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U.S. Securities and Exchange Commission

Speech by SEC Staff:
"Transparency in Regulatory Examinations"


Lori A. Richards

Director, Office of Compliance Inspections and Examinations
U.S. Securities and Exchange Commission

NYSE Regulation Second Annual Securities Conference
Grand Hyatt Hotel
New York, New York
June 20, 2006

As a matter of policy, the SEC disclaims responsibility for any private statement by an employee. The views expressed here today are my own and do not necessarily reflect those of the Commission, the Commissioners or other members of the staff.

Good morning. It's a pleasure for me to be here, and I want to thank Rick Ketchum and his team for inviting me, and also for their work towards making regulation and the regulatory process at the NYSE more transparent. This conference and its very timely agenda items are great evidence of the NYSE's effort to be clear and straightforward about regulatory requirements for NYSE members and also about the NYSE regulatory priorities and processes in each of its key regulatory groups.

It's terribly important that regulators be very clear and transparent — indeed we have to be very clear about what we expect of regulated firms — we have to speak in plain English too! How can compliance professionals in the industry be proactive in identifying compliance risk issues, in implementing policies and procedures, in training employees and in giving guidance, if they have an inadequate understanding of what the regulatory requirements are? And, for firms that today have determined that they want to be very far away from the regulatory line between compliance and non-compliance, they need to be very certain about exactly where that regulatory line falls. This conference is a terrific step in helping to make the regulatory landscape clear to NYSE member firms - and I expect that it will go a long way to helping member firms to ensure that they are in full compliance. I'll have more to say about transparency in the SEC's examination program in a moment.

I'd like to spend my minutes here with you today talking about regulatory examinations. I do so in the good name of transparency certainly, but also because I want to add some understanding to the current discussion concerning examination functions at the SROs and the SEC. I'd like to talk about securities examinations in a broader context — specifically, about the role of the SEC and the securities self-regulatory organization examinations in our scheme of securities regulation.

The securities regulatory structure for broker-dealers relies in large part on self-regulation. The Securities Exchange Act, the Maloney Act of 1938 and the Exchange Act Amendments of 1975 reflect Congress' determination to rely on self-regulation of broker-dealers. Self-regulation is considered to be "close to the ground," so to speak, so as to gain expertise and knowledge from the regulated firms. And, SROs are flexible in having the funding needed to deploy examination staff where they are needed most in terms of number, geography and expertise.

This flexibility in approach is important, given the broker-dealer industry today. Broker-dealers manufacture and market innovative products and services, advise issuers and bring new issues to market, act as market makers and specialists, commit capital to create liquidity, service the largest institutional customers and the smallest first-time retail investors. With the growing population of senior investors and investors nearing retirement age, the demands on broker-dealer firms will only grow. And, within the industry, individual broker-dealer firms are incredibly diverse. Indeed, broker-dealers range in size from the two-person office selling mutual funds and providing financial planning, to the mega-firms that provide multiple services around the globe. Some 5,113 broker-dealers are registered today, and employ over 659,000 registered employees, and operate in over 150,000 geographically-dispersed branch offices.

Given the diversity, size and breadth of the securities industry today, no one regulator — whether it is the SEC, the NYSE or the NASD — does it all, and no one regulator does it all alone.

Indeed, examination oversight of securities firms relies on an interlocking web of regulatory bodies, each with expertise and experience in a niche of broker-dealers' operations. This emphasis on expertise has been a central element of our regulatory regime since its origin. Senator Maloney of Connecticut, sponsor of the Maloney Act of 1938, said that the goal of self-regulation was to employ the "knowledge and experience" of the members of this "highly technical calling."1 More recently, in its 2004 Concept Release Concerning Self-Regulation, the Commission returned to this point. Several of the Commission's questions focused on how best to preserve the "market specific expertise of SRO regulatory staff."2

Effective regulatory examination oversight is terribly important, and is a key part of our mandate to protect investors. Examination oversight helps to ensure that securities firms are operating in compliance with the law and with SRO rules, which in turn helps to ensure that investors can have confidence in our markets and in market professionals. Effective examinations serve to: identify deficiencies and call for their prompt correction before they can become large problems; detect and halt compliance violations that harm investors; and help to deter violations from occurring in the first place. This is a tall order, and to fulfill it, examiners must have expertise, professionalism and independence. As with any examination function, in order to be effective, examiners must be ready and able to communicate difficult truths concerning any compliance deficiencies and failures they find.

