SEC staff provides guidance on investment adviser examinations

INTRODUCTION

On September 6, 2023, the SEC Division of Examinations (the “Division”) published a Risk Alert entitled “Investment Advisers: Assessing Risks, Scoping Examinations, and Requesting Documents” (the “Alert”).  This Alert offers valuable insight into the Division’s internal processes and guidance on how SEC-registered advisers (“advisers”) can bolster their internal compliance systems and prepare for the inevitable examination.

Adviser Selection

As described in the Alert, despite the growth of the registered adviser population to more than 15,000, up 13% over the last three years, the Division has not slowed its adviser examination rate, which is equal to roughly 15% of all advisers each year.  To manage the examination process over such a large and diverse adviser population, the Division employs a risk-based approach, looking not just at firm-specific risk factors but also broader areas of focus that the Division identifies as posing a potential risk to investors and the US market.

For example, an adviser may be examined to evaluate risks present at that particular firm, to respond to events that pose risks to investors and the markets more broadly, and/or to assess how registrants are adapting to new regulatory requirements. The Division also leverages technology to collect and analyze large sets of industry- and firm-level data to help identify risks and better understand an adviser’s business during examinations. The Division also reviews disclosure documents and various filings with regulators (e.g., Form ADV, including the brochure, and Form PF).

The Alert specifies eleven firm-specific risk factors that the Division considers when selecting advisers for examination, such as those related to a particular adviser’s business activities, conflicts of  interest, and regulatory history. For example, the Division may consider: (1) prior examination observations and conduct, such as when the Division has observed what it believes to be repetitive deficient practices, significant fee- and expense-related  issues, and significant compliance program concerns; (2) supervisory concerns, such as disciplinary history of associated individuals or affiliates; (3) tips, complaints, or referrals involving the firm; (4) business activities of the firm or its personnel that may create conflicts of interest, such as outside business activities and the conflicts associated with advisers dually registered as, or affiliated with, brokers; (5) the length of time since the firm’s registration or last examination, such as advisers newly registered with the SEC; (6) material changes in a firm’s leadership or other personnel; (7) indications that the adviser might be vulnerable to financial or market stresses; (8) reporting by news and media that may involve or impact the firm; (9) data provided by certain third-party data services; (10) the disclosure history of the firm; and (11) whether the firm has access to client and investor assets and/or presents certain gatekeeper or service provider compliance risks.

Examination Scope and Document Requests

Once an adviser is selected for examination, the Alert indicates that the Division will conduct an additional risk analysis with respect to that adviser to determine the specific area or areas of focus for its review, which will in turn determine what information and documentation the adviser will ultimately be required to produce (typically in electronic format if available).  While this means that no two examinations are identical, the Alert highlights certain areas of focus and initial document requests that are typically included in the Division’s review, regardless of the reasons for conducting the examination. 

Examinations may be conducted on an announced or unannounced basis.  To best prepare for a potential examination, advisers should ensure that their internal policies, procedures and document retention, particularly with respect to those items highlighted below, are in good order.

The areas of focus generally reviewed as part of every examination include, (i) the adviser’s operations, (ii) disclosures, (iii) conflicts of interest and (iv) compliance practices with respect to certain areas including, but not limited to, custody and safekeeping of client assets, valuation, portfolio management, fees and expenses and brokerage and best execution.  Consistent with the focus areas noted above, the initial document requests typically include requests for the following information, (i) general information about the adviser, including background information (e.g., organizational charts), to provide the SEC staff with an understanding of the adviser’s business and investment activities, (ii) information about compliance risks the adviser has identified and the written policies and procedures the firm has adopted and implemented to address each of those risks, (iii) information to facilitate testing with respect to advisory trading activities, and (iv) information for the staff to perform its own testing for compliance in various areas.  

To assist advisers in preparing for a potential examination, the Division included its Typical Initial Information Examiners Request of Investment Advisers as an attachment to the Alert and that attachment is included below for your reference.

Conclusion

Advisers should re-evaluate their internal policies and procedures in light of the Alert to assess what changes, if any, should be made to update or strengthen their policies and procedures and to enable advisers to respond promptly and efficiently to examiners’ requests.

Attachment: Typical Initial Information Examiners Request of Investment Advisers

Described below are the types of initial information, including documents, that staff may request and review during a typical examination of an adviser that does not engage in additional activities and/or have additional relationships (e.g., manage private funds). These information requests are generally transmitted through secure email, and responses are also typically provided electronically. If certain records are not maintained electronically or cannot be produced electronically, the staff may request that the adviser make such records available for in-person examination.