Now that you’ve seen what ACA Insight has to offer, don’t be without it. Subscribe now!

The weekly news source for investment management legal and compliance professionals

Current subscribers - please log in to the website in the upper right-hand corner

News May 16, 2011 Issue

What’s Inside An SEC Exam Information Request

The SECís National Exam Program has been announced, but itís still a work in progress.

Until then, advisers need to know what to expect from an SEC examination information request right now.

ACA Insight has obtained several SEC exam request letters that were issued from various SEC regional offices across the country. No two are exactly alike, but they do appear to spring from the same or similar exam "building blocks" that are then tailored to the particular adviserís business.

The National Exam Program may be further along than we thought.

The documents collected here reveal that the written SEC examination request (that typically arrives after a call from the staff announcing the exam) is generally comprised of five parts: a cover letter, two standard examination information forms, an "Examination Information Request List," and a sample trade blotter.

Based on the material reviewed and available through links below, hereís how each part breaks down.

The cover letter.

Besides the critical information about when the SEC plans to arrive, the letter also provides staff contact information and a brief overview of the examination process. The letter typically notes that the exam is being conducted pursuant to Section 204 of the Advisers Act. Section 204 makes all adviser records subject "at any time, or from time to time," to reasonable periodic, special, or other examinations by the SEC. For dual registrants, Section 17(a) and (b) of the Securities Exchange Act is noted as well. Those sections similarly subject broker-dealers (and transfer agents, exchanges, and other registered entities) to recordkeeping and examination requirements.

The SEC typically requests that the adviser provide some of the requested information in advance. All other requested information is expected to be collected and available for review on-site when the exam team arrives. The cover letter cautions that "[i]f the adviser becomes aware of the need for delay in the production of any requested information that extends beyond the first day of the on-site examination, the adviser should immediately contact the undersigned at the telephone number indicated."

The SEC Form 2389 brochure.

The SEC uses several standard forms that it incorporates into the examination notification and information request, which can be found on the SECís website. The first standard form, SEC Form 2389, is the "Examination Information for Broker-Dealers, Transfer Agents, Clearing Agencies, Investment Advisers, and Investment Companies" brochure. It is a three and a half page document that describes the purpose of examinations, the examination process, and completing an exam.

The brochure explains that exams are conducted to ensure registered entities are complying with the law, adhering to their disclosures, and have systems in place "reasonably designed to ensure that the firmís operations are in compliance with the law."

The brochure indicates that the staff typically will not share with the registrant whether an examination is routine, or being conducted for cause based on a tip, complaint, or referral, for example. However, routine exams more typically provide at least one week and up to three weeksí advance notice before the staff arrives on-site.

The brochure notes that when SEC staff arrives to conduct on-site examination work, the examiners will identify themselves and present their credentials. This is important because criminals have impersonated SEC examiners in the past to get access to confidential information. Truth can be stranger than fiction.

On the last day of on-site work, the SEC typically conducts an exit interview. "During an exit interview, the firm will be given an opportunity to discuss any of the issues that the examiners found and provide additional relevant information, including with respect to any actions that the firm has taken or plans to take to address the issues," says the brochure.

If your exam team does not intend to conduct an exit interview, you can request one. (That is not mentioned in the brochure, but has been offered as informal staff advice.) Once the SEC finalizes on-site work, the staff will continue its analysis in its own offices. The staff may have additional questions as a result, or inquire about additional findings. Questions and responses during any call from the staff to the registrant may constitute a final exit interview.

The brochure indicates that the SEC targets completion of exams within 120 days after the on-site portion of the exam is complete. If the staff needs more time, the registrant will be contacted on or about that 120th day to discuss a likely schedule for completing the exam. The brochure states that "a firm will be sent a written notification" when an exam has been completed. Generally, a firm will receive a "no further action" letter, or more commonly, a "deficiency" letter. Serious problems may be referred to the Division of Enforcement or other regulators such as FINRA or the states. Really serious problems uncovered during an exam may be referred to Enforcement "without an exit interview or a deficiency letter." Typically those situations involve "exigent" circumstances.

A firm receiving a deficiency letter generally has 30 days to respond. If the staff has further questions or comments to the response, the registrant is generally contacted within 60 days. "If the examiners have no further comments after receiving your response to a deficiency letter, they will send no further communication and the examination will be closed," says the brochure. While the lack of finality in the form of a closing letter can be disconcerting, no news is good news, as they say.

The SEC Form 1661 authorities and requirements to comply document.

The second form regularly accompanying an SEC information request is SEC Form 1661, "Supplemental Information for Regulated Entities Directed to Supply Information Other Than Pursuant to a Commission Subpoena." This four-page document describes the SECís authority to request the information, the effect of not supplying the information or supplying false information, and how the SEC uses the information. Form 1661 also acknowledges FOIA issues and informs registrants that Rule 5(c) permits them to "submit a written statement to the Commission setting forth their interests and position in regard to the subject matter of the investigation."

