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News October 18, 2004 Issue

SEC Examiners Won’t Play Gotcha With Advisers, Promise SEC Officials

Putting to rest pre-October 5 worries that the SEC would be looking to bring a series of post-October 5 "send a message" enforcement cases, SEC officials at last weekís NRS compliance conference in New Orleans promised to be patient while advisory firms sort out their new compliance programs.

"I think that itís important ó and weíve had discussions with our colleagues in [OCIE] ó that we give you time to put procedures in place," said SEC Division of Investment Management director Paul Roye. "Weíre not going to be looking to come in and say ĎAha! You donít have a procedure!í" he promised. "We want to be helpful. We want the procedures to work, we want them to be effective . . . . so we do see it as an evolutionary process," he said. "Weíve asked you to do a lot. I think we have to be patient . . . . Nowís the time to take a deep breath and to work with you." Roye also said that the SEC staff understands that post-October 5, advisers "arenít going to have the perfect set of compliance controls and procedures in place." Rome, he said, "wasnít built in a day."

That jives with what IM Insight heard about a inspection exit interview conducted on October 5. The firm in question had yet to appoint its CCO and had only a "rough draft" of its compliance policies and procedures, according to one industry source. Instead of citing the adviser, however, the examiner conducting the interview suggested that going forward, the firm might want to think about adding certain types of procedures to its compliance program. The examinerís approach, said the source, was "reasonable and practical."

But that doesnít mean that advisers should get complacent about their programs. During his remarks, Roye said that "hopefully" firms are now testing their procedures and verifying that they are working. SEC examiners, he said, are going to be "looking for some ongoing review and assessment of those procedures and some sense that you have confidence in those procedures and that they are working."

Roye noted that some firms had to do very little to comply with the new rule, whereas other firms had to do "a fair amount" to bring themselves into line. Moreover, he pointed out that in some firms things were very straightforward, whereas in other firms, particularly those that are part of a larger financial services organization, things may have been more complicated.

Industry experts speaking at the conference seemed to agree that however good an adviserís compliance program was on October 5, the adviser should take advantage of the next year to polish and refine it even further. "This is just the beginning," warned Dechert counsel Elizabeth Knoblock. "The reality is you are just getting started." She suggested that many advisers will find that they need to spend time drilling down in areas that were covered only at a high level in the October 5 version of their program.

Consultant Ann Oglanian agreed that advisers should continue working on their programs. "This is the year," she said. "Start to move the bar up, because as the SEC moves the bar up, as we start to hear whatís going on out there, youíre going to [ask yourself], ĎAm I really measuring up?í" The place to be, she said, is at least in the "middle of the herd." If youíre not there, she said, "you need to have a really good reason."

Of course, advisers that have thumbed their noses at the new compliance program rule still risk incurring the SECís wrath. "I hope thereís nobody out there that hasnít taken this process seriously," warned Roye. He said that SEC examiners "are going to be looking for the process that you went through" and predicted that they will not take kindly to advisers that "really havenít put the time in or havenít taken the requirements seriously," he said. Added Roye: "Hopefully, we donít have folks in that situation."

Interestingly, Roye signaled that the SEC is putting together a training program of sorts for new CCOs. Roye said that advisers, "at the right point in time," will be contacted by SEC examiners. Step one, apparently, is finding out who the firmís CCO is. (Although CCOs must be disclosed on Schedule A of Form ADV, more than half of the ADVs IM Insight sampled post-October 5 had not yet added them. That would seem to be fine, under the theory that the appointment of a CCO is not a "material change" requiring prompt updating of the ADV.)

Once the SEC identifies the CCO, it plans to get to know them better. "We want to have a dialogue with the [CCOs]," said Roye. "We want to be a resource for you" in terms of effecting compliance. "Down the road," he said, the SEC plans to launch new initiatives to "reach out and have that dialogue with you" ó not just in the context of sweep exams, he added. The staff is "trying to make sure you have access to information," he said. "Weíre looking for ways to help you be more effective and do a better job," he said. "Thatís clearly one of our goals down the road." Meanwhile, he encouraged CCOs to "feel free to pick up the phone" and call the staff. "We will strive to be helpful to you."

Bill Meck, senior assistant district administrator in the SECís Philadelphia office, described a similar process. During the next year, he said, examiners will "meet and greet the CCO" and reach what he called "a meeting of minds" of "what we expect from them, what we expect them to share with us." He characterized it as an "unusual" relationship. "We do expect a high degree of cooperation, a high degree of disclosure," he said. And he agreed with Roye that "we will absolutely be patient" while firms adjust their compliance programs. The CCO, he said, is "a wonderful new position." It should be viewed as an "somewhat of an opportunity to establish a dialogue and a relationship with the SEC."

Lastly, CCOs who are worried about what the SEC will do or wonít do post-October 5 should keep in mind that the SEC examination staff is feeling its way as it begins to inspect firmsí compliance programs. "Hey, listen," said Meck. "This is new for us, too."