After repeated complaints from broker/dealers, mutual funds, and investment advisors about the SEC’s new sweeps examination process, Congress is threatening to abolish the SEC’s Office of Inspections and Examinations (OCIE). That’s the division started in 1995 by former SEC Chairman Arthur Levitt, and is now headed by Lori Richards.
One of the key provisions of legislation introduced by Representatives Michael Castle (R-Delaware), and Vito Fossella (R-New York) in December–the Compliance, Examinations, and Inspections Restructur-ing Act of 2005 (H.R. 4618)–stipulates that SEC examiners should no longer operate under a separate division, but should instead be housed in one of the SEC’s policymaking divisions–which is the way the SEC operated before OCIE’s creation in 1995. Shannon Finney, executive VP at The Financial Services Roundtable in Washington, which is backing the bill, says the original concept of OCIE was simple enough: to create a separate inspections division at the SEC. But it’s become increasingly unclear how OCIE interacts with the policymaking divisions at the SEC, she argues. “There has been a divorce between the policymaking divisions–investment management, market regulation–and the inspectors,” Finney says. “You have OCIE going off and doing sweeps, inspections, and trying to understand the current [industry] climate, [as well as] business practices on a particular issue, except that it’s the divisions that have the policymaking authority.” SEC staff members working in the division of market regulation, for instance, “no longer have the ability to go out and have a dialogue with the industry” on a particular issue, she says. That’s up to the examiners. “The operation of the SEC would be much more effective, and investor protection would be enhanced,” Finney maintains, “if the policy-making people and the people who are doing the sweeps were back in the same division.”
Is Legislation the Answer?
While Tom Giachetti, an attorney with the law firm Stark & Stark in Princeton, New Jersey, agrees that “the scope and duration” of SEC exams have gotten out of hand (see June 2005 Playing Field, “Mini-Sweeps Season”)–particularly the SEC’s use of its new two-year exam schedule called risk-targeted sweeps, which also include mini-sweeps, in which the SEC randomly selects firms to examine in between the two-year exam cycle–he doesn’t think OCIE should be “legislated out of existence.” The answer, he believes, is for the SEC to create “one cohesive policy” that can be carried out by policymakers and the examiners, so “the examination staff is not going in its own direction.” Giachetti adds that it wouldn’t hurt OCIE staff and even SEC commissioners to hold some face-to-face meetings with industry officials and let them air their complaints. Giachetti is not alone in pointing out that SEC exams have been “greatly enlarged.” Advisors really never know when an exam is finished, he says, and this bill gives SEC officials “some appreciation of the fact that advisors need some finality.”
Indeed, David Bellaire, general counsel and director of government affairs at the Financial Services Institute (FSI), which represents broker/dealers, says FSI supports the bill because “it will help bring some sanity back to the [exam] process.” Of late, B/Ds have “been through sweep exams and requests for information at an ever-increasing rate,” Bellaire says, and the disruptions are “making it difficult to run a good, clean business.” The bill would help curtail the amount of sweeps by requiring examiners to first get approval from SEC commissioners before conducting a sweep, which is how the SEC’s enforcement division currently functions. “Because the commission is the policy-setter, [the commissioners] ought to know what is happening in terms of the sweep process,” adds Finney of The Financial Services Roundtable. “The effort is to tie together the policymaking apparatus at the SEC with the examinations and inspections function.”
A Risk-Based Schedule
Remember that it was former SEC Chairman William Donaldson who modified the exam process for investment advisors. He went from requiring examiners to inspect advisors every five years to a risk-based inspections schedule–which included sweeps–that he said was designed to catch problems before they grew into full-blown scandals. In theory, the sweeps, which are designed to zero in on areas of particular concern, aren’t a “bad idea,” notes David Tittsworth, executive director of the Investment Adviser Association (IAA) in Washington, which represents SEC-registered advisors. IAA has been vocal in airing its complaints to the SEC about the amount and types of information that SEC examiners require during inspections, particularly e-mails. SEC has yet to come up with specific guidelines on what’s required as far as e-mails are concerned, but the legislation would limit the request for documents under a sweep exam or regular exam to only those “existing books and records that the registered broker or dealer, registered investment company, or registered investment adviser is required to keep and maintain under applicable rules and regulations.” Examiners, the bill says, “may not require the creation of a new document or the calculation or presentation of data that is not required to be kept or maintained under applicable rules and regulations.” While Giachetti says he believes the SEC’s request for additional information during exams merely provides information in a way that’s easier for examiners to digest, “there has to be some middle ground whereby the advisor can conduct his business and know when the exam is over.”
Establishing an Ombudsman