Most industry firms recognize that effective examination oversight is necessary in order for investors to have confidence that when they invest, they do so in a marketplace that protects their interests. And, most firms are receptive to learning about the results of examinations — even those sometimes difficult truths about compliance deficiencies and failures — and taking steps to remedy the problem. And, for industry compliance professionals, effective examination oversight also helps to shore up the important work that you perform all day long. Someone at the SEC once said that undergoing an examination is a bit like visiting the dentist — you may not always enjoy the experience, but you know that it's good for you in the long run. I don't think we're going to give out stickers at the end of an exam, but I think that this is an apt comparison!

At the SEC, we oversee the self-regulatory organizations, and we play an important role in helping to ensure that the securities examination framework works. We do this by overseeing the self-regulatory organizations, and working to ensure that they are working together within the overall securities regulatory landscape. My office — the Office of Compliance Inspections and Examinations, conducts inspections of the SROs, and also of broker-dealers, in part to evaluate the work of the SROs in performing their regulatory responsibilities. We also oversee, through examinations, the other industry participants: investment advisers, transfer agents and investment companies, and are thus able to see the "whole picture" in terms of interrelationships and compliance issues.

Within this framework, the NYSE, the NASD, the options exchanges and other markets, and the SEC — it may seem like quite an alphabet soup of regulators — all conduct examinations of broker-dealers. From a distance, it may not seem like it, but there is method in this approach.

Indeed I think what is sometimes lost in some of the debate about the current regulatory framework is the fact that there is a great deal of thought and coordination on examination issues. To be clear, I am not taking any position on whether the current self-regulatory structure should be altered or refined or improved, and indeed the Commission has issued a concept release on this very issue and asked for comment on several alternatives. I am only addressing the current state of play, sometimes behind the scenes, that today goes into the examination process.

Let me give you some background. Beginning way back in 1995, the self-regulatory organizations, the SEC and NASAA came together to sign a memoranda of understanding. Under the MOU, regulators agreed to share information, coordinate examinations, and identify regulatory priorities to eliminate any unnecessary duplication (the MOU was later amended to include additional options regulators: the ISE, PCX and PHLX). As part of the MOU, since 1995, the firms that are members of both the NYSE and the NASD — currently about 200 firms — have the option of having either one coordinated routine exam by NASD/NYSE staff, or having separate exams. In 2005, the NYSE and NASD honored the firms' requests for coordinated exams under the MOU, and conducted 65 such coordinated exams of dual-member firms.

Then, building on this cooperation, the NYSE and NASD recently developed a plan for examining common member firms that divides up responsibilities for examining specific issues. These issues include: anti-money laundering compliance; research analyst conflicts of interest; Regulation S-P; business continuity planning; monitoring of registered representatives subject to statutory disqualification; Regulation SHO; continuing education; supervisory controls; internal controls; and electronic communications. This protocol ensures that only one regulator will be responsible for reviewing these areas at a particular firm. Thus far, feedback on the protocol has been very positive.

I am here to tell you that in the trenches, NYSE and NASD examiners are actively coordinating with each other during examinations — I've seen some of the memos shared between exam teams during the examination planning process with respect to specific firms — and they are detailed and specific with respect to the areas that each exam team will focus on. Each SRO is very motivated to defer to the other, and to rely on the other exam team's exam findings.

And more broadly, regulators actively discuss new and emerging areas of compliance risk. We at the SEC have a key role to play in helping to ensure that significant regulatory issues are identified, identified as quickly as possible, are reviewed effectively, and by the most appropriate regulator to do so. It is entirely appropriate for us to defer to an SRO if they are capably examining a particular area, and to ensure that other SROs are deferring as well. It is also entirely appropriate for the SEC to examine a particular issue, if we deem it significant to our investor protection mandate. In this vein, before we initiate any "sweep" examination, we consult internally with other Commission staff, with SROs, and we alert our Commission of the issue as well. This risk assessment process is not one that the public sees, but is one that is active and important at the SEC.

So, ten years into the MOU, I'm pleased to report that coordination efforts are healthy and ongoing. And, regulators have taken other recent initiatives to help ensure that securities oversight is effective. I'll describe a just a few:

  • State, SEC and NASD examiners recently agreed to work together on coordinated examinations of broker-dealers that sponsor "free lunch" sales seminars that may be targeting senior citizens for inappropriate and unsuitable sales of securities.
  • For firms that conduct options business with public customers, the options exchanges have developed an approach to sales practice examinations that ensures consistency and efficiency. The SROs allocate each firm to a "designated options examining authority." Only the designated SRO — currently either the NYSE or the NASD — will examine the firm's public options sales practices. To ensure consistency in these examinations, the SROs use a common examination module and they meet regularly to discuss and coordinate issues related to these exams.
  • The options exchanges have also recently developed a plan (called the "Options Regulatory Surveillance Authority" or ORSA) that calls for coordinating surveillance for insider trading across all options markets, with the goal of making such surveillance better and more efficient.
  • Securities regulators are also taking communication and coordination to new levels with respect to anti-money laundering examinations. We meet and confer regularly to discuss examination trends, regulatory issues and enforcement matters, and we conduct joint examinations and joint training for examiners. Our AML examination scopes are similar, and to further promote consistency, we're in the process of harmonizing our AML examination procedures.

