Important Actions to Take When Responding to an SEC Deficiency Letter

A deficiency letter from the SEC isn’t the end of the world. A significant majority of firms find one in their mail months after examiners have come and gone. The most SEC common findings include compliance shortcomings related to the protection of senior investors, business continuity plans, and cybersecurity. 

Regardless of the letter’s content, the SEC expects all deficiencies to be addressed and resolved in a timely manner. It’s essential to have a quick, capable, experienced response team in place when responding or considering a response to the regulator. There should be a clear line of communication in place with one voice from senior management.

Responses to the deficiency letter should be turned in to the examiners by the deadline. If you can’t meet the deadline for a viable reason, you can request an extension. Any response to a deficiency letter should be timely, factual, and thorough.

If your response to a deficiency letter states that issues will be rectified or remediation is in place, you must follow through with prompt implementation. The SEC often checks to make certain appropriate changes have been made, and any misstatement not only damages your firm’s credibility but also increases the possibility of a referral to the Division of Enforcement.

If a deficiency letter states the SEC has found material compliance infractions (particularly those that are not addressed or ignored by a registrant), examiners likely will refer the matter to the Division of Enforcement. Material infractions include, but are not limited to, market manipulation, theft, insider trading, and multiple lapses in treating investors fairly. The criteria used to determine whether to make an enforcement referral is based on facts and circumstances which vary from firm to firm.

The Value Outside Counsel Can Provide 

When responding to a deficiency findings letter, Counsel can provide critical guidance on steps to take toward strengthening internal controls now and mitigating risks in the future. But if the steps taken are not meaningful or comprehensive enough, this could result in a referral to the Division of Enforcement. 

The most likely reason an enforcement referral is made is evidence of wrongdoing (such as violation of the anti-fraud provisions) that caused harm to investors. Even if there is no evidence of fraud, the SEC turns matters over to Enforcement when EXAMS finds violations they consider to be recidivist, systemic, or severe, or they deem the firm’s supervisory procedures to be materially inadequate.

Confronting the SEC’s Division of Enforcement is not a do-it-yourself project. There are many reasons to involve outside counsel at this stage, not the least of which is to show staff you’re taking the SEC’s findings seriously and are working toward building a stronger culture of compliance.

When Jacko Law Group (“JLG”) is retained to address a formal inquiry by the Division of Enforcement, we typically send the SEC a letter of representation and ask to speak to the staff to find out more information. We also request additional information to see if a formal order for investigation has been issued. If there is a formal order, this helps us to understand the specific areas of concern by the SEC, which can then be further evaluated with the registrant. 

During initial interchanges with the staff, we generally ask the SEC to help us better understand their biggest areas of concern so we can address this with the registrant.  At times, this involves further compliance program actions, providing the staff with supporting documentation that may not have been delivered to the EXAMS team, and/or effectively demonstrating controls that the firm is implementing or has done in the past.

Positioning a Strong Response

At times registrants may be faced with a challenge when the EXAMS or Division of Enforcement requests supplemental production in an area that is very broad. Having a dialogue with the staff is imperative to let them know the time it may take to produce their request for information.  By way of example, if the SEC requests the registrant to go back seven (7) years to produce documents supporting the reconciliation of charged advisory fees to see where there might have been a miscalculation, it is possible that this may take some time and exceed the staff’s due date. 

In such situations, generally, it is appropriate to request clarification on the scope of production and request an extension so that a practical and thorough response can be formulated. A registrant’s primary concern should always be making certain the product is accurate and if an issue is detected that a plan is in place to take corrective actions, as appropriate. Outside counsel’s guidance is always strongly recommended.

One of the biggest mistakes we see when reviewing responses after the fact is seeing that the firm did not clearly understand the SEC’s concerns. Many times, this could have been resolved by having an active dialogue with the staff. Moreover, registrants that take a defiant attitude toward the SEC find that approach is not welcome. Starting a meaningful dialogue to take time to understand the staff’s concerns typically yields a more positive outcome. 

Responding to an SEC deficiency letter is a serious matter for your firm, your employees, and your clients. The staff at JLG has the knowledge and experience to assist you with every step along the way. Contact our law office today at (619) 298-2880 or visit us online at www.

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