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U.S. Securities and Exchange Commission

Speech by SEC Staff:
"SEC's Compliance Examinations in the Protection of Investors"
Remarks at the 9th Annual IA Compliance Best Practices Summit 2007, IA Week and the Investment Adviser Association


Lori A. Richards

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

Washington, D.C.
March 23, 2007

The SEC disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the speaker's views, and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.

Good afternoon. It's a pleasure to be with you today. At the outset, let me remind you that the views I express are my own and not necessarily the views of the Commission, the individual Commissioners, or my colleagues on the Commission staff.

I'm speaking to you today at lunch, which I rarely do. I always think of lunch as a break from the action, a respite from the seriousness of the day's agenda. And, I always thought that luncheon speakers should really try their hardest not to be too serious, not to be too boring, and if they can, try to be a little bit topical. I am speaking to you over dessert after all.

I was little surprised that I was asked to speak to you today, at lunch and all. I'm not exactly known for my lighthearted remarks. Looking back at my public speaking at various events, there's a certain, shall we say, similarity in my messages. Indeed, the titles of my speeches in the last few years probably say it all, when it comes to the scope of my interests:

  • "Our Shared Responsibilities for Fund Compliance" June 1999
  • "The New Internet Economy: A Compliance Imperative" April 2000
  • "Compliance Priorities for Investment Advisers" May 2000
  • "Valuation, Trading and Disclosure: Three Compliance Imperatives" June 2001
  • "Compliance Professionals Play Proactive Defense" October 2001
  • "Furthering Good Compliance" April 2002
  • "Compliance and Inspection Issues for Advisers" October 2002
  • "The Culture of Compliance" April 2003
  • "Compliance Issues for Advisers Today" April 2003
  • "Put the Compliance Rule to Work" March 2004
  • "Compliance Programs: Our Shared Mission" February 2005
  • "Compliance: Some Core Principles" April 2005
  • "The 'Process' of Compliance" October 2006

Is there a common theme? A common message? I certainly am consistent.

And what I want to talk with you about today is consistent with my message to registered firms over the course of these many years, and consistent with our mandate as examiners. Simply put, we expect registered firms to comply with the law, we hope that you will, we will do all that we can to help you do so, but when the staff's examinations reveal violations or deficiencies, you can expect that we'll call you on it. After all, that's the purpose of examinations -- to identify violations and deficiencies in firms' compliance with the law, and ensure that they get corrected to avoid harming investors. I'd like to spend some time with you today talking about the examination process, the role of healthy examination oversight in the protection of investors, the ways we're helping firms to be more compliant, some of the common deficiencies that we're seeing in examinations, and what you can expect from us in the year ahead.

The SEC's mandate is to maintain fair, orderly, and efficient markets and facilitate capital formation, and to protect investors. Your clients. So, please don't take it personally when our staff's examinations reveal deficiencies or violations. As you may know, most of our exams find that in some way, advisers have not fully complied with some provision of the Investment Advisers Act. In 2006, we conducted over 1,300 exams of advisers. The vast majority of our examinations -- 81% -- resulted in non-public letters from us to you informing you of these problems and asking for corrective action. The vast majority of firms respond to our deficiency letters by making improvements in disclosures or in compliance controls to prevent the problem from reoccurring.

In about 6% of our exams of advisers, we find indications of very serious violations - mostly fraud of some type - that result in a referral to the SEC's enforcement staff for further investigation. While small in number in the context of the overall number of examinations that we perform - each one of these instances is significant to the protection of investors. In fact, many of the enforcement actions that the Commission brings each year involving advisers or funds come from examinations that initially revealed the misconduct. Examinations have stopped frauds in progress, led to enforcement actions and to recompense for harmed investors. I know that my colleague from the Enforcement Division, Linda Thomsen, spoke with you yesterday and described some of the recent enforcement cases involving advisers, many of which came from examination referrals. These include cases involving undisclosed side arrangements involving distribution,1 insider trading involving PIPE deals,2 service arrangements that benefited the adviser at a fund's expense,3 cherry-picking by advisers,4 providing lavish gifts to fund traders in exchange for business,5 the undisclosed use of soft dollars for things that did not benefit clients,6 using fund brokerage for revenue-sharing,7 failure to obtain best execution to the detriment of clients,8 market timing and late trading,9 problems in wrap accounts,10 and many more.

