Investment Adviser Workshop How to Survive an Examination by the New SEC Gary C. Watkins ACA Compliance Group S. Brian Farmer Hirschler Fleischer May 12, 2011
The Examination Process Types of Examinations Routine Sweep Exams For Cause Frequency of Routine Exams Initial Exam Risk Based Determination 2 2
The Examination Process Possible Outcomes Closing letter with No Deficiencies Deficiency Letter (opportunity to respond) Referral to Enforcement 3 3
The Examination Timeline Initial notification Initial SEC request list Initial document production On-site examination Initial presentation Interviews Review of documents Additional document requests Exit Interview Deficiency or No Further Action Letter 4 4
Recent Changes to the SEC Exam Program OCIE enhancements New Leadership Team and Governance Structure Specialization Conducting Risk-Based Exams Focus on Assumption and Management of Risk Focus on Incentive Compensation Oversight of Risk 5 5
Recent Changes to the SEC Exam Program Coordinating Broker-Dealer and Investment Adviser Exams New uniform manual for examiners Promote consistency and goal to nationalize the Exam process 6 6
Recent Changes to the SEC Exam Program New exam initiatives Firms that have not previously been examined Review commitment to establishing and maintaining an effective compliance culture Determine whether to conduct more comprehensive exam Pilot program in six Regional Offices Improve consistency across eleven regions Risk-based, not routine Firms with a history of ignoring prior warnings 7 7
Recent Changes to the SEC Exam Program SEC Examination and Enforcement Priorities Custody/safety of investor assets Access to and use of MNPI Offering materials and disclosures Abusive marketing practices and performance advertising Investment guidelines and restrictions ( style( style-drift ) Market manipulation (rumor-mongering/front mongering/front- running) 8 8
Recent Changes to the SEC Exam Program SEC Examination and Enforcement Priorities Personal and institutional conflicts of interest Valuation of assets Controls/Processes of Advisers experiencing recent change in control Structured products/disclosures Conflicts of interest-personal and institutional Personal trading, insider trading and fraud (expert networks) 9 9
Recent Changes to the SEC Exam Program SEC Examination and Enforcement Priorities Maintenance and production of books and records Investor privacy Anti-money laundering Business continuity and disaster recovery Brokerage arrangements/ execution Trade allocation Supervision/corporate governance 10 10
Tips to Prepare for the SEC Be proactive and set the right tone Know your policies and procedures Identify key risk areas Organize books and records ahead of time Educate/train employees including how to speak to an SEC examiner Prepare abstracts/summaries of compliance program 11 11
Tips to Prepare for the SEC Allocate appropriate resources (funds, technology and personnel) Conduct mock examinations and compliance reviews Organize an SEC examination response team Understand that documentation and appearances are critical 12 12
Tips to Prepare for the SEC Prevent potential problems: Electronically store broker statements in- house Keep Code of Ethics/Compliance logs up to date Keep accurate trade error logs Keep well-organized personal trading files Organize shared drives and physical folders 13 13
Tips to Prepare for the SEC Before the SEC arrives The Logistics Review the latest SEC initial inspection request list Assemble the SEC Exam Response Team Know where your documents are located Identify working space and resources for examiners 14 14
Tips to Prepare for the SEC Make sure offices are presentable appearances matter Review website, ADV, prior exam results, annual compliance reviews, risk matrix Coordinate with counsel/consultants for real- time feedback on hot topics and review of responses/document production Identify and segregate legally privileged documents and create a privilege log 15 15
SEC Examination Request List General information to provide an understanding of the adviser s s business and investment activities. Information about the adviser s s risk matrix Documents relating to adviser internal testing to determine how effectively the adviser has implemented its compliance policies and procedures. Steps taken by the adviser to address the results of compliance reviews, quality control, or tests conducted. Information to perform testing for compliance in various areas. 16 16
Working With the Staff During an Examination Graciously receive exam notice/announcement CCO should be primary point of contact and project manager Contact SEC examiner upon receipt of notice Put key personnel on notice and clear calendars Lead document production 17 17
