It’s one of those scenarios made for film or television: there you are, sitting in your office, minding your own business. All of your firm’s personnel have submitted their quarterly attestation certifications on time and you just completed some procedural tests that found nothing anomalous. Outside your window, the sun is brightly shining, rabbits frolic and play in the verdant blades of grass, young fawns bound about, and birds sing cheerfully from the trees above. Nature itself seems to be in a joyful mood. You consider going outside for a time to take it all in.
The calm of this idyllic scene is broken by the chime of your email program—a new message. You decide to glance at it quickly before you spend 10 minutes outdoors…
…and a bolt of dread shoots through the very fabric of your being as you see it come into view in the preview window: a different animal than the ones outside—an eagle clutching a bundle of arrows and an olive branch with the Republic Shield on its chest. Congratulations! You have been selected for an SEC examination!
And you go into a panic. Or do you?
You’re Being Examined – What Now
If the notification caught you off guard, you may indeed panic. But well-prepared firms go confidently into an examination with an “only way out is through it” attitude. A great way to prepare your firm to “go through it” with confidence is with a mock SEC examination.
To understand what a mock SEC exam will entail, you first must understand the nature and sequence of a real SEC exam. The SEC conducts exams to verify compliance with its rules, to identify emerging risks in the industry, to drive potential future rulemaking, and to determine upcoming Risk Alerts and Exam Priorities. SEC exams generally come in three types:
- Routine Exams: Routine exams are usually the most extensive and in-depth, routine exams are conducted according to an approximate exam cycle. However, there is no set frequency with which a firm must be examined and the time periods that firms experience between routine exams vary.
- Sweep/Risk Assessment Exams: These exams occur when the SEC wants to assess a specific issue or topic and will select a series of firms to serve as a sample of the industry.
- Casual Exams: These exams are specific to your firm and can be seen as “for cause”, i.e. triggered by something like a client complaint, a tip, or less than flattering media attention.
Preparation
So how does a mock exam prepare you for the real thing? Think of it as a “second set of eyes” on your business. There may be procedural or regulatory blind spots in your firm’s program that get missed due to familiarity. An independent third party on the outside looking in is more inclined to question things that a firm long ago accepted as standard practice. Such questioning can uncover previously unknown anomalous conduct. This allows your firm time to remedy the deficiency and is far better than the SEC discovering it; by then, it’s too late.
SEC exams can vary based on different factors, such as the size of a firm or the state of the firm’s records. If everything goes smoothly, an exam could last as little as 3-6 weeks. SEC exams typically follow a series of steps described below:
- Initial Contact and Scheduling: The opening scenario is the typical way the SEC announces an exam. The announcement is sent to whomever is listed on Form ADV Part 1 as the Chief Compliance Officer and Additional Regulatory Contact. In this communication, the SEC will seek to schedule a date/time for an initial interview.
- Initial Interview: One or more SEC Exam Staff meets with your firm’s management and can occur in person or via videoconference. During this interview, the SEC examiners learn more about your firm and familiarize themselves with your firm’s compliance program and culture. This interview is also an opportunity for you to develop a better understanding of what the Exam Staff is looking for. The SEC has its own disclosure requirements to follow. The Exam Staff will furnish your firm with a brochure of the exam process, a copy of the Freedom of Information Act, the Privacy Act, and other applicable documents. As part of the interview, the Exam Staff (if they visit in person) may request a tour of your firm’s facility. This is to allow them to observe the day-to-day operation of your firm.
- Document Requests: The Exam Staff will give your firm a list of documents to produce. The nature of the exam will drive what kinds of documents are requested. You should never produce an “original” document but rather your production should be copies that are properly identified for ease of reference when ready to be reviewed by the examiner.
- Interviews/Questioning: Exam Staff may have questions to ask along the way. Your firm should designate someone well-versed with your firm’s operations as the point of contact to answer the questions or to direct Exam Staff to the correct party. Exam Staff’s questions could pertain to anything related to your firm. Any members of your firm’s staff who are to be interviewed/questioned should be reminded to be forthright with their answers to prevent the appearance of having something to hide, but also to answer Exam Staff’s questions and only the questions being asked. If possible, firm staff who are to be interviewed/questioned should be accompanied by the designated person or member of the compliance staff.
- Exit Interview: Exam Staff will hold a closing interview. Often, Exam Staff will not only welcome your firm’s management to join the Exit Interview, but also the members of your firm most heavily involved with the exam topics covered. During this interview, Exam Staff will discuss any deficiencies they found, to include any outstanding matters, along with a plan for their completion.
- Exiting Letter: This is the formal end of the exam when Exam Staff gives your firm a written list of observed deficiencies and follow-up action items. As everything will have been discussed during the Exit Interview, the contents of the Exiting Letter should be of no surprise to your firm.
One other note about Exiting Letters; if Exam Staff found no deficiencies, they will say as much. But they will include another statement telling your firm that just because they did not find deficiencies, it should not be construed as a validation of your firm’s compliance procedures and practices or that your firm is compliant at all. Think of the old saying, “Absence of evidence is not evidence of absence”; your firm should remain vigilant about anomalous behaviors and practices.
The Mock Exam
When Core Compliance and Legal Services, Inc. (“Core Compliance”) performs a mock exam, we attempt to reproduce a real SEC exam to show your firm what happens and what to expect. Like the SEC, we examine your procedures and records with an eye toward the hot issues in the current regulatory environment. Our mock examiners have experience with real SEC exams and bring those insights to you during your mock exam. To that end, you can expect our mock examiners to:
- Send a document request list and review documents accordingly
- Interview members of your staff—either in person or via videoconference—and evaluate the adequacy of your firm’s controls and safeguards;
- Issue a written report identifying deficiencies or gaps in your firm’s program; and
- Provide tools for your firm to improve its program and implement more effective controls and safeguards.
Core Compliance regularly conducts mock SEC exams for its clients. For additional information, please contact us at (619) 278-0020 to schedule a consultation.
Author: Matthew Rothchild, Sr. Compliance Consultant; Editor: Maggie Tavares, Sr. Compliance Consultant, Core Compliance & Legal Services (“Core Compliance”). Core Compliance works extensively with investment advisers, broker-dealers, investment companies, and private fund managers on regulatory compliance issues.
This article is for information purposes and does not contain or convey legal or tax advice. The information herein should not be relied upon regarding any particular facts or circumstances without first consulting with a lawyer and/or tax professional.