Now I know that many firms view the prospect of undergoing an SEC exam with some amount of dread, and I do understand that. Examiners' job is to understand your compliance controls, to test those compliance controls and identify any weaknesses or violations. This process requires that firms provide us with information and documents. While we're working hard to minimize disruption to firms, examinations will take your time, attention, and resources. There are benefits however, and certainly there are a fair number of firms that view the examination process as a helpful one - it may alert the firm to emerging compliance issues that, if undetected and uncorrected could have caused problems down the road, it may shore up the role of the CCO within the firm, and it allows firms to receive their regulator's feedback in a non-public way, which often leads to corrective action by firms. Most importantly, examination oversight, along with the other forms of SEC oversight and regulation, helps to protect investors, and allows investors to have confidence in securities firms and in our markets.

Let me knock down some canards about examinations - our job is not to "make policy," it's to unstintingly examine for compliance with existing laws and rules. We don't have a minimum count of exams that must result in enforcement referrals. We love it if you ask us questions, and we receive your complaints with professionalism. We even have a Hotline to encourage you to bring them to us! We coordinate extensively internally within the SEC with other divisions, including the Divisions of Investment Management, Market Regulation, Enforcement, and Economic Analysis, on any novel or unique issue, on our draft sweep reports and in crafting our examination modules to ensure that we've got the application of the securities laws just right. We also now have committees of staff from different divisions who review the referrals that are made from examinations to the enforcement staff and evaluate whether a referral is appropriate given the facts and the law. And, in developing our training programs for examiners, we call on all kinds of expertise from both inside and outside the SEC. Indeed, one of our newest training series is called "Inside the Rules." It's taught by the rule-writers themselves, and is designed to ensure that we've got the nuances of the latest rules down just right.

Because we examine all types of firms, we can better implement a truly-risk based oversight program - we see emerging trends, conduct broad risk assessments and rapidly dedicate resources where they are needed. We conduct exams of dually and multi-registered firms, consistently train all examiners, and implement consistent policy and exam tools across the professional examiner ranks and across all registered firms. We also see how the same issues "cross over" among different types of registrants -- issues like anti-money laundering, best execution, sales practices, and undisclosed payments for business have no boundaries that keep them neatly within one type of registrant. Because we are dedicated examiners, we examine for compliance with the securities laws and rules in an even-handed way across all registered firms. At the SEC, we have a professional and independent examiner corps because it best serves investors for the SEC to conduct professional and independent examinations.

But, as examiners, we have a responsibility ensure that we're applying consistent and accurate interpretations of the law. I was disheartened by criticism last week that there is sometimes a divergence in the deficiency letters that we issue, and the law or legal interpretations from the Divisions of Investment Management or Market Regulation. While not visible to firms, there is quite a lot of behind-the-scenes communication and guidance provided by other divisions at the SEC to make sure that examinations are consistent with the law and current interpretations. Nonetheless, I take these criticisms seriously, and am committed to addressing them. Our interest as examiners is to be certain that when we cite deficiencies, we've got it right. We will be working internally to identify and implement improvements to our process. In the meantime - I encourage you to tell us about any instances where you believe that there is a divergence between our exam findings and applicable law. Raise the issue with the exam team, at the exit interview or in response to the deficiency letter. Or, if this has happened in the past, this is exactly the type of issue that we'd like to learn about via our Examination Hotline at (202) 551- EXAM.

It is particularly important for us to use sound and consistent judgment when we examine firms for compliance with the new "Compliance Rule." As you know, the "Compliance Rule" is probably the best example of a principles-based rule under the Advisers Act. It requires that firms have compliance programs, though does not mandate that firms have any particular compliance policies or procedures, but only that advisers have written policies and procedures, and that they be effective. Not a lot of guidance here, for you or for us, and we're both treading on new ground. So, this rule, perhaps more than any other, requires sound judgment by our examiners when we examine your firms and when we note any weaknesses in your compliance programs. It also requires judgment by you, when you design and implement your compliance program. In this space, we're both operating without the benefits or the constraints of specific mandates, as well as with the heightened responsibility that comes with a principles-based rule.

