Trends in SEC Examinations

By Theresa Hamacher

April 6, 2023

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Investment adviser CCOs are continually preparing for their next SEC examination. Staying on top of the latest trends in exam process and focus can help ensure that their preparations are efficient and effective.

At the 2023 IAA Investment Adviser Compliance Conference, held in Washington, D.C., in March, Pete Driscoll of PwC and Mukya Porter of CIM Group provided insights on the latest developments in SEC exams in a session moderated by Carlo di Florio of ACA Group.

Di Florio opened the discussion with ACA Group’s list of key trends:

Key Trend #1. While remote exams are continuing, the SEC has announced that it will once again be conducting more exams on site.

“There’s a real value to going out to a registrant to conduct an exam,” explained Driscoll, who recently served as head of the SEC’s Division of Examinations. He noted that, prior to COVID-19, the SEC conducted only 30% of examinations through correspondence.

Firms that are operating entirely remotely can request correspondence exams, Driscoll said, but the SEC may still want to visit the adviser’s physical location. The examiners will ask, “Where are the books and records?” noted Driscoll, who mentioned that the SEC has conducted exams in private homes in the past.

Key Trend #2. The scope of exams has expanded significantly, especially for private funds. Porter noted that initial document requests have roughly tripled in recent years, yet the SEC is still giving firms just 10 to 14 days to respond.

Key Trend #3. The exam’s scrutiny may extend beyond the SEC registration period. New registrants will want to be sure that they are prepared with information about activities prior to registration.

Key Trend #4. Exams are lasting longer, as exam teams take deeper dives into technical areas. Porter confirmed that, in the exams that she was involved with, “it got more detailed” after the initial phase of the exam.

Advisers will want to be prepared to address the topics on the SEC’s exam priorities list, since the exam was likely prompted by the SEC’s interest in one of these issues.

“We don’t do routine exams,” explained Natasha Vij Greiner, deputy director and national associate director of the Investment Adviser/Investment Company Examination Program of the SEC Division of Examinations, who spoke at a later session. “We have a risk-based program.”

In a fast-paced conversation, Driscoll and Porter discussed a few areas that CCOs may want to focus on:

• Custody. “At the SEC, that was the most important rule to the bulk of the examiners, because it was the most direct to firms having access to client funds,” explained Driscoll. Porter recommended that CCOs prepare by revisiting any documents, such as investment management agreements or collateral management agreements, that discuss control over client assets. “Pay particular attention to power of attorney language,” she suggested.
• Advisers should make sure that their ESG disclosures match their actual practices, emphasized Driscoll, adding that some of his clients had found it helpful to think about where their funds would be placed in the SEC’s proposed ESG classification (integration, focused, or impact). Porter stressed that advisers shouldn’t just be focused on greenwashing and not paying enough attention to ESG factors, even though that has been the focus of recent enforcement cases. Advisers also have to be careful that they are not engaging in values-driven investing in funds that are return-focused. “Make sure you’re differentiating,” she summarized.
• Code of Ethics. Being consistent is critical in this area, stressed Porter. CCOs should test every year, and penalties for violations should be standardized. “Be very careful” when it comes to exceptions, she advised. Porter stressed the need to document exceptions, especially if they involve more senior individuals.
• Pay to play. The recent spate of enforcement cases is refocusing attention on an area that hadn’t seen activity in a “really long time,” explained Driscoll.
• E-communications. CCOs should be prepared for extensive requests in this area. “They’re going back multiple years, even pre-COVID,” noted Driscoll, who added the examiners are even looking at senior leadership’s communications. For guidance on specific concerns, the 2018 risk alert on this topic remains helpful today, said Driscoll.
• Cybersecurity. Porter recommended that advisers have appropriate governance in place, perhaps a cybersecurity committee, that reviews policies and recent developments. More specifically, she suggested firms have a mobile device management program that can wipe devices remotely and that advisers periodically remind employees of their obligation to protect client and firm data, even while working from home.
• Material non-public information. “Make sure that you are monitoring” expert networks, advised Porter. In terms of emerging risks in this area, Porter cited virtual data sites. CCOs may want to ask if their firm’s investment professionals are starting to use them.

Yet, these are just a few of the areas that CCOs will want to address. The new marketing rule, the new investment company rules, and robo advice were also mentioned in the fast-paced conversation.

Overall, CCOs will need to be prepared for an examination environment that is “a little bit more aggressive,” as Driscoll described it.