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2010 INVESTMENT ADVISER TRAINING SEMINAR. James Reese, CFE Senior Staff Accountant Office of Compliance Inspections and Examinations U.S. Securities and Exchange Commission. August 9, 2010. Disclaimer.

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James Reese, CFE

Senior Staff Accountant

Office of Compliance Inspections and Examinations

U.S. Securities and Exchange Commission

August 9, 2010


The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees.

The views expressed herein are those of the author and do not necessarily reflect the views of the Commission, its Commissioners, or the staff.

  • SEC’s Investment Adviser Examination Program
  • Risk Assessment
  • Risk-Based Examinations
  • Red Flags
  • Q & A
Financial Reform Impact

The Commission’s examination program has created a multi-office taskforce to help coordinate with and dedicate resources to state regulators as a result of the financial reforms.

Investment Adviser Examination Program
  • ~450 Examiners Nationwide
    • ~12,000 Investment Advisers
    • ~800 Investment Company Complexes
  • ~1,200 IA Examinations Conducted Each Year
Investment Adviser Examination Program
  • Examination Types
    • Risk-Based Examinations of High Risk Firms
      • Higher Risk Business Activities
      • Filing Data/Anomalies
      • Previous Examination
      • Changes in Operations
      • Never Examined
      • Surveillance of Information
    • Cause (Tips, Complaints, Referrals)
    • Sweeps
Common Findings
  • Compliance Rule
    • Policies and Procedures
    • Annual Review
  • Disclosures and Reporting
    • Inaccurate Filings
  • Personal Trading
    • Code of Ethics
  • Performance and Marketing
    • Misleading Materials
    • Performance Calculations
  • Portfolio Management
    • Internal Controls
Investment Adviser Examination Program
  • OCIE’s Self Assessment
    • Placing greater reliance on risk assessment procedures and techniques to better identify areas of risk to investors, including working closely with our Division of Risk, Strategy, and Financial Innovation to develop better risk assessment algorithms and expanding risk-based scoping prior to exams;
    • Outlining a new “open architecture” system for staffing exams that will enable management to reach across disciplines and specialties to better match the skills of examination teams to the business models and risk areas of registrants;
    • More rigorously reviewing information about firms before sending examiners out to the field so that we can use our limited resources more effectively and target those firms with the greatest risks;
    • Enhancing the training of examiners and re-focusing on basics such as exam planning, tracking, and accountability;
    • Creating a sharable database of information on registrants of mutual interest to Enforcement, OCIE, and other regulators; and
    • Redesigning our exam team structure to ensure that managers spend additional time in the field at registrants.
Investment Adviser Risk Assessment
  • How do we select exam candidates?
Investment Adviser Risk Assessment

Exam History(ies)

Additional Filing


3rd Party Data


of Form ADV Information




Examination Candidate

Commission Priorities/


Regional Office Input

Investment Adviser Risk Assessment

Form ADV Analysis

  • Assessment of Business Activities
  • Average Account Size
  • Ratio of Employees to Total Assets
  • Side-by-Side Management of Accounts
  • # of Investment Advisory Branch Offices
  • % of Owners/Officers with Disciplinary History
  • % of IA Reps with Disciplinary History
  • Material Changes in Business Operations
    • Assets
    • Custody
    • Disciplinary History
Investment Adviser Risk Assessment

