Published on March 4, 2014
CORDIUM POWERPOINT MASTER March 4, 2014 1
WHAT TO EXPECT WHEN EXPECTING THE SEC BILL MULLIGAN – CEO, CORDIUM US
Agenda o o o o Regulatory landscape OCIE National Exam Program (“NEP”) Types of SEC Exams Presence Exams o Key Areas of Focus o Recent SEC Enforcement/Common Deficiency Themes
Agenda continued o What to Expect from a SEC Exam o Timeline: o Document Production o Timing/Duration o Onsite Visit o After the Onsite o How Best to Prepare o Identification of SEC Examination Priorities for 2014
Regulatory Landscape o As of February 2014: o There were over 4,000 private fund advisers registered with the SEC. o Close to 40% of all RIAs manage one or more private funds. o Of these 4,000 private fund advisers: o Over 2,000 registered with the SEC since July 21, 2010, when the President signed the Dodd-Frank Act into law. o Of these private fund advisers, 352 (8%) are domiciled in a foreign country o Most of these are domiciled in the United Kingdom.
Polling Question #1 o How many members of the audience work at a firm that is registered with the SEC as an investment adviser? o DO NOT ANSWER YES IF YOUR FIRM SOLELY REPORTS AS AN “EXEMPT REPORTING ADVISER” WITH THE SEC. o ANSWERS: o Yes ___ o No ___
OCIE National Exam Program (“NEP”) o Andrew J. Bowden - Director of the agency's Office of Compliance Inspections and Examinations (“OCIE”) o Mission o Improve Industry Compliance o Local and national outreach seminars, risk alerts, recruitment of industry experts, etc. o Identify and Prevent Fraud o Focused, risk-based examinations of registered advisers, specialized working groups, coordination across SEC offices and Divisions of Risk, Strategy and Financial Innovation and Enforcement o Monitor Risk o Specialized units (Office of Risk Analysis and Surveillance, Office of Large Firm Monitoring and Quantitative Analytics Unit, etc.) o Inform Policy o Utilize results/findings to inform future rulemaking and provide guidance to the industry
Different Types of Exams o Routine Exams o May be based on the passage of time since last exam o Presence Exams o Risk-based, focused examinations of newly registered advisers o Usually average 90 days, ½ as long as typical exam o Industry Sweeps o Focus on a narrow issue and seek to determine how the industry is handling that issue o Recent examples include firm use of social media and disaster recovery preparedness o For Cause Exams o May be based on a tip or investor complaint o Typically unannounced
Examinations by the Numbers o RIA Exams o FY 2012: The SEC was able to examine only about 8% of registered investment advisers. o As of April, 2013, over 40 percent of advisers (including relatively recently registered advisers) have never been examined. o As of April, 2013, an estimated 20% of all advisers that have been registered for more than three years have never been examined. o Focus throughout 2013 was on conducting Presence Exams.
Polling Question #2 o If your firm is registered as an investment adviser with the SEC, has your firm ever been subject to an examination by the SEC? o ANSWERS: o Yes ___ o No ___
Presence Exam Initiative o As of January 2014 o Over 250 presence exams completed o On pace to meet goal of 15-25% of new registrants by March 2014 o Participation from EVERY regional office o Many issues in the five target areas being noted o Contributed to developments in: o Guidance from Division of IM on Custody Rule o Guidance/caution on broker-dealer registration requirements
Examination Focus Areas o 5 “High Risk” Target Areas Identified for Presence Exams Initiative o Conflicts of Interest o How does the firm address conflicts such as: fees and compensation, personal trading, allocation of expenses? o Marketing/Performance Advertising o Are disclaimers adequate/accurate? o Is appropriate back-up in place to substantiate performance/claims made? o Are there inconsistences between documents? o Cherry-Picking?
Examination Focus Areas continued o Portfolio Management o Style drift? o How are portfolio decision-making/objectives being reviewed? o Custody o Does the adviser recognize when it has custody? o Are proper procedures in place to safeguard client assets and abide by the Custody Rule (e.g., surprise exams where required)? o Valuation o Are procedures adequate/consistently followed? o What documentation is in place to evidence difficult to value securities? o How are numbers being presented to investors?
