How the SEC Selects Investment Advisers for Examination
10/16/2023In a recent Risk Alert (available here), the Division of Examinations of the SEC (the “Division”) provided guidelines explaining how it utilizes a risk-based approach for selecting SEC-registered investment advisers (“Advisers”) to examine and for determining the risk areas to examine. According to the Risk Alert, an Adviser may be selected for examination in order for the staff “to evaluate risks present at that particular firm, to respond to events that pose risks to investors and the markets more broadly, and/or to assess how registrants are adapting to new regulatory requirements.” The Division collects and analyzes large sets of industry and firm data and reviews disclosure documents and various filings to help identify risks and better understand a firm’s business. The Division’s risk-based approach supports the “four pillars” of the Division’s mission, to “(1) promote compliance; (2) prevent fraud; (3) monitor risk; and (4) inform policy.”
Implementation of risk-based approach is critical given that there are over 15,000 Advisers managing in excess of $115 trillion in the aggregate; and due to budget and time constraints, the SEC is able to examine only approximately 15% of Advisers annually.
Selecting Firms to Examine
The Division publishes its examination priorities annually, setting forth those areas that it believes present potential risks to investors and the integrity of the U.S. capital markets. In selecting Advisers to examine, the Division evaluates a firm’s risk characteristics and considers, among other things, which Advisers provide services, recommend products, or otherwise meet criteria relevant to the focus areas described in the Division’s priorities.
When it selects Advisers for examination, the Division considers “firm-specific” risk factors, such as those related to a particular Adviser’s business activities, conflicts of interest and regulatory history. Firm specific risk factors include:
- prior examination observations and post-examination repetitive deficiencies;
- supervisory concerns, such as disciplinary history of associated individuals or affiliates;
- tips, complaints, or referrals involving the firm;
- business activities of the firm that may create conflicts of interest;
- time since the firm’s registration or last examination, including newly registered advisers;
- material changes in a firm’s leadership or other personnel;
- indications that the firm might be vulnerable to financial or market stresses;
- news that may involve or impact the firm;
- data provided by certain third-party data services;
- disclosure history of the firm; and
- whether the firm has access to client and investor assets that present certain compliance risks.
Selecting Examination Focus Areas
Once an Adviser has been selected for examination, the staff will perform an additional risk assessment to determine the scope of the examination, such as selecting particular areas of the business that examiners will review. The scope of an examination and the documents requested will vary from examination to examination, depending on the firm’s business model, associated risks, and the reason for conducting the examination. Examinations typically include reviewing Advisers’ operations, disclosures, conflicts of interest, and compliance practices with respect to certain core areas, including but not limited to, custody and safekeeping of client assets, valuation, portfolio management, fees and expenses, and brokerage and best execution.
The documents requested enable examiners to gain an understanding of an Adviser’s conflicts of interest and its risks and controls, and enable examiners to test and determine the effectiveness of an Adviser’s compliance policies and procedures.
Typical Initial Document Requests
The Risk Alert included an attachment setting forth the types of initial information and documents that the staff may request and review in a typical examination. Advisers should review the attachment so they are prepared for an examination and able to promptly produce the documents requested.
* See our Client Alert dated March 29, 2023 describing the 2023 Examination Priorities (available here).
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If you have any questions concerning how to prepare or organize for an SEC examination, please contact Meryl Wiener (mwiener@wbny.com or 212-984-7731), any of the undersigned, or your regular Warshaw Burstein attorney.
Frederick R. Cummings, Jr.
fcummings@wbny.com
(212) 984- 7807
Jason Diener
jdiener@wbny.com
(212) 984-7797
Thomas Filardo
tfilardo@wbny.com
(212) 984-7806
Marshall Lester
mlester@wbny.com
(212) 984-7849
Stephen W. Semian
ssemian@wbny.com
(212) 984-7764
Martin Siegel
msiegel@wbny.com
(212) 984-7741
Meryl Wiener
mwiener@wbny.com
(212) 984-7731
