Registered investment advisors (RIAs) that register with the U.S. Securities and Exchange Commission (“SEC”) are subject to periodic examination of their compliance programs by the SEC. But what exactly is an SEC exam and what does that entail for RIAs? In this article, we will delve into what an SEC exam is, the different types of SEC exams, and the steps involved in the examination process. For an article discussing best practices RIAs should implement to prepare for an SEC exam, click here.
What is an SEC Exam?
An SEC exam is a regulatory examination conducted by staff members of the SEC’s Division of Examinations designed to assess the compliance of registered RIAs with federal securities laws. These exams are a fundamental component of the SEC’s oversight and enforcement efforts to protect investors and maintain the integrity of the securities markets.
The SEC conducts such exams through a review of the adviser’s books and records, interviews with advisory firm employees, and onsite inspections of the adviser’s offices. If deficiencies are identified, they will be raised by the SEC staff to the adviser for correction. If the SEC identifies serious concerns during an SEC exam, the staff can request an investigation of the adviser by other staff members which can potentially lead to sanctions of the RIA which could potentially include censures, monetary penalties, and potentially suspension or statutory bars that prohibit the firm or employees from engaging in certain activities within the securities industry.
What types of SEC exams are there?
There are four principal types of SEC exams, each serving a specific purpose. The primary types of SEC exams include the following:
- New Adviser Exams: These exams are conducted on investment advisory firms that have recently registered with the SEC as RIAs. In some cases, they are light-touch exams designed to help the SEC become more familiar with the adviser’s business and to help the adviser understand the expectations of the SEC. In some cases, however, they may involve a full exam of the adviser’s compliance program. Generally, the SEC attempts to conduct new adviser exams within eighteen months of the adviser’s registration with the SEC. We have seen some exams commence as early as three months after an adviser registers with the SEC.
- Routine Exams: Routine exams, also known as periodic exams, are conducted on a cyclical basis. The SEC assigns examiners to registered RIAs at predetermined intervals, typically every three to five years. The goal of these exams is to assess an adviser’s overall compliance with securities laws and regulations.
- Sweep Exams: Sweep exams are focused on specific issues or industry-wide concerns that have come to the attention of the SEC. These exams are not scheduled in advance and are often initiated in response to emerging risks or regulatory changes. For example, the SEC may conduct a sweep exam to assess how advisers are handling a particular type of investment product or to investigate widespread industry practices.
- For Cause Exams: For cause exams are initiated in response to specific concerns or evidence of wrongdoing. These exams are typically more intensive and can be prompted by whistleblower complaints, tips, or other forms of actionable information. The SEC may target advisers suspected of violating securities laws or engaging in fraudulent activities.
What steps are involved in an SEC exam?
Although the steps can vary, generally SEC exams follow the process below:
- Issuance of an Information Request: The SEC begins the examination process by issuing an information request to the RIA. This request typically includes a list of documents and records that the adviser is required to produce for the examination. The information requested can vary based on the type of exam and the specific concerns or areas of focus.
- Response by the Adviser: Upon receiving the information request, the RIA must respond promptly and provide the requested documents and records. This step is critical, as it sets the tone for the examination and demonstrates the adviser’s willingness to cooperate with the SEC. Advisers should ensure that their responses are accurate and complete. Based on responses, the SEC may issue one or more supplemental information requests to gather more information about specific topics of interest to the staff.
- Interview of Firm Personnel by the Staff: In many SEC exams, the examination staff will conduct interviews with key personnel at the investment advisory firm. These interviews provide an opportunity for the staff to gather additional information, clarify any issues, and gain insights into the firm’s operations and compliance practices. Personnel interviewed may include the Chief Compliance Officer (CCO), portfolio managers, traders, and other relevant staff members. Follow-up interviews may be requested by the staff to garner additional information based on information being reviewed by the staff.
- Onsite Visit of the Adviser: For some SEC exams, the examination staff may conduct an onsite visit to the RIA’s offices. During the onsite visit, examiners have the opportunity to review physical records, observe the firm’s operations, and conduct additional interviews. This step allows the SEC to gain a deeper understanding of the adviser’s compliance culture and practices.
- Issuance of a Deficiency Letter: Following the completion of the examination, the SEC will provide the RIA with a deficiency letter. This letter outlines any identified deficiencies, violations, or areas where the adviser’s practices may not be in compliance with federal securities laws and regulations. The deficiency letter is a crucial document that serves as the basis for further action.
- Response to the Deficiency Letter: Upon receiving the deficiency letter, the RIA is expected to respond promptly and address the identified deficiencies. The response should outline the corrective actions taken or planned, along with a timeline for implementation. Timely and comprehensive responses are essential to demonstrate the adviser’s commitment to rectifying any compliance issues.
SEC exams are not to be taken lightly by advisers, but hopefully, armed with the information above and guidance from firms like ours that regularly guide advisers through the exam process, advisers can better prepare for such exams.
What questions do you have about SEC exams? Please reach out, and we’ll be happy to help you answer those questions.
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