Alert February 05, 2008

OCIE Director Discusses Frequently Asked Questions about SEC Examinations

At a recent SIFMA Compliance and Legal Division Luncheon, Lori Richards, Director of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”), provided answers to frequently asked questions about SEC examinations.  She noted that she would be addressing “top 10” compliance issues at the annual meeting of the Legal and Compliance Division.  Ms. Richards’ questions and answers are summarized below.

  • Will my firm be examined?

Ms. Richards indicated that OCIE focuses on firms that fall in the following categories:

    • firms whose size is such that any problems may affect a significant number of investors
    • firms and areas within firms whose compliance controls or supervision appear to be weak, as indicated by, for example, prior examination or enforcement history
    • firms involved in activities that may present increased compliance risk
  • What issues are SEC examiners focused on now?

Controls Over Valuation.  Ms. Richards indicated that OCIE examiners are focusing on valuation processes and controls with a particular emphasis on difficult-to-price securities such as structured products and illiquid securities.  Examiners will look at a firm’s processes and procedures for risk management, valuation, accounting and other back office functions to determine whether they are adequate given the types of investments the firm is making.  In this process, she noted that examiners are likely to want to understand the level of experience and sophistication of the personnel involved in pricing and whether there is some level of independence in the pricing process.  She added that controls over the pricing of illiquid securities were a particular focus with examiners looking at whether prices were calibrated to absorb all trade data and whether dealer quotes used in the pricing process reflect prices at which a security could actually be sold.

Controls over Non-Public Information.  Ms. Richardson indicated that OCIE regards insider trading as a high priority for all types of entities – broker-dealers, advisers and funds.  Examiners will focus on whether a firm has identified the source and type of non-public information that it and its employees may be privy to, whether the firm has created and implemented adequate procedures to maintain the confidentiality of that information and how firms ensure their procedures are working, e.g., what kind of testing is being performed.

Senior Investors.  Ms. Richards indicated that the SEC has prioritized the protection of senior investors not only in its examination program, but also in the areas of investor education and enforcement.  OCIE will be interested in understanding the practices that firms are developing in the following areas:

    • marketing and advertising to seniors
    • account opening
    • product and account suitability
    • ongoing review of the relationship and suitability of products
    • discerning the changing needs of seniors
    • surveillance and compliance reviews
    • training for firm employees
  • What kind of information and documents are examiners likely to request

Ms. Richards indicated that although it would not comply with requests from compliance consultants and firms that OCIE follow a standard document request for examinations, OCIE was looking for ways to be more transparent in the kinds of documents and information that examiners frequently need.  Ms. Richards urged firms to feel comfortable speaking with examination teams about the documents that the firms maintain and the relative ease or difficulty in providing information requested; she indicated this dialogue was important to ensure that examiners obtained the information they need, and in a way that minimizes disruption to the firm to the extent possible.

  • What are the possible outcomes of an examination?

Following a brief discussion of the non-public deficiency letters provided at the conclusion of most examinations, Ms. Richards listed the following criteria as being among those used by OCIE to determine whether to make an enforcement referral:

    • Does it appear that fraud has occurred?
    • Were investors harmed?
    • If the conduct does not include fraud, is it serious (i.e., on-going, repetitive, systemic or severe)?
    • Did the firm apprise the SEC of the conduct and take meaningful corrective action?
    • Is the conduct of a type/degree more appropriately handled by the SEC, as opposed to another regulator.
    • Is the activity in a particular area that the SEC wants to emphasize (i.e., emerging types of wrongdoing)?
    • Did the actor profit from the conduct?
    • Did the actor appear to act intentionally?
    • Is the conduct recidivist in nature?
    • Were the firm’s supervisory procedures inadequate?
  • What can compliance staff do to ensure the examination goes smoothly?
Ms. Richards urged firms to assume they will be examined and to treat regulatory examinations as a normal part of their business as a responsible regulated firm.  She noted that a very common exam finding is that firms have inadequate written policies and procedures for the nature of their business and their particular compliance risk, or do not implement those they do have.  She suggested firms begin their preparation with this issue.  She cautioned that firms should not, however, run their compliance programs around the regulatory exam process, i.e., by focusing on areas of known regulatory concern immediately before any examination, an approach she suggested would be obvious to OCIE examiners.  Ms. Richards indicated that firms should provide examiners with accurate, responsible information in a timely way and that firm employees should be educated to do so.  Firms should discuss ground rules for an examination at the outset, for example, determining who will be the firm’s contact person, resolving any questions about the OCIE’s document request and establishing examination priorities.  She cautioned that firms should avoid accidental destruction of documents after being notified of an examination.  Ms. Richards urged firms to communicate with examiners, and in doing so, to be scrupulously honest with them and discuss a firm’s operations openly, using examiner questions as an opportunity to explain a firm, its business, its compliance risks and corresponding compliance controls.  Ms. Richards indicated that if a firm becomes aware of a problem during an examination or decides to address a compliance problem being examined during an examination, it should communicate with the examination team.