Working With the Staff During an Examination Present summary of operations and compliance program on first day of on-site exam to properly frame business and operations Coordinate and attend interviews Instruct personnel not to interact with SEC other than through interviews. 18 18
Working With the Staff During an Examination Foster constructive dialogue and relationship with examiners Be honest and set the right tone your credibility is your currency Check-in often, but not too often Determine what type of exam if you can (sweep, routine, cause, etc.) 19 19
Working With the Staff During an Examination Ask for interpretations and negotiate over requests, production and deadlines Be clear about what is and is not being produced and why 20 20
Working With the Staff During an Examination Record and Document Production Bring issues to supervisors Mirror SEC production for your reference Bates numbering Log of search terms 21 21
Working With the Staff During an Examination Segregate privileged documents and maintain log Alert staff of problems before they highlight them for you Maintain log of searches, document production, and which documents have not been produced and why 22 22
Working With the Staff During an Examination On-site Exams Other Considerations Make sure employees are cognizant of examiners on-site Offer staff telephone, water, coffee, bathrooms, etc. Convey a sense of urgency, but professional calm Keep work behind closed doors 23 23
Working With the Staff During an Examination Be prepared for request for e-maile production and review Keep notes of interaction with staff Request staff requests/questions in writing Cease any automated record/e-mail destruction 24 24
Working With the Staff During an Examination Staff Interviews Get outside help to prepare witnesses as necessary Chaperone all staff interviews Treat interviews as depositions or OTRs Listen to the question Answer only the question being asked Don t t volunteer information Take notes 25 25
Working With the Staff During an Examination Exit Interview Request an exit interview so you can pro- actively address any material issues and set expectations internally and with the SEC Remember that exam is not over just because examiners have left your location counsel staff on post-site site visit e-maile comments 26 26
Working With the Staff During an Examination Be responsive to SEC requests after the on-site portion of the examination is concluded Be patient and deliberate in your communications with the SEC after the requests cease 27 27
Working With the Staff During an Examination Drafting responses Opportunity to educate staff Be truthful and candid Use hedging language Our current understanding; we believe; based on reasonable inquiry 28 28
Working With the Staff During an Examination Supplementing the response Contact regulator or perform internal investigation if submissions are inaccurate or incomplete Self-reporting is better received by the staff 29 29
Possible outcomes Post-Examination Examination Closing Letter No deficiencies Deficiency letter The Likely Outcome Ask for clarification if unsure of anything Specify steps to correct deficiencies or advocate your position on an identified issue Do what you promise to do! Enforcement Referral and further investigation A A bad outcome 30 30
Risks Possible Risk Areas Identified by the SEC Adviser relies heavily on a paper-based record-keeping system. Adviser continuously updates its website. Adviser manages several strategies and has varying account types (i.e., institutional, retail, pooled investment vehicles). Adviser regularly loses existing clients and obtains new clients. 31 31
Risks Possible Risk Areas Identified by the SEC Adviser employs portfolio managers with impressive performance returns that were earned while employed elsewhere. Adviser completes requests for proposals and/or provides information for performance and consultant databases. 32 32
Risks Possible Risk Areas Identified by the SEC Thinly traded securities, derivatives, or other difficult-to to-value investments are included in performance figures. Adviser manages private funds Adviser self-custodies 33 33
Risks Possible Risk Areas Identified by the SEC The adviser has limited personnel resources. Advisory staff performs multiple functions (such as compliance oversight and marketing) Portfolio managers compensation is performance-based. Performance is heavily marketed and is responsible for most of the adviser s s new business. 34 34
Recent SEC Sweeps Sweep of RIAs regarding how clients managed asset-backed securities Sweep of RIAs regarding use of social media and networking Policies and procedures Training Disciplinary Actions Sweep of RIAs regarding due diligence processes Vetting of prospective investments Periodic review 35 35