Seven Tips for Preparing for an SEC Exam
March 29, 2021
While the pandemic has slowed down much of life, it has had little impact on one of the bigger challenges that an investment advisory compliance effort will face: an SEC examination.
“I have experienced vicariously a handful of examinations that clients have gone through, and I can confirm that after an initial period of figuring out the mechanics of doing remote examinations, the whole thing settled into a groove pretty quickly,” said Mark Perlow of Dechert. “It seemed like a full-bore examination.”
Perlow was speaking at the 2021 IAA Compliance Conference in a panel session titled Tips and Trends to Help Advisers Prepare for SEC Examinations. He moderated the session, which featured panelists Anil Abraham of Focus Financial Partners, Michelle Jacko of Jacko Law Group, and Kristin Snyder of the SEC’s Division of Examinations.
The speakers had these tips for compliance officers getting ready for their next exam:
- Focus on Form CRS. One of the first things that compliance officers might want to focus on is the new Form CRS.
Overall, “The challenge for the industry was trying to meet the spirit of the form – giving the essential information that the SEC wanted in the format that the SEC wanted in a user-friendly way – but not at the same time sell yourself short or leave out key points,” summarized Perlow. The SEC is looking at “the basics on content, to determine if there are any omissions of required information from the Form [and] to ensure that there is a consistent presentation of the information,” added the SEC’s Snyder.
More specifically, many advisers have stumbled over the section on disciplinary information. Some have “inappropriately marked ‘no’” in this section, noted Snyder. “People are used to thinking of disciplinary history in a particular way,” namely the way it’s treated in Form ADV, explained Abraham. “But the CRS is a different beast… It’s a very low threshold [for reporting disciplinary history.]”
Jacko stressed the need for thinking of Form CRS as a year-round exercise. She recommends evaluating “on a continuous basis” whether there has been a material change that would trigger an update.
She also advised firms to think about the operational complexities. Firms need to identify “who is responsible for delivering the Form CRS and when,” she noted.
To get up to speed, advisers should take a look at the Division of Examinations April 2020 Risk Alert on Form CRS, advised Snyder. A small entity guide is available on the SEC website as well, she added. Advisers can also ask the SEC staff questions that are not addressed in the release or related FAQs at firstname.lastname@example.org.
- Be intentional about fiduciary duty. Also on the recommended reading list: the SEC’s 2019 “Interpretation Regarding Standard of Conduct for Investment Advisers,” which sets out the Commission’s thinking on an adviser’s fiduciary duty.
“The staff is unquestionably drilling down on the particulars of fiduciary interpretation,” cautioned Perlow. He notes that the release spells out specifics that can guide firms, especially around suitability and the disclosure and mitigation of conflicts of interest.
Advisers should be careful to document that they are paying attention to their fiduciary responsibilities. “We all know that we have to do what’s in the best interest of clients,” explained Jacko. “The challenge is the documentation. . . I’ve seen a lot of analysis being done, but that analysis isn’t necessarily documented.” Advisers should be writing down why a client has been placed in a particular program type, strategy or mutual fund share class.
She also suggested that compliance professionals should be able to say, “Not only have we thought about it, we’ve documented it, [and] we’ve developed an internal control system to better assess whether what we’re doing is truly in the best interest of the clients.”
- Standardize across offices. The move to a remote working office has highlighted the risks that result from multiple offices.
“Folks don’t necessarily do things the same way as the home office,” noted Jacko. “That’s the challenge.” For example, different offices may compute advisory fees differently. “One office may aggregate a household for the purposes of fee breakpoints in one way, while another office is doing it with a completely different definition of household” she explained.
In fact, a November 2020 Division of Examinations Risk Alert reported that, in its examinations of 40 investment advisers with multiple offices, the “vast majority” of the advisers were cited for at least one compliance deficiency and “more than one-half” were cited for deficiencies related to portfolio management practices.
Jacko cautioned advisers that, “You need to think about policies and procedures at an enterprise level.”
- Harmonize ESG disclosures. “ESG is probably one of the biggest secular trends that we as a firm have been seeing,” noted Perlow. “The SEC has not been ignoring this trend.” Notably, ESG is priority for the Division of Examinations again this year.
“Like any other strategy, we are looking to see whether the disclosure and the marketing around the strategy matches up with what’s happening in practice,” noted Snyder. “As an example, if a firm is stating that they exclude certain stocks . . . do they have mechanisms in place to ensure that those securities are being excluded from the portfolio?”
Advisers should consider, “What does it mean across the enterprise?” suggested Jacko. Firms should think about how an approach will affect trading and proxy voting in addition to portfolio management and marketing.
- Don’t forget about private funds. “Private funds are an important part of the portfolio we cover,” said the SEC’s Snyder. “Almost 36 percent of the adviser population manages one or more private funds.”
In terms of new priorities for 2021, the Division of Examinations will be looking at the impact of the market volatility, focusing on firms that may have been harder hit by the pandemic because they own commercial real estate or certain structured products.
In addition, the SEC will continue to review the “bread and butter” areas outlined in the Division’s June 2020 Risk Alert. “Conflicts is certainly an important area,” Snyder emphasized. “What’s surprising is that we continue to see issues around undisclosed fees and expenses” given enforcement activity in the past. “It’s something to be looking at on a dynamic basis with compliance involved,” she suggested.
Other areas of SEC focus include allocation of investment opportunities and controls over material nonpublic information. With regard to the latter, Snyder stressed that firms need “good controls around the intake and the due diligence” on alternative data and other nontraditional sources of information that drive portfolio decision making.
- Develop a “meet the firm” presentation. “We advised for some time that firms should voluntarily prepare a ‘meet the firm’ deck, and share that with the staff right up front,” said Abraham. “If you can help them understand who you are, it gets the exam off on the right foot.”
Jacko concurred, noting that attention to the “opening ceremonies” can lead to a “difference in the examination experience.” She recommends that firms include a discussion of how they dealt with the COVID crisis. “It sets a great tone for compliance in the organization and how you responded to the pandemic,” she added.
- Accentuate the positive. Abraham ended the session on a positive note: “People tend to think of them as a burden,” he argued, “But another side of exams is that they’re an opportunity, because here’s a chance to hear from your primary regulator.” If you prepare properly, it can help make your compliance effort “state of the art,” he concluded.
TAGS: Compliance Conference, Takeaways, Columns, SEC Examinations, Form CRS