Preparing for SEC Examinations

Preparing for SEC Examinations

About our Contributors
ICS Group is a regulatory compliance consulting firm specializing in providing compliance support to the financial services and insurance industries. We help our clients comply with regulatory requirements and industry standards. Our clients include: registered investment advisers, private equity funds, hedge funds, mutual funds, broker-dealers, insurance companies and state pension plans. Our team of highly experienced compliance professionals know from first-hand experience what regulators are looking for, the industry standards that apply, and how to develop and implement cost-effective business-oriented solutions.

Over the past few months several ICSGroup clients have had their very first SEC examination. We’ve noticed some noteworthy trends in the types of issues that the regulators are most concerned. Being aware of these issues will enable you to be more prepared for the inevitable SEC exam and help you avoid being cited for a compliance deficiency.

What We’ve Noticed

Here we have compiled a list of those areas of inquiry and feedback from examiners that ICSGroup’s consultants found particularly surprising.

  1. Compliance with Investment Guidelines/Investment Restrictions: Examiners are requesting documentation relating to investment restrictions and investment policies imposed by each LP and inquiring as to not only how the advisor ensures compliance with each restriction, but also how the CCO tests that investment restrictions have been adequately coded into the trading system, and how exceptions are identified. They’ve also been requesting any reports relating to violations of investment restrictions and what was done to remedy each violation. Does your CCO test the accuracy of the coding of investment restrictions and guidelines? Does your firm track violations of investment restrictions or guidelines? Does your firm notify the investor when a violation has occurred? The SEC expects that all responses to these questions be in the affirmative.
  2. Personal Trading and Controls to Limit the Risk of Insider Trading: Examiners will likely request all policies and procedures and staff training materials relating to limiting the risk of insider trading within the firm. The SEC will request all access persons’ personal trading activities, including brokerage statements and confirmations as well as documentation of pre-approvals. Also, be prepared to share a list of all independent research providers as well as a log of all discussions (detailing date, participants and topic) with independent research providers, the names of the companies that were being researched, whether the discussion was chaperoned, whether the discussion was in person, and a copy of any notes taken.
  3. Whistleblower Policy: The examiners are focused on whether firms have implemented whistleblower policies as we expected, but they also expect those policies to contain specific language indicating that employees are not discouraged from contacting the SEC directly with any known or suspected regulatory violations as well as information on how to contact the SEC. If it does not already, your Whistleblower Policy should contain a provision with language similar to the following:“Nothing in this policy is intended to impede an individual from communicating directly with the SEC staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement with respect to such communications. The SEC may be contacted at https://www.sec.gov/whistleblower/.”
  4. Solicitation Activity or Investors Outside the US: If your firm engages in solicitation of investors outside the US or even if your firm has investors residing outside the US that were not solicited by the firm, you are expected to have a Foreign Corrupt Practices Act (“FCPA”) Policy. Examiners seek to ensure that firms have a robust FCPA policy to prevent firm employees, directors or third-party agents or consultants from making any payment or provide anything of value, to any person, to improperly influence that person to secure any advantage for the firm, including obtaining or retaining business or directing business to any person or entity (a.k.a. bribery).
  5. Outside Business Activities: The SEC continues to be focused on conflicts of interest among advisory firms and their staff and outside business activities that might pose a conflict. SEC closely scrutinizes outside business activities of advisers. In the past, the SEC has been only concerned with for-profit outside business activities. However, lately, we’ve noticed the examiners inquiring about not-for-profit activities, including serving on the board of not-for profit organizations that could pose a potential conflict of interest, such as serving on the investment committee of a university that oversees the endowment. Advisers should include not-for-profit activities of its employees in its conflicts of interest assessment and be prepared to produce detailed information on all outside business activities, whether for-profit or not-for-profit.
  6. Vendor Due Diligence: Vendor due diligence has been a best practice in the industry for some time but there is no formal rule requiring it. Accordingly, we were somewhat surprised by the depth of inquiry into vendor due diligence. Who are the firm’s vendors, the services performed, how regularly due diligence occurs and by whom, the substantive area assessed, and how often on-site due diligence occurred were all part of the examiners inquiry. The SEC clearly expects that a robust and effective compliance program include due diligence of its third-party service providers, both during the onboarding and ongoing monitoring phases.

This is not an exhaustive list of SEC requests but rather is a summary of the inquiries that we found to be more expansive than in past years. We have included a recent SEC exam request letter to help you prepare for your inevitable SEC exam. Keep in mind that SEC requests will vary depending on the nature of your firm’s business. We hope you found this information helpful.