Speech by SEC Staff:
The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or the other members of the staff.
Thank you for inviting me to present my views on compliance from the perspective of the SEC examination program. The scope and coverage of topics being discussed at this conference are a clear demonstration that the industry is well aware of the many compliance challenges facing us in today's complex and dynamic capital markets. In general, the goal of our SEC examination program in the Office of Compliance Inspections and Examinations (OCIE) is to promote compliance in the securities industry and to detect and correct problems and wrongdoings. This morning I would like to cover three general topics that relate to these areas: first, enhancements to our examination program; second, the examination process; and third, some of our current examination focuses and concerns about potential compliance challenges.
I. Enhanced Examination Program
Over the past several years, we have enhanced our SEC examination program through increased risk-focusing and coordination, use of new procedures and improved technology, and increased training. We are also looking to firms to take a more proactive approach, anticipating potential problems and implementing controls to prevent violations. To achieve the latter goal we have encouraged firms to build strong, supervisory, compliance, risk management, surveillance, and internal audit programs. We have also encouraged firms to assess their conflicts of interests and other issues that may raise the potential for compliance problems. Conducting comprehensive compliance and risk management examinations and having discussions with firms on conflicts controls are some ways the SEC examination program is taking a more proactive approach. We have seen significant progress at firms in building more robust programs in these areas and we hope this trend will continue as firms realize the benefits achieved from proactive and preventive efforts.
Another mechanism we are using to improve the effectiveness of our examination program is increased risk-focusing and analysis to anticipate potential compliance challenges. We now use a comprehensive risk assessment process to permit all examiners in our nationwide program to identify and prioritize risks to investors, registrants, and the markets. Examination staff also provides risk-focusing insights through continual monitoring of news and examination results and trends. For example, we monitor developments of new products and market trends, and also identify developing problems found during examinations. In addition to compiling risk-focusing information from our own examiners, we also receive compliance information from our Office of Investor Education and Assistance, trends and economic information relating to the capital markets from our Office of Economic Analysis, and information from the Divisions of Corporation Finance, Market Regulation, Investment Management, and International Affairs on issues they believe warrant examination review. OCIE uses the information to assist in setting goals and priorities for the examination program, deciding if sweeps on focused risk areas may be appropriate, providing information to the Commission on areas where interpretations or new rules may be valuable, providing recommendations for interpretations or investor education, and using the information to inform the Commission, the industry, and the general public of risks and concerns.
We are also enhancing our risk-focusing in selecting candidates for examination and scoping what we cover in examinations. Mechanisms we use for risk-focusing specific examinations are: information from prior examinations; enforcement actions; customer complaints; compliance reports; surveillance and trading information; financial reports; information from regulators, analysts and news reports; and tips we may receive from various sources. A relatively new procedure we have implemented with respect to our risk management examinations is to limit or adjust our examination scope (coverage) - thus, risk-focusing -- by leveraging off high quality, effective internal audit work performed by firms. Our reliance on the firm's own independent reviews will depend on whether examiners can become confident that effective independent oversight has been conducted and that the firm has taken meaningful corrective action as appropriate. Based on this initial assessment, we might limit our review of areas effectively covered by internal audit at the firm and focus on high risk areas and areas not adequately covered by the firm's reviews. Utilizing all of these risk-focusing processes should assist us in more effectively spending our time and resources rather than conducting more time-consuming broad-based examinations, thus also reducing the burden on firms.
Coordination of examination work among securities regulators is another process that contributes to the effectiveness and efficiency of examinations for compliance with securities laws. Like you, we believe that coordination is essential to prevent unnecessary duplication of efforts and wasted resources. We also recognize that coordination begins within our own organization - the various groups in our SEC examination program.
As you know, the SEC has responsibility for the examination of broker-dealers, investment advisers, investment companies, transfer agents, clearing agencies, and the Self Regulatory Organizations ("SROs"). There are currently about 9,000 registered investment advisers, 990 fund complexes with over 8,000 mutual fund portfolios, and 6,100 registered broker-dealers with 170,000 branch offices and almost 660,000 registered representatives. There are also 550 SEC-registered transfer agents and 7 clearing agencies. While entities may be separately incorporated and registered and subject to different laws, they are often affiliated and their businesses frequently intersect. Large firms may perform multiple functions, have multiple registrations, have common revenue lines, and perform inter-related services. Best execution, valuation, brokerage commissions, sales practices, use of confidential customer trade information, and supervision all may cross registrant boundaries and require a more coordinated examination approach. In addition, where firms conduct regulatory responsibilities on a consolidated basis - such as business continuity planning, anti-money laundering, information security, and risk management - the examination program is making every effort to coordinate in all areas where the Commission has responsibilities. We also coordinate with other regulators having responsibilities in these areas.
