Tag: Compliance Outreach Program

SEC Compliance Outreach Program National Seminar

SEC Seal 2

The SEC’s Office of Compliance Inspections and Examinations (OCIE), Division of Investment Management, and the Asset Management Unit of the Division of Enforcement jointly sponsor the compliance outreach program. On January 30, 2014, there was a national meeting.

These are my notes.

Welcoming Remarks from Chair Mary Jo White

Investors and the SEC relies on compliance officers. OCIE has only 450 dedicated who have to look over 11,000 registered investment advisers. The top goal is getting firms to express a dedication to compliance throughout the organization. She highlighted the exam priorities for 2014.

Introductory Remarks

Speakers:

  • Drew Bowden, Director, Office of Compliance Inspections and Examinations
  • Norm Champ, Director, Division of Investment Management
  • Andrew Ceresney, Director, Division of Enforcement

Andrew started off as the person you don’t want to meet. If your talking to enforcement, you are being accused of doing something seriously wrong. One focus is firms with past problems. The first thing examiners will do is look at the deficiencies from an exam and see if the firm has fixed those noted problems. Custody is a critical rule because its focus is on the safety of client assets.

He highlighted a case his group brought under Rule 38a-1(c) of the 1940 Investment Company Act. That rule makes it unlawful to mislead or obstruct a firm’s CCO in the performance of his or her duties. Andrew also highlighted the Convergex case for failing to highlight markups and markdowns.

Norm highlighted the guidance and updates issued by the SEC. The initiative came out of failed no-action letters. The SEC would deny the relief, but that denial was rarely public. He highlighted the guidance update on misleading fund names and the guidance on the custody rule for private stock certificates.

He also highlighted some facts on the new public private-placement rules under 506(c). He is not seeing a lot of use of the new regime.

The SEC’s goals are to be transparent. The vast majority of investment advisers are trying operated in a proper and ethical way. The panel clearly highlighted custody as an item subject to close scrutiny.

Panel I: Program Priorities

Speakers:

  • Jane Jarcho, National Associate Director, National Exam Program
  • David Grim, Deputy Director, Division of Investment Management
  • Julie Riewe, Co-Chief, Division of Enforcement, Asset Management Unit

Julie highlighted the aberrational performance inquiry initiative. The mismatched performance usually lead to to a large cache of other misdeeds at the adviser. On the private fund side of things, the SEC is looking at conflicts of interest, allocations of opportunities, mis-allocations of expenses.  She highlighted multiple funds investing in the same opportunity. (Are you using the second investment to prop up the first?)

David focused on the floating NAV for money market funds (I hate that idea.) and other mutual fund reporting issues.  He expects a new rule-making proposal on target date funds.

Jane talked about the selection of priorities and the priorities for the upcoming year and rest of the panel joined in.

  1. Wrap fee program
  2. JOBS Act
  3. Cybersecurity
  4. IA-BD harmonization

Examiners are looking at certain aspects of wrap fee programs. It starts with a suitability policy and procedure. Do you have one and is it being followed?

There is a clear focus on the issues that will arise from lifting the ban on general solicitation. He acknowledged the murkiness caused by releasing the proposed rules for investor protection on the same day as the adoption. This will be a big priority for 2014.

Question & Answer Session (Advisers with $1 Billion or Less in Regulatory AUM)

25% of the registered advisers have more than $1 billion under management’ 62% have less than $500 million and 12% are between $1 billion and $500 million.

Panel II: Private Fund Adviser Topics

Speakers:
  • Ashish Ward, Exam Manager, National Exam Program, Los Angeles Regional Office
  • Alpa Patel, Senior Counsel, Division of Investment Management
  • Igor Rozenblit, Specialist, Division of Enforcement, Asset Management Unit
  • James Capezzuto, General Counsel & Chief Compliance Officer, Cornerstone Capital Management LLC
  • Barbara Burns, Chief Compliance Officer, AEA Investors SBF LLC
Key focus areas in presence exams: (1) investment conflicts of interest, which includes allocation of opportunities and fees, (2) Marketing, in particular performance marketing, (3) valuation and (4) custody. The SEC has conducted about 250 exams and found numerous issues in these areas.
Fees need to be disclosed, including fees charged to portfolio companies and expenses charged for back-office operations. Are you generating additional revenue for the management company while reducing cash to the funds.
The panel pointed out Rule 206(4)-8 that looks through the fund to investors in the fund for fraudulent, deceptive or manipulative acts.

