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COMPLIANCE GROUP
Investment Adviser WorkshopHow to Survive an Examination by the New SEC
Gary C. WatkinsGary C. WatkinsACA Compliance GroupACA Compliance Group
S. Brian FarmerS. Brian FarmerHirschler FleischerHirschler Fleischer
May 12, 2011
22 22COMPLIANCE GROUP
The Examination ProcessThe Examination Process
Types of ExaminationsTypes of Examinations
RoutineRoutine
Sweep ExamsSweep Exams
For CauseFor Cause
Frequency of Routine ExamsFrequency of Routine Exams
Initial ExamInitial Exam
Risk Based DeterminationRisk Based Determination
33 33COMPLIANCE GROUP
The Examination ProcessThe Examination Process
Possible OutcomesPossible Outcomes
Closing letter with No DeficienciesClosing letter with No Deficiencies
Deficiency Letter (opportunity toDeficiency Letter (opportunity torespond)respond)
Referral to EnforcementReferral to Enforcement
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The Examination TimelineThe Examination Timeline
Initial notificationInitial notification
Initial SEC request listInitial SEC request list
Initial presentationInitial presentation
Initial document productionInitial document production
InterviewsInterviews
OnOn--site examinationsite examination
Review of documentsReview of documents
Deficiency orDeficiency or ““No FurtherNo Further
ActionAction”” LetterLetter
Additional document requestsAdditional document requests
Exit InterviewExit Interview
55 55COMPLIANCE GROUP
Recent Changes to the SECRecent Changes to the SECExam ProgramExam Program
OCIE enhancementsOCIE enhancements
New Leadership Team and GovernanceNew Leadership Team and GovernanceStructureStructure
SpecializationSpecialization
Conducting RiskConducting Risk--Based ExamsBased Exams
Focus on Assumption and Management of RiskFocus on Assumption and Management of Risk
Focus on Incentive CompensationFocus on Incentive Compensation
Oversight of RiskOversight of Risk
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Recent Changes to the SECRecent Changes to the SECExam ProgramExam Program
Coordinating BrokerCoordinating Broker--Dealer and InvestmentDealer and InvestmentAdviser ExamsAdviser Exams
New uniform manual for examinersNew uniform manual for examiners
Promote consistency and goal toPromote consistency and goal to ““nationalizenationalize””the Exam processthe Exam process
77 77COMPLIANCE GROUP
Recent Changes to the SECRecent Changes to the SECExam ProgramExam Program
New exam initiativesNew exam initiatives
Firms that have not previously been examinedFirms that have not previously been examined
ReviewReview ““commitment to establishing andcommitment to establishing andmaintaining an effective compliance culturemaintaining an effective compliance culture””
Determine whether to conduct moreDetermine whether to conduct morecomprehensive examcomprehensive exam
Pilot program in six Regional OfficesPilot program in six Regional Offices
Improve consistency across eleven regionsImprove consistency across eleven regions
RiskRisk--based, not routinebased, not routine
Firms with a history of ignoring prior warningsFirms with a history of ignoring prior warnings
88 88COMPLIANCE GROUP
Recent Changes to the SECRecent Changes to the SECExam ProgramExam Program
SEC Examination and Enforcement PrioritiesSEC Examination and Enforcement Priorities
Custody/safety of investor assetsCustody/safety of investor assets
Access to and use of MNPIAccess to and use of MNPI
Offering materials and disclosuresOffering materials and disclosures
Abusive marketing practices and performanceAbusive marketing practices and performanceadvertisingadvertising
Investment guidelines and restrictions (Investment guidelines and restrictions (““stylestyle--driftdrift””))
Market manipulation (rumorMarket manipulation (rumor--mongering/frontmongering/front--running)running)
99 99COMPLIANCE GROUP
Recent Changes to the SECRecent Changes to the SECExam ProgramExam Program
SEC Examination and Enforcement PrioritiesSEC Examination and Enforcement Priorities
Personal and institutional conflicts of interestPersonal and institutional conflicts of interest Valuation of assetsValuation of assets Controls/Processes of Advisers experiencingControls/Processes of Advisers experiencing
recent change in controlrecent change in control
Structured products/disclosuresStructured products/disclosures Conflicts of interestConflicts of interest--personal andpersonal and
institutionalinstitutional Personal trading, insider trading and fraudPersonal trading, insider trading and fraud
