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Bulked-Up SEC to Take On Asset Managers

OCIE Pursuing Headline-Making, Groundbreaking Cases


BOSTON -- The Securities and Exchange Commission is about to get a lot bigger and tougher, once Congress approves significant funding increases in its financial reform legislation. The soon-to-be-bulked-up agency is also planning to restructure its resources to place heavy emphasis on inspections, examinations and prosecuting high-profile cases.

"The SEC wants to bring groundbreaking, publicity-generating cases in order to shore up the deterrent value that enforcement cases provide," said Lori Richards, principal, PricewaterhouseCoopers LLP, during NICSA's General Membership Meeting here. Her remarks were made during a roundtable panel on "The Regulatory Landscape and Emerging Compliance Considerations," moderated by Bruce Treff, CitiFund Services' managing director, regulatory & compliance services.

Richards, who is the former director of the SEC's Office of Compliance Inspections and Examinations (OCIE), said the agency has been "beefing up their litigation staff," and has created a dedicated team of 70 enforcement attorneys to watch the asset management industry.

The SEC's asset management enforcement team wants to bring enforcement cases against and involving asset managers, including mutual funds and hedge funds, Richards said. "Their first and foremost concern is detecting fraud and identifying the worst conduct in the industry."

The House version of the financial reform legislation working its way through Congress includes a provision to allow the SEC to collect user fees from independent advisors to pay for compliance inspection and examinations.

The Senate Appropriations Committee recently granted the SEC $230 million for fiscal year 2010 and $256 million for 2011, allowing the SEC to hire approximately 375 more staff members. The Senate is also considering the SEC's request for a self-funding mechanism, which would allow the agency to control the estimated $1.5 billion in fees it charges public companies and other entities to register.

"The whole area of insider trading has heightened the attention of the SEC, and indeed, of regulators globally," Richards said. "In the UK for example, they put people in handcuffs for the first time."

In addition, examiners are more likely to be skeptical of verbal representations during exams, as they have had experiences where firms misled or lied to them, she said. Because they want to have confidence that they have surfaced any fraud or serious violations, these examinations are also more likely to stretch out investigations over several months, and one particular exam that began last summer is still going, Richards said to gasps from the audience.

Under the leadership of Chairman Mary Schapiro and Enforcement Director Robert Khuzami, the agency is looking for big, groundbreaking cases that show it is tough on Wall Street, she said, and this headline risk to firms will have repercussions throughout the industry.

"We have seen headline after headline about derivatives, the resurrection of Glass-Steagall, and the investment advisor registration component," said Francine Rosenberger, a partner at the law firm K&L Gates LLP. These sweeping reforms could be burdensome, she said.

Rosenberger said the new SEC will be relying more on tips and complaints to locate misconduct, rather than trying to do a routine inspection of everyone.

Last year the SEC received approximately 750,000 tips and complaints, ranging from credible-seeming allegations to anonymous letters, some from prisoners and some that were no more than "scribbles on cocktail napkins," Richards said. Given that it is difficult to assess credibility based on a reading of the complaint or tip alone, the SEC is reluctant to dismiss a tip or complaint, she said.

The SEC's Boston office famously ignored a tip from Putnam whistleblower Peter Scannell before former New York A.G. Eliot Spitzer blew the door open on the late trading scandal.

Federal legislation requiring large hedge funds to register with the SEC now appears to be inevitable, Treff said.

Hedge fund firms are preparing for this eventuality by setting up checks and balances, conducting regular compliance reviews and documenting everything, Richards said. "For a lot of firms, this is a sea change in the way they do business," she said.

Many firms have a dominant control person, such as an entrepreneur who founded the firm, and are not used to working in a regulated environment, with formal policies and procedures and internal controls, she said.

"These people may have a lack of knowledge of legal provisions, regulatory expectations, as well as of compliance best practices," Richards said. "How do you operationalize compliance?"

She said firms will need to adapt quickly, as SEC examiners will expect new managers to be up to speed with fully operational and effective compliance programs by the day they register as advisers, which hasn't been set yet.

If the SEC staff hasn't inspected your firm lately, you're probably about due for a visit, Rosenberger said.

"I'm worried that if OCIE is moving away from routine exams, many advisors may stop being prepared," she said.