Panel III: Registered Investment Company

This was not relevant to me, so I skipped this session.

Panel IV: Valuation Issues

Speakers:
  • Matthew O’Toole, Senior Special Counsel, National Exam Program, San Francisco Regional Office
  • Leo Chan, Senior Specialized Examiner, National Exam Program, San Francisco Regional Office
  • Sarah ten Siethoff, Senior Special Counsel, Division of Investment Management
  • Jaime Eichen, Chief Accountant, Division of Investment Management
  • Jeffrey Blockinger, Chief Legal Officer & Chief Compliance Officer, Och-Ziff Capital Management Group
The big theme is that there is no one-size-fits-all approach for valuation. There was discussion about whether the SEC would offer some guidance on valuation expectation. That sounded unlikely.
Mutual funds and BDC are required to use GAAP financing. Advisers are not as limited. However, a panelist pointed out that for private funds to comply with the custody rule, it must have GAAP financials.

Panel V: Chief Compliance Officer Obligations

Speakers:
  • Mark Dowdell, Assistant Director, National Exam Program, Philadelphia Regional Office
  • Janet Grossnickle, Assistant Director, Division of Investment Management
  • Marshall Sprung, Co-Chief,Division of Enforcement, Asset Management Unit
  • Chris Marzullo, General Counsel & Chief Compliance Officer, Brandywine Global Investment
  • Management LLC
  • Judy Werner, Executive Director, National Society of Compliance Professionals
I missed this session.

Closing Remarks

by Drew Bowden, Director, National Exam Program
I missed this session.

Materials

SEC’s Compliance Outreach Program

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I was able to attend the Boston stop on the SEC’s Compliance Outreach Program.

Michael Garrity, the Associate Director of the Boston Examination Program kicked off the program, by highlighting some examination statistics. There are 1200 registered adviser in the Boston region. But there are only 50 examiners. Last year, they had 80 exams. They are clearly taking a risk-based approach to examinations because the resources are so limited. They are getting increased data and are working on finding the signal through all the noise.

The first panel focused on examination priorities and risks.

The selection process is one involving qualitative and quantitative review. The SEC uses the Form ADV information, third-party data providers, and media stories, among other sources to select firms for examination.  These are some of the red flags that may make an exam more likely:

  • Firms in the media
  • Firms with new product lines / closed product lines
  • Management changeover
  • New fee arrangements
  • Decentralized firms or odd structures
  • Use of riskier service providers

In a post-Madoff world, the SEC takes Tips, Complaints, and Referrals as the top indicators for examination. The biggest red flag is when someone takes the time to the tell the SEC that a firm is doing something wrong.

The SEC is trying to be transparent in examination priorities. The 2013 SEC Examination Priorities clearly lay out what the SEC is most likely to focus upon. The exam staff expects to update the exam priorities each year.

The panel made it clear that the Form ADV is used in selecting firms for examination. However, they seemed to indicate that the exam staff has not quite figured out how to deal with all of the information in Form PF.  Examiners will use the information in Form PF as part of the examination. But its seems that the data is not yet an integral part of the selection criteria.

Valuation was the number one topic for examination when it comes to funds. It affects performance marketing and fee generation. The examiners are not going to second-guess assumptions, but do want to see a robust process. Although an examiner will not second-guess assumption, an examiner may look at other market data to see if it distinctly contradicts the assumptions used.

In particular, an examiner will note if valuations are “being tweaked when new funds are raised”. The panel referred to the Oppenheimer case where there was distinct change in the valuation process with no justification or disclosure. The panel also referenced the Morgan Keegan case where there was distinct hanky-panky during the valuation process.

