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News October 24, 2005 Issue

Preparation is Key to Surviving SEC Exam, Says CCO of Small Adviser

Hereís some advice from the CCO of a small, Chicago-area adviser that recently underwent a four-day SEC examination: "If you are organized, itís a piece of cake."

In an interview with IM Insight, the CCO recounted how his pre-exam preparation and organization helped his firm weather the exam and, he believes, make a good impression on the examiners. "It really wasnít too bad," said the CCO. "The Ďideaí of the SEC exam was certainly more stressful than the actual event," he said, adding that he felt "relieved" that the exam had finally taken place.

Among other things, the CCO said he felt ready for the exam "because of what Iíve read, from the conferences Iíve gone to." He said that he regularly reads a certain compliance newsletter "cover-to-cover" each week. As a result, "I really wasnít surprised by anything," he said. "Everything was as I anticipated."

The CCO also said that he had familiarized himself with the various SEC document request lists going around. "I knew what other requests lists looked like," he said. True to form, the list sent over by the SEC was "fairly similar" to the versions he had seen. For example, he was ready to answer the exam question about material compliance violations. "I knew that was a question on other request lists," he said. "Iíve had a file [tracking material compliance violations] for awhile now just for that purpose." He said that he had identified a few "pretty minor issues" that he was able to summarize, including how he dealt with the issues and whether there was now a policy in place to prevent the issue from happening again. "That was a clear example where knowing whatís on the request list ahead of time certainly prepared me," he said. "I had that one all ready."

Despite his preparation, the exam still involved a lot of work. "You are never 100 percent ready," he said. "I worked non-stop from Thursday [when the SEC faxed over its document request list] to Monday morning [when the examiners arrived] getting everything perfect for them, but it was worth it," he said. "I really had a lot for them the first day. I had answered everything and had written out in a very organized manner answers to all of their questions." The CCO labeled every document so that the examiners "didnít have to fish through things" to find a response. Although it took a lot of time, "I think that really helped," he said. "It was worth being so organized."

He described his firmís business model as fairly straightforward. "I donít have 200 employees," he said. The examiners understood that his firmís business was simple. "Sometimes they would ask a question saying ĎI know this stuff doesnít apply to you, but I still have to just make sure and ask the questioní," he said, "which was no big deal."

The two SEC examiners were on-site for four days. At one point, they interviewed the CCO for two hours straight. However, the tone of the interviews "was very comfortable," the CCO said. The examiners, he said, "were very personable and reasonable." In fact, the examiners kept "saying over and over" not to be nervous, he said.

He wasnít. Although the CCO admitted he "had a certain level of anxiety" about the exam, he indicated that his pre-exam preparation boosted his confidence about the actual event. "Iím coming from a place where Iím very prepared," he said, "so maybe I wasnít as nervous."

Of course, not everything went smoothly.

"As prepared as I was, I knew that I had been procrastinating on a few items," he said. For example, he had not finalized one of his firmís policies. "It was in my head, more than on paper, and that was not good," he said. While he was able to get it on paper prior to the examinersí arrival, it was not as polished as he would have liked.

He said that the examiners asked for e-mails for only three individuals (out of a dozen or so staff), and specified two months: one last year and one this year. However, the examiners did not ask for the CCOís e-mails. Also of note: the e-mail request did not contain key word parameters, and the examiners did not ask the CCO about e-mail surveillance.

The CCO said that his firm was not able to provide examiners with certain other types of information in electronic form, as had been requested. "Our office just didnít have the capability to produce [the documents] in electronic format," said the CCO. And that, he said, "was my only answer." Because the firm simply couldnít produce the documents electronically, he basically had to tell the examiners, "Sorry, you have to take home two feet of copied documents." The examiners, he added, "didnít really seem to get too upset about that."

Another challenge during the exam: The CCO reported that it was sometimes difficult to respond to document request list questions that require a narrative description of the firmís system of internal controls for specific areas (personal trading, marketing, etc.). Prior to the exam, he said, he had "a hard time understanding" how to demonstrate internal controls or risk management techniques as applied to each substantive area. "It seemed vague in a lot of the conferences Iíve been to," he said.

The CCO offered the following advice to other CCOs: "Although it seems pretty simplistic to say, one of your jobs as CCO when undergoing an exam is really to make the examinersí job easier for them" by organizing documents in advance to facilitate the exam process, added the CCO. "They really do appreciate it when youíve done just that." He noted that the examiners remarked that other advisers werenít always as organized. When records are presented in an organized fashion, he said, it fosters a sense of compliance and competence. "The last thing you want to do," he added, "is confuse and frustrate an SEC examiner."

(Editorís Note: identifying details in this story have been changed.)