Gohlke Outlines Exam Approaches
According to OCIE associate director Gene Gohlke, the SECís Office of Compliance Examinations and Inspections is working off a menu of six different examination approaches for advisers and fund complexes. Gohlke outlined the options, which are also partially described in the SECís 2006 budget request, at last weekís Mutual Fund Directors Forum.
1. Risk-targeted exams. Perhaps better known as "mini-sweeps," these exams involve looking at one issue, in-depth, across a variety of firms. Last year, OCIE conducted approximately 20 to 25 minisweeps, according to Gohlke. "Many of those are now winding down," he said, adding that "we are finding a continuing stream of issues" that lend themselves to new mini-sweeps. "We are starting new sweeps that came out of issues identified in old sweeps."
2. Cause inspections. OCIE is doing "a lot more" of these, said Gohlke, who reported that the percentage of cause exams "more than doubled" from 2003. One reason is that OCIE is "much more attuned" to information coming in the form of tips or complaints.
3. Routine exams of firms with higher-risk profiles. What makes a firm high-risk? If a former exam reveals deficiencies in the firmís internal control systems, "bad things can happen" and the firm "may or may not find it in time to prevent harm to investors," said Gohlke. Other categories of high-risk firms: newly-registered firms that have not been examined, firms with someone on the staff with a disciplinary history, or if the firm has "significant conflicts of interest." High-risk firms will receive "at least one full exam every two to three years." Interestingly, Gohlke did not mention asset size as a factor pointing toward high risk.
4. Routine exams of everybody else. Gohlke noted that aside from the firms that have been identified as high risk, there are approximately 7,500 other SEC-registered investment advisers, with an additional 1,000 hedge fund managers registering next year. "In order to oversee that large group of firms," said Gohlke, "what we are now doing is conducting exams on a random basis at the beginning of each year."
The exams are truly random: each firm gets a number and OCIEís computer randomly selects the lucky firms. Examined firms will receive a "full scope exam," in which OCIE will look at the firmís compliance program, "request[s] some e-mails from particular people in the firm," and "do a lot of testing" to corroborate that the firmís controls around particular issues are, in fact, doing their job. Full-scope exams conclude with an exit interview with the CCO, said Gohlke. "We talk to the CCO about where we think that the firm can do better" and "what we are thinking of doing." Gohlke noted that OCIE is considering whether to encourage the fund CCO "to reach out to independent directors and see if they want to participate in those exit interviews telephonically." That, said Gohlke, might be a better way to communicate OCIEís concerns to the independent directors. "Itís not going to be required, but we will offer them that opportunity."
5. Surveillance. Gohlke described this as "still in the implementation stage." The SEC, he explained, will "get certain pieces of information" from firms "in on a regular basis," and "look for firms that have outliers or patterns of performance that doesnít match up with either their historical performance or the performance of their peers." If an outlier was detected, he said, the staff would contact the firm and follow up on the issue. He described this as being a "more intelligent use of our resources." (According to the SECís 2006 budget request, we can expect to begin being surveilled "during the second half of 2006.")
6. Monitoring teams. Gohlke described this as "still in the development stages." Under this approach, local SEC offices will deploy teams of three to four people to the largest advisory firms and fund groups. The teams would be responsible for "being the eyes and ears of the Commission." The goal would be to get to know the firm and its employees "on a very intimate basis." Hopefully, he added, the firmís employees would get to know the team very well, as well. As a result, the team would know where the firmís "strong points [and] weak points." Moreover, the team would operate on a "no surprises relationship" with the CCOs of the firm. If there is a major issue, explained Gohlke, the hope would be that the CCO would inform the staff. The teams would be at the firms "quite frequently," perhaps on a two-to-three year cycle, but would not "live at the firm" the way bank examiners do, said Gohlke. "Hopefully all of this will be implemented by the end of this fiscal year."