SEC Risk Alert: Scope of Investment Adviser Examinations

September 8, 2023

What happened?

On September 6, 2023, the SEC’s Division of Exams (the Division or EXAMS) published a risk alert on how the Division assesses risk, decides on the scope of an examination, and the methodology for document requests during an examination.

Selecting Firms to Examine

The Division still takes a risk-based approach for selecting firms to examine and has consistently outlined this approach alongside its most current focus areas in its annual examination priorities memorandum (see here for the 2023 version). Particular firm risks, events that pose risks to investors and the broader markets, and new regulatory requirements or focus areas are possible reasons a firm may be chosen. In the alert, EXAMS also acknowledged their use of large data sets of industry level and firm level data, firm disclosure documents, and filings to help identify risks.

The alert identified eleven firm-specific risk factors that EXAMS considers:

1. Regulatory History – prior observations of deficient practices, fee and expense issues, and significant compliance program concerns;
2. Supervisory Concerns – including disciplinary history of associated individuals or affiliates;
3. Complaints – tips, complaints or referrals involving the firm;
4. Conflicts of Interest – including outside business activities and dual registration or affiliation with brokers;
5. Examination History – the length of time since initial registration (see new registrant risk alert) or since the firm’s last examination;
6. Material Changes – material changes to firm leadership or personnel;
7. Vulnerable Firms – indications that a firm may be “vulnerable to financial or market stresses;”
8. Media Reports – News coverage of the firm or events that may impact the firm;
9. Vendor Data – data provided by outside vendors and third-party data services;
10. Disclosure History – firm history of public and regulatory disclosures;
11. Access to Assets and/or Other Risks – whether “the firm has access to client and investor assets and/or presents certain gatekeeper or service provider compliance risks.”

Selecting Examination Focus Areas

Once a firm is selected for examination, the scope of its exam will vary depending on “the firm’s business model, associated risks, and the reason for conducting the examination.” Typically, EXAMS will review “advisers’ operations, disclosures, conflicts of interest, and compliance practices with respect to certain core areas, including but not limited to, custody and safekeeping of client assets, valuation, portfolio management, fees and expenses, and brokerage and best execution.” These core areas are reviewed so that EXAMS can gain an understanding of firm risks and conflicts of interest and so that EXAMS can test the effectiveness of the policies and procedures to monitoring, mitigating, and managing such risk.

Selecting Documents to Request

EXAMS usually sends an adviser a letter notifying the firm of the upcoming examination, though footnote 7 of the risk alert makes clear that examinations can be conducted on an announced or unannounced basis.  In the case of unannounced examinations, an adviser may be provided with a request for information and documents upon arrival by EXAMS staff.  An initial request for information will typically include:

1. General information on the business and investment activities of the adviser;
2. Information on compliance risks the adviser has identified and the written policies and procedures in place to address those risks;
3. Information on trading activities to allow for EXAMS testing;
4. Information to facilitate testing on various compliance areas

The Division attached a four-page list to the alert entitled “Typical Initial Information Examiners Request of Investment Advisers.” See the alert for the full list.

What does this mean for me?

These observations are consistent with the Division’s stated priorities and past guidance for advisers. The perennial work of identifying risks, adopting written polices for those risks and documenting your compliance program’s monitoring and testing efforts should be maintained. The risk alert’s insights into selection and specific information requests can be a great place to start when educating departments outside of compliance on the importance of consistent recordkeeping, archiving, and documentation.

Fairview Investment Services provides comprehensive and ongoing compliance services including complete examination support. Contact us today for additional information about maintaining your compliance program.