On September 6th, the U.S. Securities and Exchange Commission issued a Risk Alert, providing investment advisers with information regarding the Division of Examination’s process by which they select advisers for examination. The Division also included an attachment that mirrors the Division’s typical initial request for documents and information.
- The firm’s risk characteristics;
- A tip, complaint, or referral;
- The staff’s interest in a particular compliance risk area.
The Division considers factors such as which advisers provide services, recommend products, or otherwise meet criteria relevant to the focus areas described in the Division’s annual publication of its examination priorities.
Particular firm-specific risk factors are also considered when selecting advisers for examination. Examples of such factors include:
- Observations of repetitive deficient practices;
- Supervisory disciplinary history;
- Tips, complaints, or referrals involving a firm;
- Business activities that may create conflicts of interest;
- Length of time since the firm’s registration or last examination;
- Material changes in a firm’s leadership or other personnel;
- Indications that the adviser might be vulnerable to financial or market stresses;
- Reporting by news and media that may involve or impact the firm;
- Data provided by certain third-party data services;
- Disclosure history of the firm;
- Whether the firm has access to client and investor assets; and/or
- Whether the firm presents certain gatekeeper or service provider compliance risks.
Upon selection of an adviser for examination, the staff defines the scope of the exam. The parameters of the exam may focus on particular aspects of the business that correspond with areas of risk that the staff identify during assessments they conduct prior to requesting documents from the adviser. The staff explained that the scope and documents requested will vary from examination to examination depending on the adviser’s business model, the risks associated, and the reason for which the examination is being conducted.
Thereafter, the staff described a typical request for information that SEC registered advisers receive in respect to an upcoming examination. An initial request from the Division of Examinations usually includes:
- A request for general information that will provide staff with an understanding of the adviser’s business.
- A request for information that will allow staff to evaluate the compliance risks the adviser has identified and the written policies and procedures the firm implements to address those risks.
- A request for information that allows the facilitation of testing with respect to advisory trading activities and the staff’s own testing for compliance in various areas.
Generally speaking, the states follow very similar procedures. Investment advisers that are registered with their state securities division also benefit from reviewing the Risk Alert and the Alert’s attachment that describes a typical initial information examiners request, in order to simulate how the firm would respond to a state audit. If the investment adviser, whether registered with the SEC or with a state, maintains all the books and records as prescribed by the applicable books and records rule, then the adviser will be ready to respond to any examiner’s request at any time. Keep in mind that states typically have their own books and records rule that state registered advisers must adhere to.