What I Learned at Our Compliance Conference, Pt. 2: What SEC Examiners Are Pursuing

This is the second in a two-part blog series from David Tittsworth, executive director of the Investment Advisers Association, in which he tells us what he learned during the IAA’s annual compliance conference in the first week of March. In part one of the series, he looked at the legislation, regulation and policies now in place and what’s next. In part two below, he looks at the SEC’s priorities in examining RIAs. 

As I wrote in the first posting in this series, I tend to lump relevant legal, regulatory and compliance developments into two different big boxes. In box one I place the significant legislative, regulatory, or policy developments that are being pursued in Washington, along with a look at what’s coming next inside the Beltway. In the second box I look at the changes being pursued and the initiatives being discussed in the SEC’s inspection and enforcement realm. In this post, we’ll focus on the latter.

Oversight and Enforcement Activities 

The second basket of issues relates to the SEC’s oversight of investment advisory firms.  I must start by praising the SEC for a heightened level of transparency and information.  Carlo di Florio, director of the SEC’s Office of Compliance Inspections and Examinations, his deputy Drew Bowden, and their team have made unprecedented efforts to inform the advisory community of their priorities and potential problem areas. While one can always argue with the details, I applaud OCIE for making the effort to notify investment advisory firms of what OCIE is planning and how firms can be prepared for SEC examinations. 

Late last month, Mr. di Florio publicly released OCIE’s “Examination Priorities” for 2013. The document illuminates key aspects of the SEC’s current examination program.  Specific to investment advisory and investment company firms, the document lists the following areas of “ongoing risks” when scoping and conducting examinations: (1) safety of assets; (2) conflicts of interest related to compensation arrangements; (3) marketing/performance; (4) conflicts of interest related to allocation of investment opportunities; and (5) fund governance.  The document also lists the following “new and emerging” areas of concern for investment advisory firms and investment companies: (1) new registrants; (2) dually registered BD/IA; (3) “alternative” investment companies; and (4) payments for distribution in guise. For anyone who is wondering where the SEC’s inspection program is heading—and what a firm should be looking at to prepare for such a visit—this document is required reading.

OCIE also released a “risk alert” on March 4, entitled “Significant Deficiencies Involving Adviser Custody and Safety of Client Assets.” This important document details the many custody rule deficiencies the SEC has found.  

The number of these deficiencies—more than 140—should cause firms to sit up and take notice. They include:

(1) failure by advisors to recognize that they have custody (citing the role of employees or related persons, bill-paying services, online access to client accounts, where the adviser acts as a general partner, physical possession of assets, check-writing authority and receipt of checks made to clients);

(2) potential problems with the surprise exam requirements of the custody rule;

(3) qualified custodian requirements;