If there’s anything scarier at Halloween than the classic 80’s horror films featuring Jason Voorhees, Michael Myers, and Freddy Krueger, it’s the prospect of an SEC examination. Although compliance examinations can be a nightmare if your firm isn’t prepared, mock SEC exams can get you ready for whatever questions and document requests are thrown at you by examiners.

Did you ever notice that watching a horror movie for a second time seems less scary? This is likely because you are prepared for what is about to happen next. The same can be said for using a mock exam to help prepare for a regulatory examination. Mock exams can ensure that Registered Investment Advisors (“RIAs”) and their Chief Compliance Officers (“CCOs”) feel confident that their books and records are complete, and they can produce whatever documents are requested by examiners. Importantly, mock examinations can also help RIAs identify and correct compliance deficiencies before they are detected by SEC examiners.

The Odds are in the SEC’s Favor

What is the likelihood that your firm will be examined in the next few years? While there are a number of factors the SEC uses to select which firms it will examine, unless you’ve been examined in recent years, odds are that your firm meets at least one of the SEC’s criteria.

There are a number of factors that can increase the likelihood of an examination. In 2020, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) prioritized the examination of certain products, practices and services that represent a potentially higher risk to investors or to the integrity of capital markets. OCIE increased its scrutiny of firms that hire representatives with a history of disciplinary infractions, as well as those with custody over client assets.

According to SEC statistics released on January 7, 2020, examinations of RIAs in fiscal year 2019 remained strong at approximately 2,180. This figure represented 15 percent of the investment advisor population and would have been higher if there had not been a 35-day lapse in appropriations. As a result of those exams, OCIE issued numerous deficiency letters. Those letters required RIAs to take direct corrective actions such as:

  • Amending compliance policies and procedures or a regulatory filing;
  • Enhancing their disclosures; and
  • Returning fees to investors.

Depending upon the nature of the deficiencies and whether an RIA has worked diligently to correct them, examiners might refer the advisor’s case to the SEC’s Division of Enforcement.

OCIE plans to increase its examination of investment advisors through:

  • Implementation of program efficiencies in the areas of process and technology;
  • Realignment of internal staffing to improve the coverage rates for RIAs; and
  • Ongoing training of staff and the onboarding of experienced subject matter experts.

The end result is that the number of examinations is likely to increase.

A Mock Examination is an Integral Preparation Tool

Like many things in life, whether it be running an investment advisor’s compliance program or watching a horror movie (two very different scenarios, indeed), the better prepared you are for what is about to come next, the easier the experience will be. Investment advisors and CCOs are best served by preparation. A mock exam simulates the examination process, helping investment advisors learn where their compliance programs are weak. Better yet, the mock exam will give the advisor time to shore up those weaknesses.

Mock exams do more than just prepare advisory firms for the days or weeks during which examiners review their compliance programs. Engaging a third party to conduct a mock exam demonstrates to examiners that the firm and its management are committed to compliance.

Other Types of Exams and Assessments

In addition to a mock regulatory exam, Foreside can conduct a small-firm compliance assessment or a 206(4)-7 “annual compliance review”. Rule 206(4)-7 under the Investment Advisers Act of 1940 requires RIAs to review their adopted policies and procedures for their adequacy and effectiveness, ensuring those policies and procedures are designed to prevent violations of federal securities laws and regulations. Foreside’s small firm compliance assessment and annual compliance review services are risk-based exams intended to review whether the firm’s compliance program adequately addresses and mitigates the firm’s compliance and regulatory risks. As firms grow and offer new services and products, different risks arise, and the RIA’s policies and procedures must address them.

Takeaways

Adequate preparation is key to a successful regulatory exam. A mock exam helps CCOs get ready for their debut with securities examiners. Though examinations are likely to be conducted remotely for the near future, advisors will still face serious challenges if they have not prepared in advance. Foreside offers cost effective options for RIAs of any size.

The SEC expects RIAs to allocate sufficient resources for compliance. Engaging a firm to conduct a mock exam is a worthwhile expenditure and may be considered a form of regulatory protection. Mock exams uncover deficiencies, giving the firm time to adequately address deficiencies before they become a regulatory problem. Hidden compliance deficiencies and failures, when uncovered by regulators, can be absolutely frightful – even worse than a horror movie!

 

 

Home