The SEC recently released its 2013 Examination Priorities letter. FrontLine Compliance, LLC is often hired by firms to guide them through the examination process. Over the years, we have gathered first-hand knowledge of the SEC examination process and how it has evolved and changed. Firms need to be prepared for the significant changes that have occurred in the SEC’s examination approach and methodology, especially those of the past two years. Here’s what we see as the SEC’s real examination focus in 2013:
Overall Focus
First and foremost, the SEC will continue its vigilant efforts to fight fraud. It has begun to take investor tips and complaints seriously. In addition, it has forged strong relationships with other governmental entities, both domestically and internationally to expedite the process when cross-jurisdictional issues arise. We expect to see continued focus on insider-trading and Ponzi schemes.
Funds
- Mutual Funds – OCIE will focus on money market funds, ETFs, alternative style funds, and fund governance issues. Money funds will be visited to help the Staff determine if additional rulemaking is warranted. Alternative style funds will be examined for proper risk disclosures and compliance with the ’40 Act restrictions on leverage. Fund boards will continue to be scrutinized during examinations to see if they have been given the proper tools to exercise their fiduciary duties effectively.
- Private Funds – SEC Presence Exams are fully underway. Private equity firms and hedge funds have been hearing from the SEC since the new exam program was initiated. The exams are typically broad overview exams and any private fund advisers without proper compliance programs or programs that exist only on paper should beware. The SEC is already citing firms for deficiencies.
Advisers
- Pay-to-Play – Now that the rule has been effective for over two years, the Staff expects advisers to have effective policies in place. Advisory firms with government clients need to be especially aware of how this rule affects their business.
- Performance Advertising – The SEC has been boasting about its new technology that allows it to find firms that are performance outliers in relation to their peers. Any firm with unusually high or low performance in relation to its competitors will be scrutinized.
- Custody – Thanks to Madoff, advisers with custody will always be at the top of the list for OCIE. Any adviser that serves as trustee, general partner, or otherwise is deemed to have access to customer funds or securities will be considered high- risk to the Staff.
Broker-Dealers
- Dual Registrants – The SEC has been focused on dually-registered advisers and broker-dealers for the past two years. This makes sense since one examination team can visit two firms at one time to provide cost efficiency to the Agency. The inherent conflicts of interest that arise from this business model pose a greater regulatory risk. The SEC is beginning to find that many of these entities tend to focus more on one side than the other, resulting in at least one weak compliance program, typically the adviser’s compliance program.
- Trading – Those firms that offer algorithmic trading platforms or high-frequency trading are of great interest to the SEC. Technology has added much needed transparency on the one-hand but also increased the risk of market moving events caused by tech glitches. The SEC wants to see that firms have the proper controls in place to prevent and mitigate these errors.
- Proprietary Accounts – Any firm that trades for itself in addition to clients is on the SEC radar. MF Global and JPMorgan are prime examples of what can go wrong when firms take large proprietary positions on a routine basis. The Staff will look to see how firms trade in their proprietary positions versus similar positions for clients.
The SEC has a busy year ahead as it seeks to accomplish many of its goals. The examination program is much stronger and more effective than it was five years ago. If it has been more than five years since your last SEC exam, you should prepare now.