A similar SEC Form 1662 is available for entities responding to information requests pursuant to a subpoena. This is not typically the case in an examination. However, with the Division of Enforcementís enhanced subpoena power, the ramp-up of the tips, complaints and referrals system, and the increased collaboration and cooperation among areas of the staff, it is possible an adviser in a cause examination or that is resisting the production of certain information could see this form as well.

Sample trade blotter.

The final form document is the "Layout for Securities Trading Blotter/Purchase and Sales Journal. This document appears to contain fairly standard sample information in table form that is tailored only with respect to whether the adviserís business involves equities, fixed-income securities, derivatives, or any combination of the three. The sample requests that the information be provided most commonly in Excel format, but occasionally also in Access format, on cds. The layout typically requests separate worksheets for "(i) equities (Note: ETF trades should be included with equities); (ii) fixed income; (iii) cash or cash equivalents, maturities, calls, pay-downs, expirations, or reinvestments of mutual fund dividends or capital gain distributions; (iv) mutual funds; and (v) options, futures, swaps and other derivatives."

The main attraction Ė The Examination Information Request List.

This is where the requests get personal.

The request list springs from a relatively standard format. However, it is more like a menu from which individual exam teams can tailor information requests for individual advisers. Like a fingerprint or a snowflake, they can look similar but no two are the same.

The request list is typically thirteen to fourteen pages long.

Here are the general categories:

General Information. This includes, among other things, the complete Form ADV (all parts), organization charts, affiliate information, specimen copies of current standard client advisory contracts, disciplinary actions against employees, and any litigation or arbitrations involving the adviser or its supervised persons.

Information Regarding the Adviserís Compliance Program, Risk Management and Internal Controls. This is where advisers pony up their compliance manual and the results of compliance testing and any compliance reviews. Risk assessment, internal audit information and supervision of remote offices or independent advisory contractors is covered here, as well as client complaints, the annual review, valuation, the compliance log, and the adviserís business continuity plan.

Information to Facilitate Testing with Respect to Advisory Trading Activities. This request is all about the trade blotter, brokerage arrangements, trade allocations, the code of ethics, and any fee splitting or revenue sharing arrangements.

Performance Advertising and/or Marketing. Pitch books, client solicitations, RFPs, and GIPs claims are requested here, as well as composites and the accounts that went into them Ė as well as the accounts that didnít and the reasons why.

Financial Records. Everything from bank statements to balance sheets, cash flows and the adviserís chart of accounts are included in this category. The SEC also looks at any loans from clients to the adviser or sales of the adviserís or any affiliateís stock to clients.

Custody. The request here is simple. The SEC wants contact information for every custodian of client assets, and the name and location of any securities not held by a qualified custodian. For securities not held with a qualified custodian, the SEC also wants the names of the clients that own those securities.

Role of Sub-advisers/Fund of Funds Sub-advisers. Not only will an adviser be required to identify any sub-advisers and provide due diligence records related to their selection or recommendation to clients, but an adviser may also be required to disclose and produce information related to any business activities between the adviser and/or its affiliates and the sub-adviser and/or its affiliates. The SEC will review the circumstances of a sub-adviserís use of an adviserís preferred or affiliated broker-dealer.

Advisers Sponsoring or Managing Privately Offered Funds. Information requested here can be extensive and covers all aspects of the private funds. The request includes organization documents, the identity of investors and their equity interests, the equity interests of the adviser and any affiliates, details regarding side pockets and other special situation accounts, valuation information and performance fee calculations.

Expect the SEC to have at least some level of understanding of your business when the exam team arrives, and to request more information over the exam period as that understanding deepens.

In organizing responsive information, the request asks advisers to group the information so that it corresponds to the item number in the request list. "If the information provided is responsive to more than one request item, you may provide it only once and refer to it when responding to the other request item numbers."

Sample SEC examination letters and information requests.

Now to the requests themselves.

The SEC conducts examinations from its eleven regional offices and its Washington, DC headquarters. Not all of the regions are represented here. The documents are presented as they were obtained in pdf format. All have been redacted as necessary to remove any personally identifying information of the adviser or SEC examiners. The requests are all recent from within the past six months, dating from December to as recent as several weeks ago.

A sample trade blotter is attached to the back of each examination information request list.

To review a complete request from the New York Regional Office, click here.

To review an examination information request list from the Boston Regional Office, click here.

To review an examination information request list from the Chicago Regional Office, click here, and for a sample cover letter from the Chicago Regional Office, click here.

To review a cover letter and examination information request list from the Fort Worth Regional Office, click here.

To review an examination information request list from the Los Angeles Regional Office, click here, and for a sample cover letter from the Los Angeles Regional Office, click here.