Polling Question #3 o Which of the 5 targeted risks areas expected to be focused upon by the SEC in Presence Exams give you the greatest concern? o PLEASE ANSWER THE QUESTION REGARDLESS OF WHETHER YOUR FIRM IS ACTUALLY REGISTERED AS AN INVESTMENT ADVISER WITH THE SEC. o ANSWERS: o Conflicts of Interest ___ o Marketing/Performance Advertising ___ o Portfolio Management ___ o Custody ___ o Valuation ___ o None ___
Recent SEC Enforcement o During 2013 - SEC brought 686 enforcement actions o Recent Conviction: o Former SAC Capital portfolio manager Matthew Martoma was found guilty of insider trading on February 6, 2014 o The verdict was the eighth insider trading conviction of a current or former employee at SAC Capital o SEC intends to continue to direct its focus on insider trading cases o 44 such cases were initiated in 2013 o New Enforcement Strategies: o “Broken Windows” – pursuing “smaller” violations as a deterrent (Minor violations can feed bigger ones..) o Aberrational Performance Risk Analytics – using advanced technologies to identify issues o Increased Expertise
Common Deficiency Themes o Cases where CCOs were charged – four main themes: o Deficient/nonexistent compliance programs (or “off the shelf” and not tailored to firm) o No annual review, no Code of Ethics adopted o Recidivism – Firm/CCO was warned by the SEC staff or an outside consultant and did not fix the issue o Consultiva case – 5 years of failure to address deficiencies o Egregious behavior – alteration of documents o Omni case – CCO backdated signature
What to Expect from a SEC Exam o How Does it Start? o Notification – usually by phone/email o Request Letter o What Does Life of Presence Exam Look Like? o o o o Document Production – often on a rolling basis Timing/Duration Onsite Visit After the Onsite
What to Expect from a SEC Exam o Document Production o Usually 15 to 25 requests in the initial request (normal exam could be from 40 to 50 requests in initial request) o Example of Information Requested: o o o o o o o o o o o Org charts – including ownership % and list of affiliates List clients, type, AUM, name of custodian, type of strategy, types of fees (in EXCEL) List of private funds, number of investors, domicile, master/feeder, nature of lock-up, amount of leverage, etc. (in EXCEL) QTRs and all other personal trading records (in EXCEL if you use software to track) Trade blotter/ ten most and least profitable trades List of JVs (this should include outside business activities of key employees) Written policies and procedures Violations of Policies Investor complaints Committee minutes (if any) ADV Part 2Bs, marketing materials, Pitchbooks, etc.
What to Expect from a SEC Exam o Document Production o Could be 5 to 10 additional requests (could be another 20 to 30 in a normal exam) o If you don’t understand something on a request list - call and ask o Should Consider; o Attorney Client Privilege o Freedom of Information Act o Bates Stamping and other Logistics o Timing/Notice o SEC can request information that pre-dates registration o Notice Periods could be as short as 4-7 days
What to Expect from a SEC Exam o Onsite Visit o Typical Presence Exam onsite time ranges from 2-3 days o Helpful Tips: o Do not try to delay the visit o Present your “story” to the SEC on day 1 o Prepare your partners and key people – the SEC will want to talk with certain people (CCO, CFO, IR, Head Trader, etc.) o Keep the office clean, file cabinets locked, no papers out o Set up a room for the examiners o Make yourself available o Discuss potential issues with counsel/compliance consultants in advance! o It’s ok to say “let me get back to you on that” o Ask for it in writing if they have follow-up document requests
What to Expect from a SEC Exam o After the Onsite o Exit Interview o Clarify questions/correct any perceived inaccuracies during the call o Be proactive – if an issue is identified– work to remedy it ASAP o Consider responding with the manner in which you have corrected or are in the process of correcting any issues identified o A proactive written response to the Exit Interview may affect the content/substance of your firm’s Deficiency Letter o Could be additional requests for information o Potential for Deficiency/”Findings” Letter o Generally received within 120 days of the exam (although not required) o Generally have 30 days to respond o Next examination will likely address issues raised by examiners – Need to followthrough on corrections!
What to Expect from a SEC Exam o How Should You Prepare? o When Preparing for an Actual Audit: o Prepare a written response to each requested item o Gather and Organize requested documents o Prep team for possibility of interviews o Things to Start Doing NOW: o o o o o Create a “First Day” presentation Proactively identify conflicts, gaps and possible problems Critically review Compliance Manual – are policies in line with practices? Test P&P throughout the year Beef up Annual Reviews – SEC is concerned that firms may only be doing cursory annual reviews of policies and procedures o Consider conducting Audit Prep or Mock Audit exercise o Conduct periodic trainings
Headline Review of SEC Examination Priorities for 2014 o o On January 9, 2014, the NEP published its 2014 examination priorities o Contains areas that the staff perceives to have heightened risk in part based on (i) information reported by registrants, (ii) information gathered through examinations and (iii) comments and tips NEP-Wide Initiatives o Fraud Detection and Prevention o Utilize and enhance its quantitative and qualitative tools and techniques o Corporate Governance/Conflicts o Evaluate firms’ control environment and “tone at the top” o Understand firms’ approach to conflict and risk management o Technology o Examine governance and supervision of information technology systems, operational capability, market access, information security and preparedness to malfunctions/outages o Noted as a big focus area for 2014 during January 30, 2014 SEC Compliance Outreach Program
Headline Review of SEC Examination Priorities for 2014 o Core Risks Identified for RIAs o Safety of Assets and Custody – Failing to realize the firm has custody and/or failing to comply with Rule 206(4)-2 o Noted as the #1 Core Risk by OCIE o Conflicts of Interest – Putting interests of the firm ahead of client interests or failing to identify and mitigate conflicts (e.g., compensation arrangements, allocation of investment opportunities, etc.) o Marketing/Performance – Accuracy and completeness of claims/performance information, hypothetical and back-tested performance, use of composite performance figures, record-keeping, compliance oversight, cherry-picking, etc. o New and Emerging Issues and Initiatives for RIAs o Never-Before Examined Advisers – Focused, risk-based exams for advisers that have been registered for more than three years and have never been examined o Quantitative Trading Models – Are policies tailored to address compliance issues and risks of relying on such models? o Presence Exams – continue 2012 initiative
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