Given the principles-based approach of the Compliance Rule, as well as the fact that there are so many recently-installed CCOs, it's important for us to communicate effectively with firms and to do what we can to assist CCOs in ensuring strong compliance. And, it's enormously healthy for us to hear directly from firms about the compliance issues they face, and the challenges they encounter. The CCOutreach Program, sponsored jointly by the Division of Investment Management and OCIE is aimed at exactly that. I know that many of you have already attended the free seminars that are a part of the CCOutreach Program. CCOutreach is a way for us to communicate with CCOs in an environment that fosters communication. One strong message that we've heard from the compliance community is that, while understanding the overarching legal principles is interesting, what they want and need is practical information about specific compliance mechanisms that work.

So, at CCOutreach events, examiners are sharing information with CCOs about the compliance deficiencies that we see, about compliance policies and procedures, about the exam process, and the results of our recent examination sweeps -- valuable information about compliance problems that CCOs should be alert to in their own firms. We're also talking about what examiners do with the information they obtain from firms as part of the examination process -- the tests that we run and the methodologies we use to identify deficiencies. This information is not only interesting, it's valuable, as these same tests can also be used by CCOs in their own compliance programs. One industry newsletter reporting on CCOutreach called this information a "goldmine" for CCOs!

We've just announced our regional seminars for 2007, including the dates and locations for 27 seminars across the country. The topics that will be addressed at this year's regional seminars include those that CCOs told us they were most interested in hearing about:

  • the examination and risk assessment process;
  • books and records and disclosures and filings;
  • brokerage arrangements, best execution, trade allocation, and soft dollars;
  • portfolio management; and
  • marketing, performance, advertising, and distribution.

In sum, through CCOutreach, we intend to continue to provide firms with information that we think can help you be "ahead of the curve" on compliance issues. Watch our website for more information. By the way, we've recently expanded the OCIE portion of the SEC's website to provide helpful information about examinations of all types of registered firms. If you have questions or want to know what we're up to, it's a "go to" website. At the seminars, we'll provide CCOs with information about the most common deficiencies that we find in examinations. What are they? In 2006 exams, they were:

  • Deficiencies in information disclosure, reporting and filings. For example, examinations revealed inaccurate or incomplete disclosures, untimely filings with the Commission, and untimely delivery of the disclosure documents to clients. Examinations found disclosures that were inaccurate or incomplete with respect to firms' conflicts of interests, various compensation arrangements, solicitation arrangements, fee structures and brokerage/soft dollar arrangements.
  • Deficiencies with respect to the Compliance Rule. For example, firms' compliance manuals did not address firms' risks, listed risks that did not exist at firms, or established procedures that firms did not follow.
  • Deficiencies with respect to personal trading by advisory firm personnel, including that the firms' code of ethics were deficient or not implemented, employees' trading was not reported or not reviewed, and improper allocations of securities to personal or proprietary accounts.
  • Problems in performance advertising and marketing, including omitting relevant disclosures so as to not make the advertisement misleading, advertising performance that was not accurate.
  • Problems in information processing and the protection of customer information. For example, examiners found weaknesses with respect to firms' business continuity plans, Regulation S-P procedures, and the creation and compilation of certain books and records.

In addition to these issues, in exams this year, we'll also be looking for possible insider trading, at brokerage arrangements, best execution and soft dollars, allocations of trades ("cherry-picking"), personal/proprietary trading by advisers, pricing and valuation, controls to prevent the theft of client funds and information, and supervision.


As I said at the outset, we expect registered firms to comply with the law, we hope that you will, we want to do what we can to help you do so, but when our staff's examinations reveal violations or deficiencies, you can expect that we'll call you on it. After all, that's the purpose of examinations -- to identify violations and deficiencies, and ensure that they get corrected to avoid harming investors.

I hope today that I've provided you with information today that helps you understand us as examiners a little better - the examination process, the role of healthy examination oversight in the protection of investors, the ways we're helping firms to be more compliant, some of the common deficiencies we see in examinations, and what you can expect from us in the year ahead.

Thank you. Have a good conference.



Modified: 03/26/2007