(expert networks)(expert networks)
1010 1010COMPLIANCE GROUP
Recent Changes to the SECRecent Changes to the SECExam ProgramExam Program
SEC Examination and Enforcement PrioritiesSEC Examination and Enforcement Priorities
Maintenance and production of books andMaintenance and production of books andrecordsrecords
Investor privacyInvestor privacy AntiAnti--money launderingmoney laundering Business continuity and disaster recoveryBusiness continuity and disaster recovery Brokerage arrangements/ executionBrokerage arrangements/ execution Trade allocationTrade allocation Supervision/corporate governanceSupervision/corporate governance
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Tips to Prepare for the SECTips to Prepare for the SEC
Be proactive and set the right toneBe proactive and set the right tone
Know your policies and proceduresKnow your policies and procedures
Identify key risk areasIdentify key risk areas
Organize books and records ahead of timeOrganize books and records ahead of time
Educate/train employees includingEducate/train employees including ““how tohow tospeak to an SEC examinerspeak to an SEC examiner””
Prepare abstracts/summaries of compliancePrepare abstracts/summaries of complianceprogramprogram
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Tips to Prepare for the SECTips to Prepare for the SEC
Allocate appropriate resources (funds,Allocate appropriate resources (funds,technology and personnel)technology and personnel)
Conduct mock examinations and complianceConduct mock examinations and compliancereviewsreviews
Organize an SEC examination response teamOrganize an SEC examination response team
Understand that documentation andUnderstand that documentation and““appearancesappearances”” are criticalare critical
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Tips to Prepare for the SECTips to Prepare for the SEC
Prevent potential problems:Prevent potential problems:
Electronically store broker statements inElectronically store broker statements in--househouse
Keep Code of Ethics/Compliance logs up toKeep Code of Ethics/Compliance logs up todatedate
Keep accurate trade error logsKeep accurate trade error logs
Keep wellKeep well--organized personal trading filesorganized personal trading files
Organize shared drives and physical foldersOrganize shared drives and physical folders
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Tips to Prepare for the SECTips to Prepare for the SEC
Before the SEC arrivesBefore the SEC arrives——The LogisticsThe Logistics
Review the latest SEC initial inspectionReview the latest SEC initial inspectionrequest listrequest list
Assemble the SEC Exam Response TeamAssemble the SEC Exam Response Team
Know where your documents are locatedKnow where your documents are located
Identify working space and resources forIdentify working space and resources forexaminersexaminers
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Tips to Prepare for the SECTips to Prepare for the SEC
Make sure offices are presentableMake sure offices are presentable——appearances matterappearances matter
Review website, ADV, prior exam results,Review website, ADV, prior exam results,annual compliance reviews, risk matrixannual compliance reviews, risk matrix
Coordinate with counsel/consultants forCoordinate with counsel/consultants for ““realreal--timetime”” feedback onfeedback on ““hot topicshot topics”” and review ofand review ofresponses/document productionresponses/document production
Identify and segregate legally privilegedIdentify and segregate legally privilegeddocuments and create a privilege logdocuments and create a privilege log
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SEC Examination Request ListSEC Examination Request List General information to provide an understandingGeneral information to provide an understanding
of the adviserof the adviser’’s business and investment activities.s business and investment activities.
Information about the adviserInformation about the adviser’’s risk matrixs risk matrix
Documents relating to adviser internal testing toDocuments relating to adviser internal testing todetermine how effectively the adviser hasdetermine how effectively the adviser hasimplemented its compliance policies andimplemented its compliance policies andprocedures.procedures.
Steps taken by the adviser to address the resultsSteps taken by the adviser to address the resultsof compliance reviews, quality control, or testsof compliance reviews, quality control, or testsconducted.conducted.
