The scope of the regulatory examination process continues to become more complex.
For investment advisors registered with the Securities and Exchange Commission, the frequency and scope of compliance inspections is, for the most part, determined by the Commission’s perception of advisors’ compliance risk profile. Examiners will focus on issues that represent the greatest potential threat to investors, and the corresponding frequency of examinations will be based upon the scope of the advisor’s operations and the results of previous exams. In order to be prepared, the firm should be familiar with both the examination process and the issues that will be raised during the examination.
The SEC has been doing an increasingly good job assessing initial advisory firm risk via its “limited scope” examination. The limited scope exam is a “mini” exam generally intended for newer registrants, but has also been used for firms that have not been examined for a substantial period of time. The primary objective of the limited scope exam is for the SEC to assess a firm’s level of risk and correspondingly determine when a full examination of the advisory firm should be conducted.
Most advisors tend to think about risk in terms of investments and portfolio management. However, the SEC also requires that advisors assess risk relative to operational and compliance risks. We advise investment advisory firms to perform an annual risk assessment as part of their annual CCO review, each of which should be provided to the SEC during a regulatory examination.