Exam History

  • Poor controls/inadequate compliance structure
  • Types of deficiencies

Additional Filing Data


3rd Party Data

  • Mostly marketing-oriented
Investment Adviser Risk Assessment

Tips, Complaints, Referrals

  • External and internal

Regional Office Input

  • Closer to Registrants

Commission Priorities

  • Focus Areas
  • Themes
  • Trends
Risk-Based Examinations
  • Identify Important Activities and Related Control and Supervisory Systems
  • Identify Activities that Present Greater Risks of Violations or Harm to Clients or Shareholders
  • Identify Areas from Previous Exam that Warrant Greater Scrutiny
  • Evaluate Potential Problem Areas
Risk-Based Examinations
  • Measuring Risk
    • Higher Risk: High level of uncertainty that problems/conflicts will identified and resolved
    • Lower Risk: Low to moderate level of uncertainty that problems/conflicts will be found and resolved
Risk-Based Examinations
  • What are the factors that should be considered to determine the level of control risk present in a firm?
Risk-Based Examinations
  • Is a firm’s process for identifying and assessing the problems and conflicts of interest that may occur in all of its activities effective and is that process likely to identify new problems and conflicts that may occur as the future unfolds?
    • What is the firm’s process for identifying and assessing the impact of possible problems and conflicts?
    • The risk identification process should cover all activities of a firm.
Risk-Based Examinations
  • Is a firm’s process for creating policies and procedures that address the need to mitigate and manage its potential problems and conflicts effective?
    • Is each risk addressed?
    • Do the policies and procedures include quality control, forensic tests, reporting of results and follow up?
    • How does the firm keep its policies and procedures current and comprehensive?
Risk-Based Examinations
  • Are policies and procedures implemented based on sound principles of management?
    • Have clear lines of responsibility for each risk area and related policy and procedure been assigned?
    • Is there a separation of functions?
    • Is there any exception reporting?
    • What is the escalation process?
Risk-Based Examinations
  • Review and Renewal
    • Does the firm’s compliance program should include policies and procedures that promote automatic processes for reviewing existing risk inventory and reviewing the factors found to be weak or ineffective?
    • Do business and compliance events trigger review and renewal process?
    • Are there plans provide for a continuous or rolling review and renewal of all activities not touched by events?
Risk-Based Examinations
  • Bottomline:
  • Are a firm’s risk management processes, its operating policies and procedures and its control processes likely to identify and resolve the problems and conflicts?
    • If controls appear to be effective, risk may be low and examiners can rely on the controls and may limit any further testing.
    • If controls are ineffective, risk may be high and examiners may need to conduct a more detailed review of an area or all areas.
    • If maybe, controls in some areas may be effective in other areas ineffective and examiners may need to do further testing
Examination Red Flags
  • Information doesn’t “make sense” given what we know or what is portrayed to the public
    • Documents provided by Registrant
    • Interviews conducted with personnel
    • Information in the public domain
      • Websites
      • News Articles
      • Public Databases
Red Flags: Credential Verification
  • Education Claims
    • Can be verified with the Institution or via National Student Clearinghouse
  • Professional Work Experience
    • Can be substantiated (or contradicted) with news/media/press releases, CRD info, Bloomberg, etc.
    • Unrelated Work Experience
    • Firm’s Website or Individual’s Webpage
  • Professional Licenses
    • Can be verified directly with the Organization/Association
      • (E.g. CPA, CFA, CFP, etc.)
red flags legal history
Red Flags: ‘Legal’ History
  • Lawsuits, Regulatory Actions, Tax Liens
    • Identify frequent ‘run-ins’ with the law
    • Identify information within cases that contradicts other data
    • Regulatory History via CRD
  • Databases/Sources
    • Westlaw, Lexis, CLEAR
red flags lifestyle assessment
Red Flags: Lifestyle Assessment
  • Public Record Review of ‘Lifestyle’
    • Is the individual living outside his/her means?
      • Identify individuals with several assets (cars, boats, planes, real estate)
        • Financial stress of assets (liabilities)
      • View bankruptcy filings
      • Assessment of firm’s revenues
  • Databases/Sources
    • Westlaw, Lexis, CLEAR, Web CRD
red flags other business activities
Red Flags: Other Business Activities
  • Undisclosed Conflicts?
      • Related business that presents certain conflicts
      • Co-located
  • Databases/Sources
    • GoogleMaps, Westlaw, Lexis, CLEAR, CRD/IARD, Internet, LinkedIn
red flags negative information
Red Flags: ‘Negative’ Information
  • Identification of any ‘negative’ information said about a firm/individual
  • Databases/Sources
    • Internet
red flags other considerations
Red Flags: Other Considerations
  • Unique Red Flags
    • Use of personal email addresses
      • Yahoo, Google, Hotmail, etc.
    • No information found
    • Time gaps in information
    • Name changes (firm name and employee names)
    • Multiple offices/locations for records
red flags consider your findings
Red Flags: Consider Your Findings
  • Is the due diligence consistent with information provided by the firm?
    • Marketing Materials
      • Website(s), pitch books, 3rd party data submission
    • Financials
      • Payments to and revenue from
    • Other Disclosures to Clients
      • Offering docs, contracts, prospectus, etc.
red flags caveats
Red Flags: Caveats
  • Conducting Research on Individuals is Very Difficult
    • False Positives
    • Name Iterations
      • John Doe, Jon Does, Jonathan Doe, J. Doe
      • JPMorgan, J.P. Morgan, JP Morgan, J P Morgan
    • Acronyms/Abbreviations
      • Two Twelve Partners may manage the 212 Hedge Fund
      • Aston Martin Management Inc. vs. AMM Inc.
      • Mario Brothers vs. Mario Bros.
      • Energy Fund vs. The Energy Fund

Thank You