Simons Says: New Variations on the Traditional Exam

"Simon Says" Post Series
“Simon Says” Post Series

We all know that the SEC’s examination numbers for FY 2013 were abysmal, 8% to 9% of the investment adviser population, depending on whose numbers you use, or an exam every 11.1 to 12.5 years, on average.  Since we know that the SEC is selecting advisers for examination based on a risk assessment, the more risky firms will be examined more often and the less risky firms less often.  The SEC, Congress, and the investing public are not happy with those numbers.

When I started with the SEC’s Philadelphia Office in 1988, the average time between exams was 17 years, and the increase in examination staff over time lowered that average time between exams to about 12 years.  The National Securities Markets Improvement Act of 1996 was supposed to move the average to 5 years, and that almost worked.  I believe the stats indicated that all of the advisers registered with the SEC in 1996 were examined within the 5 year period starting in 1996.  The problem was, of course, that none of the advisers registered between 1996 and 2001 had been examined, other than for cause.  Once again, the SEC had slipped behind the curve.

Chair White of the SEC asked for additional funding for FY 2014, to cover the cost of adding 250 additional examiners and 131 additional enforcement staff.  Unfortunately, Congress didn’t pass a budget for FY 2014.  In 2010, those advisers with less than $100 million in assets under management were moved to state jurisdiction, and added were those advisers to private funds that would have to register with the SEC, dropping the total from about 11,600 SEC registered advisers to about 10,600.  But then adding the newly registered advisers brought the industry up to 11,055 as of March 4, 2014.

In an effort to get a handle on the investment adviser population, the SEC has commenced several new variations on the traditional adviser examination.

Presence Exam – Private Fund Advisers

The first initiative is a shorter but perhaps more comprehensive examination of advisers to private funds, many of which have never been subject to SEC regulation, and never needed nor implemented compliance policies and procedures or a written code of ethics.  This new type of examination is called a “Presence Exam,” with the intent to educate the firm to the presence of the SEC.  As in the traditional exam, the private fund advisers to be examined are selected based on their risk profile, but rather than “a mile wide and two inches deep,” the Presence Exam would be “five feet wide and a mile deep.”  The outcome of the Presence Exam could be credit for an examination, the scheduling of a full more traditional exam, or in more extreme situations, a referral to enforcement.   The request list is shorter than the list for the traditional exam, with the key focus areas being marketing, portfolio management, conflicts of interest, safety of client assets, and valuation. Notification is typically a week before information has to be delivered electronically to the SEC, with the office visit scheduled for the following week.

Never-Before Examined Advisers

In February, the SEC announced that it is launching an initiative directed at investment advisers that have never been examined, focusing on those that have been registered with the SEC for three or more years.  These examinations will concentrate on the advisers’ compliance programs, filings and disclosure, marketing, portfolio management, and safekeeping of client assets.

Starting later this year, OCIE will invite SEC-registered investment advisers who have yet to be examined to attend regional meetings where they can learn more about the examination process and additional guidance on the SEC’s website.  The SEC sent out a letter to those advisers identified as having been registered with the SEC for more than 3 years but never examined.  The intent of the letter is to provide those identified advisers with information about the National Exam Program (“NEP”), information about upcoming examinations of never-before examined registered investment advisers and the topical areas that may be examined.  The fact that you received this letter only means that your firm has been identified, not necessarily that your firm will be examined this year. The NEP staff will contact you separately if your firm is selected for an examination.

Two Other Request Lists

There are also two other request lists floating around, one very similar to the Presence Exam request list, but not aimed at private fund advisers, and another which appears to be a Non-Presence Exam request list.  Each of these request lists has been 21 to 22 items (not pages), and the difference between these two is that the first generally gives the date for the presence part of the exam, but the second does not even mention that SEC staff may visit the firm.  I think that difference is the result of the SEC staff reviewing publicly available information about your firm and deciding that it may be less risky than someone else and therefor the public does not need the protection of the more rigorous examination.  We’ll keep you updated as we receive more information.

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