How To Survive An SEC Examination
November 28, 2005
By Theodore E. Eichenlaub Partner Adviser Compliance Associates
During my five-year tenure as an examiner with the Securities and Exchange Commission, I heard countless comments from investment advisory personnel about how stressful it was to undergo an SEC examination. Increased monitoring efforts due to recent regulatory initiatives and market events have caused stress levels to rise exponentially.
While the process requires a tremendous commitment of time, patience and cooperation by your employees, with preparation you can greatly improve your inspection preparedness and chances for a successful SEC examination.
Historically, SEC inspections have lasted between three and five days (longer obviously for certain of the larger and more complex organizations). However, we have recently seen a marked increase in the amount of days that SEC examination teams are spending onsite examining registrants. While you may think that your advisory business is simple and low risk from a regulatory perspective, you must still be prepared for intense SEC scrutiny until the examination team feels comfortable with your compliance efforts.
Unfortunately, the individuals who commit fraud and misappropriate clients' assets do not come forward voluntarily to announce their sins to the SEC. Thus, the regulators are trained, and rightly so, to be skeptical and suspicious of each and every investment advisor they examine.
The single most important step an advisor can take to ensure its survival through its next SEC examination is developing and maintaining a strong compliance program. The ongoing process of an effective compliance program must include written policies and procedures, a clear delineation of responsibilities and independent oversight. The workings of an advisor's compliance program must be contained in a code of conduct and regulatory compliance manual, or, simply, a compliance manual. This became a required document for investment advisors on Oct. 6, 2004, the mandatory compliance date of Rule 206(4)-7, or the compliance program rule, under the Investment Advisers Act of 1940.
The importance of developing a strong compliance program and documenting it in the compliance manual cannot be stressed enough. In the past, the compliance manual was typically viewed as a static document that was a good place to regurgitate rules and regulations. The compliance manual typically did not adequately or accurately reflect an advisor's business practices and did little more than to reiterate the overly simplistic message, "We will act in our clients' best interests." Such an approach is no longer adequate. Advisors must develop and enhance their compliance manual to adequately reflect their business practices, and to continually strengthen their compliance programs.
The compliance manual is the single most important document that you provide to the SEC examination team. Accordingly, the care that you take in developing and maintaining the compliance manual must parallel the importance that the SEC will place on the document.
In addition to the presentation of your compliance manual, you should also be mindful of the following ideas that enable you to survive your next SEC examination.
Coupled with the development of your compliance manual, as required by the compliance program rule, you must also appoint a chief compliance officer, who, ideally, will be the individual who manages the SEC examination process. The CCO must periodically check in with the SEC, respond to inquiries, collect requested documents and be present for all interviews conducted by the SEC examination team.
Take an inventory of certain documents that are typically requested by the SEC examination team yet rarely change, such as an organization chart, investment advisory contracts, offering documents/prospectuses, marketing materials, etc. Include these documents in a central file for easy access.
Diligently respond to any SEC inquiries regarding the strength of your internal controls and your "tone at the top." The SEC has recently incorporated a new series of requests in its standard examination document request list, including items that essentially provide advisors the opportunity to demonstrate the strength of their compliance programs. It is advisable to develop thoughtful responses to these questions and to anticipate questions about your business during the course of the examination.
Review all past deficiency letters from the SEC to be certain that you followed up on the corrective action that you represented to the SEC.
Formally address each item on the SEC's list of requested documents in a written format and place each response in a separate folder labeled to correspond with the SEC request. As appropriate, respond "not applicable" to requests that do not apply to your firm.
Set aside a room for the SEC examination staff that includes a comfortable work space, a telephone and access to the Internet.
Inform your staff about the SEC examination, and stress the importance of being mindful of their presence when carrying on conversations.
Refrain from initiating a combative approach with the examination team, as generally such conduct does little to expedite the examination process.
Be clear and direct when answering the examiners' questions and do not try to answer questions that you do not know. You may consider conducting mock interviews to prepare individuals for questions that they may expect from the SEC.
Expect to receive additional document requests over the course of the examination. While additional document requests are normal, be mindful of the issues that the examination team appears to be focusing on and any matters that they may be pursuing. If prudent, seek outside assistance and/or advice.
Coupling a strong compliance program with my advice will provide you with the best chance for ensuring that your next SEC examination is less stressful on you and your firm's resources.
Theodore E. Eichenlaub is a founding partner of Adviser Compliance Associates, a compliance consulting firm with offices in Boston, Chicago, Los Angeles, New York, Richmond, Va., and Washington. ACA is almost exclusively comprised of former SEC and state examiners who consult state and SEC-registered investment advisors, hedge funds, administrators and mutual fund companies on regulatory matters.
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