The examiners want to see if the written polices and procedures are effective. They want to make sure that marketing pressure does not affect valuations. The exam staff is looking for ad hoc changes.

Social media is hot topic for examination. The panel pointed to last year’s risk alert on investment adviser use of social media. The use of social media is clearly subject to the anti-fraud rule. Most of it will also be subject to the advertising rule. The exam will focus on social media if the adviser uses social media to target clients and potential clients, not for personal or non-business use.

Safety and security of client assets is another hot topic for examinations.  Based on the recent risk alert, the SEC is not happy with compliance under the custody rule. Many advisers fail to understand that they have custody.

A new issue is the application of the identity theft rules under the FRCA. Dodd-Frank made the Red Flags Rule applicable to the SEC. Regulation SID will have a November compliance deadline.

The second panel was on the current topics in money management regulation.

The first line of discussion was who would show up at an examination. In the Boston office, it is now common to have a member of enforcement take part in an examination. However, this is for educational purposes, not because of the likelihood to bring an action. With the massive inflow of hedge funds, private equity funds, and real estate funds, the SEC is trying to develop expertise in these types of advisers. The Boston office also has staff intern in different divisions. So an examination person will work for six months in enforcement and an enforcement person will work for six months on exams.

The number one reason for an enforcement action is failing to fix problems that you say you will fix. The SEC is now routinely making follow-up returns to see if a firm has made the changes mandated in the deficiency letter.

The panel downplayed the enforcement actions against compliance staff. The cases against compliance officers are for egregious failures.

Expenses bubbled up as a hot topic. Examiners will look closely at expenses billed to investors.  The examiners want to know that these expenses are clearly disclosed to investors. For funds that means the PPM and Partnership Agreement. The examiners said they want to see written expense policies and to see them tested.

The SEC examiner strongly suggested that registrants prepare a risk matrix.  One advisor thought this was providing a blueprint for the SEC to conduct their audit. They want to see a catalog of risks, status, rating and worst case impact for the risk.

The panel listed a few things that make an enforcement action more likely:

  • Fraud
  • Misappropration of funds
  • Intent
  • Investor harm
  • Recidivism
  • Failure to respond to exam staff
  • Providing false information to staff

The panel raised the current hot topic of Broker-dealer registration for internal marketing personnel at private fund managers.  The panel noted the David Blass speech on private funds and broker-dealer registration.

The third panel focused on the examination process.

There are four types of exams:

  1. Risk priority exam
  2. Cause exam
  3. Sweep exam
  4. Presence exams for new registrants.

The presence exam program started 10/12 and is expected to end in the  fall of 2014. The SEC plans on compiling findings from these exams and releasing that compilation or risk alert to all registered advisors. The presence exams are short – less than a week.  The focus is on the five areas in the October welcome letter: Marketing, Conflict of interest, Safety of client asset,  Portfolio Management, and Valuation.

They also mentioned a fifth type of exam: corrective action review. This a follow-up after an “exam summary letter” (nee’ deficiency letter) and focuses on whether the firm fixed the deficiencies they said they would in the letter.

It is the SEC’s policy to not disclose the type of exam during the examination process.

As for the process, it usually starts with a phone call to let you know they are coming.  The notice could be from none to two weeks. Typically it will be one week’s notice. Can you postpone the field date? Almost never. (One participant told me that the SEC came on the date of his annual investor meeting and would not move the date.)

The examiners will interview senior staff. The CCO can be present for all interviews.

The panel paid a lot of attention on annual reviews. After all, it is required by the SEC rules. They expect the following to be addressed in the annual review:

  • Review and document compliance issues for the year
  • Review change in business activities
  • Note Regulatory changes
  • Changes in key personnel

It’s okay to outsource the annual review.

Identify risks and either (1) change the policies and procedures, (2) test, and/or (3) mitigate.

Use the annual review as an opportunity to highlight your resources and all of the good things you have done over the past year.

At the end of the exam you will get a letter to know its over. The letter will be either a summary letter or a no further action letter.

 

As you can tell from my notes, this was a great program for compliance officers.