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News February 12, 2007 Issue

Advisers to Face Fewer Exams in 2007

For the past four years, the number of fund and adviser exams conducted by OCIE has hovered close to 1,550. But in 2006, OCIE conducted only 1,346 fund and adviser exams. And, according to the SECís recently-released 2008 "Performance Budget" report, the agency plans to conduct even fewer fund and adviser exams going forward: In 2007 and 2008, OCIE is slated to conduct 1,300 fund and adviser exams.

Whatís behind the slow-down? The SECís Performance Budget report listed a variety of reasons why fewer fund and adviser exams will be conducted:

  • An increase in the complexity of registrantsí operations, including the need to review the activities of hedge funds in conjunction with examination of the fundsí advisers (the report noted that in 2006, OCIE reviewed more than 750 private funds);
  • A substantial increase in the time needed during each routine exam to evaluate the effectiveness of new compliance programs adopted pursuant to the compliance program rule;
  • An increase in exam scope in order to review advisersí and fundsí compliance with other new regulatory requirements;
  • A decrease in the number of targeted special examinations conducted, a.k.a. "sweeps" (the report noted that these exams are generally shorter in duration than routine exams);
  • Dedication of staff resources to new initiatives designed to improve compliance, such as CCOutreach and monitoring large advisory groups; and
  • A decrease in resources.

Although OCIE is conducting relatively fewer fund and adviser exams, they are finding slightly more significant deficiencies. Last year, 39 percent of fund and adviser exams resulted in a finding of a significant deficiency, up from 37 percent in 2005.

A few additional trends evidenced by the report:

Fewer enforcement referrals. The level of OCIE referrals to the Division of Enforcement seems to be tapering back to its pre-scandal levels. In 2003, before the scandal broke, OCIE made only 171 enforcement referrals. As a result of the market timing and late trading scandals, that number jumped to 482 and 399 in 2004 and 2005, respectively. Last year, however, examiners made 223 enforcement referrals.

Fund and adviser cases make up an increasing percentage of all SEC enforcement cases: 16 percent in 2005 and 2006, up from 11 and 14 percent in 2003 and 2004, respectively. The opposite trend is seen in broker-dealer cases. In 2003 and 2004, broker-dealer cases comprised 20 and 22 percent of the agencyís caseload. In 2005, that dropped to 15 percent, and in 2006, it fell to 13 percent. The SEC doesnít set hard and fast targets in this area, but going forward it predicted that fund and adviser cases would not comprise more than 40 percent of the agencyís caseload. It made the same prediction for broker-dealer cases and other types of cases.

Increased SEC staff turnover. Last year, the SEC experienced a 9 percent employee turnover rate, a bit higher than the predicted 8 percent rate. Compare that to the just under 6 percent turnover rates experienced in 2002 and 2003. The agency predicted a slowdown in employee turnover in 2007 and 2008, with projected turnover rates of under 7 percent.

Division of Investment Management priorities. Fund disclosure reform is at the top of the Division of Investment Managementís to-do list: "One of the top strategic priorities for the Division of Investment Management in [fiscal] 2008 will be to implement new rules designed to provide mutual fund investors with more reader-friendly disclosures and to improve the delivery of mutual fund information through increased use of electronic means, including the Internet," said the SEC in a separate "Congressional Justification" report.

The Division also plans to recommend new rules to eliminate the need to submit exemptive applications that are substantially similar to previously-granted applications.

In yet another document, the Office of Management and Budget reported the results of a "program assessment" of the effectiveness of the Division of Investment Management. The Division received OMBís highest rating: "Effective." In OMBís view, the Divisionís programs "set ambitious goals, achieve results, are well-managed and improve efficiency." At last weekís PLI "SEC Speaks" conference, Division director Buddy Donohue highlighted the top OMB ranking, praising the IM staff as well as his predecessors in office.

(Note: All year references in this article are to the SECís fiscal year, which runs from October 1 to September 30.)