SEC Exams are Escalating


Business graphAlthough only small percentages (around 10%) of firms are actually examined each year, the SEC has found ways to cover more ground with the resources they have.  From a recent industry report, “SEC exams are on the rise with nearly a 27% hike in firms visited from 2013 to 2015 – and more are coming.”  

We too have seen a huge influx in SEC exams among our clients: 20% have been examined in the last two years, up from 3% in the prior two!

We anticipate this trend to continue considering that the SEC sought to hire upwards of 100 new investment adviser examiners during 2016, proposed a program of third-party compliance reviews for registered investment advisers in 2015, and has employed the use of technology, data analytics, and varied types of examinations to streamline their examination process.

While traditional SEC Examinations—top-to-bottom reviews with 25-page request lists and weeks or even months spent on site—are almost a thing of the past, most firms are being captured under a different category of exam that can be conducted in short order, with a request list no more than five pages and an onsite visit no more than five days.  However, we shouldn’t rule anything out when it comes to the SEC and their examinations.  Although not as common as they once were, primarily due to a lack of SEC resources, routine examinations may still occur on a random basis and any advisory firm may be subject to one. Prepare for the most stringent, and hope for the least!

Examination Selection Process – Duck, Duck, Goose?

The SEC examination selection process is nothing like a childhood game.  Your name isn’t randomly selected out of a hat; conversely, the selection process is largely based on the SEC’s risk analysis and although the reason why an advisory firm has been selected for examination is nonpublic information and typically not shared with the advisory firm, there are specific indicators that could increase your chances of being selected.  How can you determine if your firm is at a greater risk?




If you answered “Yes” to any of these questions, you could be at an increased risk of being selected for an SEC Exam.  In case you’re wondering why…


In 2014, the SEC announced the Never-Before Examined Initiative. The name of this initiative is somewhat misleading because, while it does include firms that have been registered for three years or more and have never been examined, it also includes advisers that have been examined…that just haven’t had an examination within the last three years.  This exam is intended for advisers who may be rated as very low risk either because of small size, simple operations, or few deficiencies on a previous exam.

Dual registrants were an exam priority in 2013 and 2014.  That’s not to say that they’re not for 2016.  It may not be as high a priority as it has been in the past, but it is still on their radar.  Advisers that are also registered as broker-dealers are typically examined by a team made up of investment adviser examiners and broker dealer examiners.  The team looks for conflicts of interest that may not be apparent or understood by clients.

Private fund advisers previously had very little oversight.  Many of these advisers were exempt from registration prior to Dodd Frank, and most had no written policies and procedures, no code of ethics, and no scheduled testing of internal controls.  In October 2012, the SEC launched the Presence Exam Initiative to help educate private fund advisers on their regulatory obligations.  If you’re a private fund adviser that has not been examined in the last five years, it’s a double risk.

Not only is the SEC using data from your Form ADV, they are also extracting information from public records, SROs (e.g., FINRA), and consultant databases and comparing them against investment advisers websites to find inconsistencies.  If you have a website and/or populate consultant databases, you might want to be fanatical about checking for consistency with the information you publicize about your firm.

If your firm has been examined in the past and deficiencies were noted, no matter how big or how small, you are at a greater risk of another exam.  There is no such thing as an immaterial deficiency.  In fact, the SEC is committed to aggressively pursuing smaller violations to send the message that every element of compliance is important.

The SEC is monitoring political contributions for possible pay to play violations. If your firm or its supervised persons are making frequent and/or large political contributions, you may be on the SEC’s radar. They are looking for advisers who improperly influence their clients through this method.

When there are significant changes within a firm, it is a red flag for the SEC. With changes comes a learning curve and adjustment period; as such, compliance policies and procedures could slip through the cracks. Some examples of materials changes that could increase your risk of exam include changes in: personnel (particularly in higher-level and compliance roles), custody, affiliates, ownership, assets, and services.

When your firm or personnel from your firm are mentioned in the news, regardless of if it is good or bad, your firm is at a heightened risk of an exam.  If good news, the SEC will want to verify the veracity, and if bad news, the SEC will want to determine whether all of the problems have been identified, whether they warrant further examination/investigation, and whether the Division of Enforcement should be involved, or in extreme cases, law enforcement such as the FBI or State Police.

We are in a post-Madoff world where custody will always be on the SEC’s radar. If your firm did not claim to have custody in the past and has recently update the Form ADV to indicate that it now has custody, this could trigger a review from the SEC. You will want to make sure your Firm is in full compliance with the Custody Rule and its requirements.

If more than one of these is applicable to your firm, your risk grows multiplicatively, not just additively.

Going Through the Motions

Are you registered with the SEC?  If so, you should expect to be visited, even if your risk of an exam seems low.  As the Boy Scout and Girl Scout mottos state, always “Be prepared!”

In our opinion, there is no better way to prepare for an SEC examination than to simulate the experience with a mock SEC exam.  Going through a mock examination helps staff understand the process, familiarize with the request list, and practice being interviewed.

We’re sure you’ve heard of the phrase “Practice makes perfect”?  Well, we take a slightly different stance. We believe that “Perfect practice makes better.”  No matter how hard you work, if you’re practicing something incorrectly, you likely won’t improve, and you certainly won’t become perfect.  But when you have a mirror to reflect upon or a coach to point out areas of improvement, you can certainly get better – even close to perfect.

One of the highlights of our job is when clients come back to us after an actual SEC exam, and the letter states:

No further action by Registrant is required at this time.  The fact that we have no written comments does not mean that all of Registrant’s activities comply with the federal securities laws or other applicable rules and regulations, but only that no deficiencies or violations came to our attention during the course of the examination.

So rewarding for us!  We do a happy dance on the inside.


There are a several benefits of undergoing a mock SEC examination.  Some of them are discussed below in order of importance, as we see it.

  • Organizational Preparedness. By carefully documenting the process of collecting the information being requested, you should end up with a road map of where the information resides (e.g., system, specific report name, etc.), who in the firm is the gatekeeper of that information, and what the lead time would be.  The more prepared you are, the easier you’ll make the Staff’s job, which will be a benefit to your firm in the long run.
  • Exposure of Inconsistencies. The interviews will reveal any inconsistencies between what your compliance manual says, what the documentation presents, and what your actual practices are.  Additionally, if you’ve never experienced being interviewed, or even if you have, it’s a very useful exercise for you and those interviewed on your team, particularly if the person conducting the interview shares his or her insights on how the interviewee could have better responded or prepared, which we always do.
  • Real-time Feedback. While the exit interview and resulting review letter will summarize the areas reviewed and outline any findings and suggestions for improvement, the real benefit is your ability to interact with the examination team for real-time feedback and suggestions for improvement. Do your best to clear your schedule while the examination team is on-site.
  • Resolution of Deficiencies. Mock SEC examinations compliment the annual review.  Some firms choose to have a mock SEC examination conducted annually to fulfill their annual review requirement – a more resource-intensive and likely more expensive way to go, but effective nonetheless.  Any deficiencies noted can be recorded in a firm’s risk assessment, with review, testing, and updates to key compliance documents noted.  Most importantly, all deficiencies should be addressed; and elimination, mitigation, or disclosure should be documented.  Focus 1 includes 6-months of complimentary consulting after each mock SEC exam so that the CCO has the opportunity to work with us to implement any suggested changes and review any amendments made to the firm’s key compliance documents.

Has your firm ever undergone a mock SEC exam?  If not, given the rise in SEC examinations, you may consider it.


Check out our Mock SEC Exam Service ›



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