Information to perform testing for compliance inInformation to perform testing for compliance invarious areas.various areas.
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Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Graciously receive examGraciously receive examnotice/announcementnotice/announcement
CCO should be primary point of contactCCO should be primary point of contactand project managerand project manager
Contact SEC examiner upon receipt of noticeContact SEC examiner upon receipt of notice
Put key personnel on notice and clearPut key personnel on notice and clearcalendarscalendars
Lead document productionLead document production
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Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Present summary of operations andPresent summary of operations andcompliance program on first day of oncompliance program on first day of on--sitesiteexam to properlyexam to properly ““frameframe”” business andbusiness andoperationsoperations
Coordinate and attend interviewsCoordinate and attend interviews
Instruct personnel not to interact with SECInstruct personnel not to interact with SECother than through interviews.other than through interviews.
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Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Foster constructive dialogue andFoster constructive dialogue andrelationship with examinersrelationship with examiners Be honest and set the right toneBe honest and set the right tone——youryour
credibility is yourcredibility is your ““currencycurrency””
CheckCheck--in often, but not too oftenin often, but not too often
Determine what type of exam if you canDetermine what type of exam if you can(sweep, routine, cause, etc.)(sweep, routine, cause, etc.)
2020 2020COMPLIANCE GROUP
Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Ask for interpretations and negotiate overAsk for interpretations and negotiate overrequests, production and deadlinesrequests, production and deadlines
Be clear about what is and is not beingBe clear about what is and is not beingproduced and whyproduced and why
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Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Record and Document ProductionRecord and Document Production Bring issues to supervisorsBring issues to supervisors
Mirror SEC production for your referenceMirror SEC production for your reference
Bates numberingBates numbering
Log of search termsLog of search terms
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Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Segregate privileged documents and maintainSegregate privileged documents and maintainloglog
Alert staff of problems before they highlightAlert staff of problems before they highlightthem for youthem for you
Maintain log of searches, documentMaintain log of searches, documentproduction, and which documents have notproduction, and which documents have notbeen produced and whybeen produced and why
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Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
OnOn--site Examssite Exams——Other ConsiderationsOther Considerations
Make sure employees are cognizant ofMake sure employees are cognizant ofexaminers onexaminers on--sitesite
Offer staff telephone, water, coffee,Offer staff telephone, water, coffee,bathrooms, etc.bathrooms, etc.
Convey a sense of urgency, but professionalConvey a sense of urgency, but professionalcalmcalm
Keep work behind closed doorsKeep work behind closed doors
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Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Be prepared for request for eBe prepared for request for e--mail productionmail productionand reviewand review
Keep notes of interaction with staffKeep notes of interaction with staff
Request staff requests/questions in writingRequest staff requests/questions in writing
Cease any automated record/eCease any automated record/e--mailmaildestructiondestruction
2525 2525COMPLIANCE GROUP
Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Staff InterviewsStaff Interviews
Get outside help to prepare witnesses asGet outside help to prepare witnesses asnecessarynecessary
““ChaperoneChaperone”” all staff interviewsall staff interviews
Treat interviews as depositions or OTRsTreat interviews as depositions or OTRs
Listen to the questionListen to the question
Answer only the question being askedAnswer only the question being asked
DonDon’’t volunteer informationt volunteer information
Take notesTake notes
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Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Exit InterviewExit Interview
Request an exit interview so you can proRequest an exit interview so you can pro--actively address anyactively address any ““materialmaterial”” issues andissues andset expectations internally and with the SECset expectations internally and with the SEC
Remember that exam is not over justRemember that exam is not over justbecause examiners have left your locationbecause examiners have left your location ––counsel staff on postcounsel staff on post--site visit esite visit e--mailmailcommentscomments
