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Regulation and Compliance > Federal Regulation > SEC

Mini-Sweeps Season

By Melanie Waddell

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Investment advisors and mutual funds are prodding the Securities and Exchange Commission to revamp and curtail its use of its new two-year examination schedule called risk-targeted sweeps, including mini-sweeps, in which the SEC randomly selects firms to examine in between the two-year exam cycle. Moreover, advisors are once again pressing the SEC to clarify advisors’ e-mail retention requirements, as they believe the SEC is abusing its power when requesting access to internal e-mails during exams.

Advisors and fund firms complain the SEC is asking for voluminous amounts of information when conducting sweeps–which can occur during a routine exam, or willy-nilly throughout the year. These firms also complain that SEC regional offices are requesting the same documents, and that the requests for information just keep on coming. “There doesn’t appear to be any concise endpoint [to the sweeps], and that can be very disconcerting,” says Thomas Giachetti, chairman of the Securities Practice Group of Stark & Stark in Princeton, New Jersey. “There is an initial request for documents, and the follow-up requests continue, and continue, and continue.” The SEC asks for more information that may be unrelated to the original request, says Giachetti.

David Tittsworth, executive director of the Investment Adviser Association in Washington, says member firms are irritated with the duplicate requests for documents that they’re being asked to provide to the SEC’s Office of Compliance Inspections and Examinations (OCIE) and SEC regional offices, or they are receiving similar requests from two different regional offices. During routine exams or a sweep, advisors “get one document request list from OCIE headquarters, and then one of the regions will come in and make another request list that isn’t quite the same,” Tittsworth says. “The SEC should at least try and coordinate among its various arms and legs.”

The SEC is attempting to do just that, according to John Heine, an SEC spokesman. He says the securities regulator is “improving coordination of sweeps to better target them to cover a broader range of registered entities”–investment advisors, mutual funds, and hedge fund advisors. The SEC is also “reducing duplicative document requests by improving internal use of documents,” Heine says. “By improving the way that we use the documents internally, we don’t have to ask for them again.”

How the SEC implements these changes is anyone’s guess, and Giachetti says that while he appreciates the SEC’s response to industry complaints, he hasn’t seen evidence of improvement yet. His biggest concern with the SEC sweeps is that “the vast majority of the issues that the SEC is very diligently reviewing at this time have very little application to the day-to-day business affairs of the vast majority of the firms that are being reviewed. I think the SEC needs to get a better understanding of the firm’s advisory operations and narrow the scope of the requests.”

The SEC is currently performing sweeps to get more information on firms’ practices in the areas of directed brokerage, soft dollars, and best execution. Tittsworth says an advisory firm with $50 billion was recently hit with an SEC sweep on directed brokerage. The firm’s general counsel says everything else at the firm has been “put on hold” because there’s so much information to compile, he says. The advisory firm is also unsure if an SEC examiner will be in to visit. With “some of these sweeps, the SEC requests documents and calls you on the telephone and there isn’t necessarily an in-person follow-up at all,” Tittsworth says. SEC examiners say they “reserve the right to just show up,” he says, which is a practice they use “to keep people guessing.”

Nancy Lininger, founder of The Consortium in Camarillo, California, which provides compliance and marketing services to investment advisors and broker/dealers, says she knows of one B/D that is going through an NASD mini-sweep of its sales of annuities to the military. Sometimes the SEC and NASD fact-finding missions are just that, while other times the regulators are attempting to target what they may think are troubling practices, she says.

Geoff Bobroff, an independent consultant to the mutual fund industry, agrees. “There are lots of issues where the SEC staff is attempting to gather information, some educational,” he says, but it’s also “developing additional areas for enforcement.” Warns Lininger: “Sometimes a mini-sweep is a precursor to an exam.”

Heine, the SEC spokesman, also says the regulator is “improving targeting requests for e-mails.” In the aftermath of the mutual fund and hedge fund scandals, the SEC “cast a wide net as far as requests for e-mails, but now we are narrowing our focus as far as these requests are concerned,” he says. The Association of the Bar of the City of New York has become so incensed over the SEC’s use of e-mails when examining investment advisors that it has asked the SEC to provide more explicit written guidance, through the public rulemaking process, on advisors’ obligation to retain and produce e-mail. Stuart Coleman, chair of the city bar’s Committee on Investment Management Regulation, told the SEC in a May letter that the bar has “serious concerns” about how the SEC has used the inspection and enforcement process to implement Rule 204-2 under the Investment Advisers Act of 1940 as it relates to e-mail. The industry has historically interpreted Rule 204-2 to apply only to communications between an advisory firm and third parties, not to internal documents, Coleman wrote. But SEC examination staff has taken the position that the rule applies to “communications among a firm’s employees.”

Advisors have been waiting for some time for the SEC to clarify, in writing, its stance on advisors’ retention of e-mail. But Giachetti, for one, isn’t holding his breath. “Certain advisors have expended unnecessary funds to comply with an unwritten e-mail policy that has never been clarified by the SEC,” he says. “These advisors have [spent tons of money to comply] out of fear of enforcement, and that is unfair.” While Giachetti hopes the SEC comes out with an explicit rule, he says it’s highly likely guidance could be derailed by one of the “many intervening issues” that must be handled by a limited SEC staff.

Giachetti says the SEC needs to apply its limited resources “to the real issues,” which, as far as he’s concerned, do not include e-mail or a revised Part II of Form ADV. Under the amended Part II, advisors would have to disclose, in narrative form, conflicts of interest that could arise. Giachetti argues the current form “works fine.” As for advisors’ retention of e-mail, “although it’s important, it’s not a big issue because there wasn’t a problem [with advisors' e-mail] before,” he says. The SEC “needs to differentiate between criminal activity and the day-to-day operations of investment advisors across the country that do not engage in any type of improper conduct whatsoever.”

SEC Chairman William Donaldson instituted the risk-based exam cycle as a way to catch problems before they grew into scandals. With Donaldson’s departure at the end of June, his nominated successor, Rep. Christopher Cox (R-California), may, as Bobroff puts it, “alter the traditional way the [SEC] staff has operated.”

Washington Bureau Chief Melanie Waddell can be reached at [email protected].

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