28, 2008

Add Forensic Testing to the SEC Exam Checklist

At the Securities and Exchange Commission's meeting on April 17 and 18 in Washington, D.C., open only to chief compliance officers, SEC chief examiner Gene Gohlke announced that mutual funds can now add forensic testing to their SEC exam checklist of funds' own annual internal compliance reviews.

If an asset management firm has not conducted forensic testing, it runs the risk of being found deficient.

Adding forensic testing to their long list of responsibilities doesn't make CCOs' jobs any easier, but it is a smart move for an asset management firm to make, both in terms of preventing internal fraudulent activity and monitoring for market, credit and other types of risk, such as the subprime debacle that took so many in the financial services industry by surprise.

Truth be told, while mutual fund executives have been savvy to the importance of fair valuation and mark-to-market risks, many money mutual fund managers had exposure to subprime, collateralized debt obligations and auction rate securities, as we have reported in recent weeks and months here in the pages of Money Management Executive.

Thus, the SEC presents our industry with another double-edged sword that we would be wise to accept. Yes, it means more work, but it will inevitably prevent losses.

As Gohlke, the associate director for the SEC's Office of Compliance Inspections and Examinations, said in a recent public speech, "The touchstone for examiners in evaluating a firm's annual review will be: Did the firm's annual review result in the firm continuing to have a set of compliance policies and procedures that effectively prevent compliance problems, find those problems that happen and promptly correct the issues that occur.?"

PricewaterhouseCoopers Parner Kevin O'Connell recently told us that his firm has been advocating forensic testing and accounting for the past year. "It's not just a CSI' scenario," O'Connell said. "We believe this should be an integral part of a fund firms' compliance overview and testing, as it is an indispensable tool for CCOs and their boards of directors to identify potential problems and improve internal controls."

So far, industry insiders say that only the very largest mutual fund companies have added such internal audits to their arsenals. It's time for the rest to get on board.

(c) 2008 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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