Examination coordination among the SROs is performed under a Memorandum of Understanding signed in 1995 by the SEC, the SROs and the North American Securities Administrators Association. The MOU requires cooperation and coordination in examinations to "most efficiently and effectively oversee the financial, operational, and sales practice activities of broker-dealers, maintaining the highest level of examination oversight quality for the protection of investors, while working to eliminate any unnecessary and burdensome duplication in the examination process." Under the terms of the MOU, the SROs ask firms with multiple SRO memberships if they choose to have all SRO examinations coordinated. That is, routine examinations by all SROs would be conducted at the same time and coordinated. SROs also agree upon the scope each will cover to prevent duplication. Since the time the MOU was first signed, the SROs have been quite successful in coordinating exams as requested, and over the past year the SROs were more than 95% successful in coordinating. We have also worked with the NASD and NYSE to create a system to monitor exams being performed by each of the SROs and the SEC. This enables us to avoid unnecessary duplication of efforts and has been particularly helpful in our coordination with respect to sweeps and branch exams. Regional and national examination summits and joint training programs are also held to increase coordination and consistency.
II. The Examination Process
I would now like to turn to my second topic - the examination process. All of our SEC examinations follow the same general process. This process is outlined in our examination brochure, which firms are given at the beginning of an examination. The brochure:
An "announced" examination will usually begin with a document request letter. More documents will most likely be requested throughout the process. If the exam is "unannounced", documents will be requested by exam staff upon arrival. It helps the examination process proceed smoothly and more quickly if you provide documents to the examiners as promptly as possible - perhaps piecemeal - if some documents will take longer to produce. You should also communicate with the examiner if you are unable to provide any documents by the due date or if you have questions or concerns. The request for information can be adjusted in situations where better, more precise, or more appropriate documents can be provided.
Upon arrival on-site at your firm, examiners identify themselves and present their SEC identifications. The examiners may conduct an initial interview asking questions about the firm and the activities to be examined. This information assists examiners in understanding the firm and its operations, and often assists examiners in determining the scope of the examination. The examiners may also ask for a walk-through of the firm's offices to gain an overall understanding of the firm's organization, flow of work, and control environment. Then the main process begins, which is the examination of the firm's books and records combined with meetings and consultations with firm personnel.
On the last day of the on-site visit, examiners will typically conduct an "exit interview" during which they will discuss the status of the examination and any outstanding information requests and, if appropriate, the issues identified during the examination to that point. The firm will be given an opportunity to discuss any of the issues that the examiners found and provide additional relevant information.
The examiners then return to the SEC offices to perform additional analyses. They may also contact the firm to ask clarifying questions or to request additional information. In formulating the findings of the examination, the examiners may consult with other staff within the SEC to ensure that the findings are consistent with Commission rules, regulations, and interpretations.
If work performed subsequent to completion of the on-site portion of the examination identifies issues in addition to those discussed during the exit interview conducted on the last day of the on-site visit, the examiners will contact the firm to discuss these additional findings. During this "final exit interview," the firm will be given an opportunity to discuss any of the issues that the examiners found and provide additional relevant information, such as a description of any actions the firm has taken or plans to take to address the issues identified. Cooperation during the exam and promptly providing complete and relevant information will assist in timely completion and an effective examination.
Once the examination is complete, the firm will be sent written notification. To the extent there are findings of weaknesses or concerns, these will be included in the written notification together with any of the firm's preliminary responses or information provided by the firm on corrective actions. Firms will be asked in the notification to formally address in writing any weaknesses or concerns, typically within 30 days. If special circumstances arise and you believe you will be unable to complete the response within the time requested, you should contact the examination staff or supervisor to request an extension. It is our expectation that with recent enhancements, our SEC examination process will be more effective, more efficient, and less burdensome, producing a more accurate result, using less time and resources - both by SEC examiners and firm personnel.
III. Examination Priorities and Challenges
Now I will turn to my third and final topic - some of our current examination priorities. These are in the general areas of supervision, sales practices, risk management, financial issues, and trading practices. They include the following:
Looking over the horizon, it is my view that there are some potential challenges we can already anticipate. First, there is an ever increasing stream of new and complex products being offered. While marketing and sales seem to proceed promptly, it is a challenge to keep pace in the areas of operations, controls, compliance, and training. Structured product marketing and sales continue to escalate with a reported 500% growth in commodities-related structured products. There continues to be an increased focus on sales and marketing of securities products to senior citizens and those in the pre-retirement stage, where suitability and marketing must be carefully monitored. Changes in interest rates will impact home mortgages, home equity loans and fixed income products in ways that may not be expected by investors. As more and more activities are outsourced, firms will be challenged with maintaining appropriate controls and supervision. Technology continues to offer challenges - there are increasing volumes, increased rapidity of trades, more nonpublic customer information on potential trading that should be appropriately protected, and more sophisticated hackers and security breaches. Maintaining robust and flexible controls and continually monitoring and addressing risks are the best defenses against compliance problems and financial failures. And it is hard-working compliance professionals like all of you who I am sure will keep these as top priorities at all of your firms. Thank you.
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