2727 2727COMPLIANCE GROUP
Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Be responsive to SEC requests after theBe responsive to SEC requests after theonon--site portion of the examination issite portion of the examination isconcludedconcluded
Be patient and deliberate in yourBe patient and deliberate in yourcommunications with the SEC after thecommunications with the SEC after therequests ceaserequests cease
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Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Drafting responsesDrafting responses
Opportunity to educate staffOpportunity to educate staff
Be truthful and candidBe truthful and candid
Use hedging languageUse hedging language
Our current understanding; we believe;Our current understanding; we believe;based on reasonable inquirybased on reasonable inquiry
2929 2929COMPLIANCE GROUP
Working With the StaffWorking With the StaffDuring an ExaminationDuring an Examination
Supplementing the responseSupplementing the response
Contact regulator or perform internalContact regulator or perform internalinvestigation if submissions are inaccurateinvestigation if submissions are inaccurateor incompleteor incomplete
SelfSelf--reporting is better received by thereporting is better received by thestaffstaff
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PostPost--ExaminationExamination
Possible outcomesPossible outcomes
Examination Closing LetterExamination Closing Letter——No deficienciesNo deficiencies
Deficiency letterDeficiency letter——The Likely OutcomeThe Likely Outcome
Ask for clarification if unsure of anythingAsk for clarification if unsure of anything
Specify steps to correct deficiencies or advocateSpecify steps to correct deficiencies or advocateyour position on an identified issueyour position on an identified issue
Do what you promise to do!Do what you promise to do!
Enforcement Referral and furtherEnforcement Referral and furtherinvestigationinvestigation——A bad outcomeA bad outcome
3131 3131COMPLIANCE GROUP
RisksRisks –– Possible Risk AreasPossible Risk AreasIdentified by the SECIdentified by the SEC
Adviser relies heavily on a paperAdviser relies heavily on a paper--basedbasedrecordrecord--keeping system.keeping system.
Adviser continuously updates its website.Adviser continuously updates its website. Adviser manages several strategies and hasAdviser manages several strategies and has
varying account types (i.e., institutional,varying account types (i.e., institutional,retail, pooled investment vehicles).retail, pooled investment vehicles).
Adviser regularly loses existing clients andAdviser regularly loses existing clients andobtains new clients.obtains new clients.
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RisksRisks –– Possible Risk AreasPossible Risk AreasIdentified by the SECIdentified by the SEC
Adviser employs portfolio managers withAdviser employs portfolio managers withimpressive performance returns that wereimpressive performance returns that wereearned while employed elsewhere.earned while employed elsewhere.
Adviser completes requests for proposalsAdviser completes requests for proposalsand/or provides information forand/or provides information forperformance and consultant databases.performance and consultant databases.
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RisksRisks –– Possible Risk AreasPossible Risk AreasIdentified by the SECIdentified by the SEC
Thinly traded securities, derivatives, orThinly traded securities, derivatives, orother difficultother difficult--toto--value investments arevalue investments areincluded in performance figures.included in performance figures.
Adviser manages private fundsAdviser manages private funds
Adviser selfAdviser self--custodiescustodies
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RisksRisks –– Possible Risk AreasPossible Risk AreasIdentified by the SECIdentified by the SEC
The adviser has limited personnel resources.The adviser has limited personnel resources.
Advisory staff performs multiple functions (suchAdvisory staff performs multiple functions (suchas compliance oversight and marketing)as compliance oversight and marketing)
Portfolio managersPortfolio managers’’ compensation iscompensation isperformanceperformance--based.based.
Performance is heavily marketed and isPerformance is heavily marketed and isresponsible for most of the adviserresponsible for most of the adviser’’s news newbusiness.business.
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Recent SEC SweepsRecent SEC Sweeps
Sweep of RIAs regarding how clients managedSweep of RIAs regarding how clients managedassetasset--backed securitiesbacked securities
Sweep of RIAs regarding use of social mediaSweep of RIAs regarding use of social mediaand networkingand networking
Policies and proceduresPolicies and procedures
TrainingTraining
Disciplinary ActionsDisciplinary Actions
Sweep of RIAs regarding due diligenceSweep of RIAs regarding due diligenceprocessesprocesses
Vetting of prospective investmentsVetting of prospective investments
Periodic reviewPeriodic review