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News March 13, 2017 Issue

Examination of Advisers and Funds Up 20 Percent in FY 2016 Over Previous Year

Mary Jo White must have been particularly pleased with this statistic before she left office as SEC chair last month: The number of investment advisers and investment companies examined by the agency’s Office of Compliance Inspections and Examination in FY 2016 increased by more than 20 percent over the number examined in FY 2015.

That figure, along with other performance metrics, was released recently in the SEC’s Summary of Performance and Financial Information for FY 2016, which concluded on September 30, 2016. In it, the agency noted that it conducted more than 1,600 exams of advisers and investment companies. It also conducted more than 2,400 exams of all regulated entities, which the SEC said also represented a 20 percent increase over the previous year, as well as "the highest number of examinations in the preceding seven fiscal years."

"The SEC’s report reiterates key statistics that reflect White’s legacy," said Ropes & Gray counsel David Tittsworth. "For asset management firms, this legacy is particularly striking in terms of the agency’s aggressive enforcement program, the far-reaching rulemaking agenda that has been pursued during the past 2 years, and attempts to bolster OCIE’s examination resources."

The report provides selected results on how the agency performed against strategic goals and objectives set in its FY 2014 – FY 2018 Strategic Plan. That plan contains 12 strategic objectives, each with specific goals against which the agency measures itself. The full set of performance results is expected to be released when the SEC issues its FY 2018 Congressional Budget Justification later this year.

Stradley Ronon partner Lawrence Stadulis suggested that this year’s report probably won’t matter much 12 months from now with a new SEC, perhaps with a different enforcement philosophy, likely to be in place. "What intrigues me is trying to envision what next year’s report will look like, generally, and whether it will bear any resemblance to this year’s report, in particular," he said. "For example, will next year’s report once again tout a record number of enforcement proceedings and staff increases? Or will it celebrate successful initiatives to reduce agency costs and streamline the regulatory process? I don’t know the answer but suspect next year’s report will look quite different."

Following are the report’s performance results:

Advisers, funds and broker-dealers examined

Performance goal 2.2.1 of the Strategic Plan sets a goal for the percentage of investment advisers, investment companies and broker-dealers examined during the year. The FY 2016 goal set for adviser was to examine 11 percent of advisers, which the report says it met. This is part of a steady increase in examination coverage since FY 2011, when OCIE reported that 8 percent of advisers were examined. That percentage has gradually increased, and was 10 percent in FY 2015.

For investment companies, the SEC surpassed the goal, with OCIE reporting that it examined 17 percent of all funds, compared with its goal of examining 15 percent, the same percentage examined in FY 2015.

The trend of increasing examinations may well continue, since, according to the report, the agency took steps "to increase staff in the IA/IC examination program by about 20 percent through targeted hiring and redeployment of staff from other examination program areas," and these changes became effective when FY 2017 began this past October 1. Much of the examination staff redeployment came from the broker-dealer side, where staff were reassigned to investment advisers (ACA Insight, 2/8/16).

As for examination of broker-dealers in FY 2016, the SEC set a target of 50 percent of broker-dealers being examined by either the SEC or by an SRO (i.e., FINRA), and the report states that the target was met. That result, however, is still 1 percent below the percentage of broker-dealers examined in FY 2015, which was 51 percent.

The reported also notes that OCIE made about 200 referrals to the Division of Enforcement based on the results of examinations.

Enforcement actions the SEC won

Performance goal 2.3.1 is formally labeled as the "percentage of enforcement actions in which the Commission obtained relief on one or more claims." The agency describes the metric as the percentage of enforcement actions during the fiscal year in which the SEC "obtained a judgment or order entered on consent, a default judgment, a judgment of liability on one or more charges, and/or the imposition of monetary or other relief" – in other words, in which the agency, in one way or another, won at least some part of each case.

That percentage is high, and was higher than past years in FY 2016. The strategic plan set a goal of 92 percent for such results, but the actual result was 97 percent. That compares to 95 percent in FY 2015, and as low as 89 percent in FY 2012.

Response time to written requests

This performance goal, 1.3.1, is used to measure "the length of time to respond to written requests for no-action letters, exemptive applications, and written interpretive requests," according to the report.

"These queries may seek interpretations of the securities laws or regulations, or assurances that no enforcement action will be taken if the individual or market participant engages in a specific activity," the report says. What this metric does is measure the timeliness of initial responses to those requests within a division’s required timeframe, although the report does not state just what that timeframe is for the three divisions that receive such requests: Investment Management, Trading and Markets, and Corporation Finance.

Investment advisers and investment companies, of course, would send their requests to the Division of Investment Management – which received a perfect performance score for FY 2016 of 100 percent. This was particularly significant, given that the FY 2016 goal was 80 percent. The Division scored 100 percent in FY 2015, as well, although the goal in that year was 99 percent.

Disclosure review

The Sarbanes-Oxley Act requires that the SEC review, at least once every three years, disclosures filed by companies and investment company portfolios reporting under the Exchange Act. Performance goal 3.1.1 measures the "percentage of public companies and investment companies with disclosures reviewed each year."

Disclosures from 36 percent of investment companies were reviewed in FY 2016. That result exceeded the agency’s goal for the fiscal year of 33 percent, and was higher than the 35 percent scored in FY 2015.

Beating the enforcement drum

White’s tenure at the helm of the SEC was known for both aggressive enforcement and for the amount of rulemaking it undertook. The agency in FY 2016 undertook 868 enforcement actions, a number that is composed of 548 of what the SEC calls stand-alone actions, meaning cases where the SEC initiated charges on its own through an administrative hearing without having been previously heard in federal court; 195 follow-on proceedings, meaning administrative proceedings seeking bars against individuals based on criminal convictions, civil injunctions or other orders; and 125 delinquent filing proceedings.

"A reading of the report raises questions about what the asset management agenda will look like at this time next year," said Tittsworth. "I expect that Jay Clayton will be confirmed as SEC chairman by the Senate in the coming weeks. He will have the ability to shape the enforcement, rulemaking, and inspection agenda for the agency, including hiring key staff in all these areas. In addition, I expect that President Donald Trump will nominate two other persons to fill the other vacant commissioner seats in the not-too-distant future. To say the least, it will be interesting to see how the agenda and priorities of the ‘new’ SEC for asset management firms will change during the coming months."

Whatever happens in FY 2017, there can be little doubt that FY 2016 was a year of enforcement achievements. Here’s some of what the report lists as its FY 2016 enforcement achievements:

  • Brought the "most-ever" cases involving investment advisers or investment companies, totaling 160;
  • Obtained judgments and orders for more than $4 billion in penalties and disgorgement;
  • Charged 78 parties in insider trading actions;
  • Continued to prioritize cases against "gatekeepers," such as attorneys, accountants and consultants;
  • Brought several "first-of-its-kind" actions involving complex financial instruments;
  • Awarded more than $57 million to 13 whistleblowers; and
  • Made use of data through "innovative analytical tools," for enforcement, among other things, involving insider trading, hedge funds, municipal issuers and complex financial instruments.