In these and in other ways too numerous to mention here, this interlocking web of securities firm examination oversight works.

Here's a caveat — while an enormous amount of work goes into coordinating examination oversight, we — as regulators — have an obligation to continue to work to ensure that examination oversight is effective in detecting, preventing and detecting violations, and that we're not duplicating efforts. Indeed, this requirement to cooperate and coordinate is built into our own statutes. Speaking of plain English and transparency, Section 17(k) of the Exchange Act expresses this perfectly — it states that "the Commission and the examining authorities, through cooperation and coordination of examination and oversight activities, shall eliminate any unnecessary and burdensome duplication in the examination process." I assure that we are, and will continue to do so.

And we invite your input — tell us if you become aware of any duplicative efforts or any other issues for that matter — indeed the NYSE, NASD and SEC all include specific language to this effect in our letters commencing examinations.

I said at the outset that we value transparency and clarity in the regulatory process — and in that vein, I wanted to share with you some of the ways in which we at the SEC are making sure that our examination process is transparent.

First, we understand that firms would like more information about the examination process itself — examination oversight, while a normal part of doing business with investors as a registered firm — can cause anxiety, and certainly we understand that. Accordingly, we are updating our "examination brochure" that examiners provide to firms at the outset of examinations to provide more information about the examination process. As you may know, under existing policies, at the conclusion of an examination, the firm is informed of the results in both an oral exit interview and in writing (with limited exceptions, such as when there is a risk that documents will be destroyed or investors' funds at risk).

We've promulgated a new policy to advise registrants of the status of the examination while it is underway, again in the good name of transparency. Thus, if the examination is ongoing for more than 120 days following the end of the fieldwork, examiners will inform the firm that the exam is underway, and provide a sense of the likely timeframe for completion.

The revised examination brochure will also invite registrants under examination to communicate with the exam staff about any questions that they may have regarding the examination. To further facilitate communications and questions to appropriate staff, we're also updating our public website at the SEC to provide the names and phone numbers of examination supervisory staff in each SEC office.

And, if there are ever any problems, complaints or concerns about examinations that firms wish to communicate, anonymously or not, they can do so through our Examination Hotline. The Examination Hotline provides registrants with a means to communicate any problems or complaints about examinations in a manner that preserves their confidentiality. It is staffed by senior-level attorneys in the Office of Compliance Inspections and Examinations' Office of Chief Counsel who follow up and try to resolve any complaints or concerns that are raised. While relatively new, the Hotline appears to be facilitating communications between registrants and SEC staff.

And, beyond the examination process, firms are encouraged to bring questions that they may have about the application of securities laws and rules to the SEC and to the SROs. How do you know who at the SEC to contact? To ensure that firms can find the appropriate SEC staff to contact concerning questions about the federal securities laws, the SEC's website has the names and contact information for SEC staff in the Divisions of Investment Management, Market Regulation and Corporation Finance (http://www.sec.gov/divisions/investment.shtml, http://www.sec.gov/divisions/corpfin.shtml, and http://www.sec.gov/divisions/marketreg.shtml). The staff in these divisions regularly receive calls and correspondence concerning the application of the federal securities laws, and registrants are encouraged to communicate any questions or issues to SEC staff.

In addition, to further facilitate communications between firms' compliance staff and the SEC, we've been meeting with firms' compliance staff in a variety of locations across the country to discuss common examination findings and compliance issues, and we thank the Securities Industry Association's Legal and Compliance Division for assisting in these efforts.

And, for mutual fund and investment adviser chief compliance officers, we initiated a formal "CCOutreach" program. The CCOutreach program consists of regional seminars (held by SEC regional offices across the country) and a national conference in Washington, DC, that allows compliance professionals the opportunity to meet, discuss and ask questions about compliance issues and trends, SEC examinations, rules and regulations and other matters directly with SEC staff. In total, more than 3,112 chief compliance officers attended these events during the inaugural programs in 2005 (with another 3,920 participants via webcast). I'm excited about this initiative because I think that greater discussion and communication about compliance issues and compliance controls will ultimately lead to stronger compliance programs to help prevent, detect and correct compliance problems.

And that's a goal that securities regulators and self-regulators share with the many able compliance staff in this room — we all want to prevent, detect and correct compliance problems — indeed finding them and correcting them before they can blow up to harm investors is our primary goal.

My time with you this morning is up — and I appreciate your time and attention. Have a good conference!



Modified: 10/28/2008