If you speak to most business owners in the investment advisory world, one area they may feel uneasy about is an SEC examination. This response is not necessarily a result of the business owner worrying about the firm’s fiduciary efforts with their investors; rather it often stems from a sense of
“I don’t know what I don’t know,” as it relates to the latest regulatory focus areas and whether enough has been done particularly within the compliance program.
One thing is for certain. It is not if – but when the SEC examination staff comes a knocking – first impressions matter. How senior management interacts with the staff and the timeliness and thoroughness of deliverables is immediately noted. Conversely, non-responsiveness, incomplete and/or curt responses can lead the staff to perceive there is a lack of compliance culture, which can lead to a remarkably different examination experience.
The dialogue that the firm engages in with the SEC examination staff is of critical importance. In this month’s Legal Risk Management Tip, Jacko Law Group, PC (“JLG”) will focus on various ways for investment advisers to best communicate with the SEC during an examination. Through use of a case study, we will explore how interactions with the staff can help to lead to a positive examination experience. JLG will then offer practical tips to take to prepare for your next SEC exam.
Richie Rich is the owner of Opulent, LLC (“Opulent”), a $800 Mil Assets Under Management (“AUM”) investment advisory firm. It has been over 10 years since Opulent had its last SEC examination. The firm’s Chief Compliance Officer, Sally Newbie, joined Opulent last month. Sally just received notification from the SEC that they intend to examine Opulent in two weeks. Sally notifies Richie of this newsbreak, and provides him with a copy of the 8-page document request list just received from the SEC.
As Richie begins going through the document, he notices that a big focus of the exam appears to be related to retirement planning services and one particular advisor, Alex P. Keaton, who provides retirement planning services to military personnel and also is one of the firm’s top producers. The document production that the staff is seeking is voluminous in nature and broad in scope. Richie and Sally debate on how much and what to provide but are purely speculating as to whether they gathered the “right things” responsive to the staff’s request.
Q: Should they consider contacting the SEC staff for more guidance or would this be viewed as a weakness?
A: It is always best to ask clarifying questions prior to production. Often times the SEC staff does not receive a voluminous amount of material that is not responsive to their request or intent. If unsure about what you are about to ask is responsive to the staff, it is prudent to have your outside counsel contact the examiner and inquire. In addition, if you are going to need to create documents or spend an excessive amount of money in production, it is wise to see if the scope of the request can be narrowed (which is generally accomplished by seeking a certain time period for the production, such as the last 12-months).
Finally, if the focus of the exam is on one particular advisor, you may wish to ask if there is a particular concern or concentrated area the firm should consider when producing documents relating to that individual. While the SEC staff does not have to share the motivation for focusing on a particular individual, engaging in dialogue may help you to ascertain if there is a problem that warrants further investigation by Compliance.
During the onsite portion of the exam, the SEC staff wishes to interview Terry Tense, who is the financial assistant to Alex P. Keaton. Terry has never been involved in a regulatory examination and is extremely anxious.
Q: As the CCO, what guidance might Sally provide to Terry?
A: When speaking with the SEC, it is always important to listen to their questions carefully and respond to the question that is being asked. While “yes” and “no” responses are perfectly acceptable, it is important to provide enough information to provide clarity when responding. Most importantly, if Terry does not know the answer to the staff’s question, do not make one up or speculate. Instead, indicate that you will get back to them and research the appropriate response. When in doubt, contact outside counsel.
An additional consideration would be to have the CCO join the interview. It is very common to have the CCO present for interviews to both add to the discussion but to also liaise between the SEC staff and the firm’s employees. If a question is technical in nature and/or related to a specific regulation, often the CCO can help to add context so that the employee can better understand and respond to the staff’s inquiry.
One month after the SEC conducted the onsite portion of the exam, Opulent received its Findings Letter from the Staff. Sally was surprised to see that it was longer than expected, with several deficiencies noted. Nervously, she shares the letter with Richie who exclaims, “The SEC must not have understood our business model. Sally, make sure that you clarify things with the staff in Opulent’s response letter.” Sally rereads the SEC staff’s letter again, and she does believe that perhaps the staff did not understand some of the responses provided by Opulent.
Q: What should Sally do if she believes that either the SEC staff is confused or mistaken about the production provided by Opulent, which lead to unanticipated deficiencies?
A: Prior to putting pen to paper to author the response, Sally should confer with outside counsel on the best approach to take. Many times, that may be to engage in dialogue with the staff regarding their findings. Assumptions should not be made; rather, take the time to clarify what their concerns are so that those areas can be addressed by further compliance internal control development. If documentation was not provided that would be responsive to the alleged deficiency, let the SEC staff know that you would like to provide that to see if that will adequately address the concerns which the staff has expressed.
Risk Management Tips
An SEC examination can be daunting. By following these risk management tips, it will help you to keep on track to have a positive exam experience.
- Do not be afraid to engage in dialogue with the SEC.
- Ask clarifying questions when needed.
- Listen and be responsive to questions that are asked.
- Consider conduct mock interviews prior to the SEC’s examination to help prepare employees on how to react to questions, particularly if the answer is not known at the time.
- If the registrant believes that an SEC finding is incorrect or is confusing, confer with outside counsel on the best approach to take to address this with the staff.
JLG assists firms and individuals through the numerous complicated and nuanced considerations relating to SEC, FINRA and state examinations. For more information on this topic or to find out about our services, please contact us at (619) 298-2880 or at firstname.lastname@example.org.
Author: Michelle Jacko, Esq., Managing Partner, Jacko Law Group, PC. JLG works extensively with investment advisers, broker-dealers, investment companies, private equity and hedge funds, banks and corporate clients on securities and corporate counsel matters. For more information, please visit https://www.jackolg.com/.
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