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News April 3, 2006 Issue

SEC No Longer Measuring its Performance By Number of Deficiencies Found

While the SEC will continue to keep an eye on the number of exams that result in significant deficiencies or referrals to the Division of Enforcement, it is no longer using those numbers as a measure of its effectiveness as a regulator.

"[I]t would be inappropriate for the agency" to conduct examinations "with an eye toward hitting predetermined numerical targets rather than evaluating the evidence as presented," acknowledged the SEC in its recently-released 2007 Performance Budget report.

Thatís a change. In the 2006 version of its Performance Budget report, the agency seemed to set goals for itself based on how many exams turned up problems. One so-called "Performance Measure" was the "Number and percentage of examinations finding Ďsignificantí violations."

Another "Performance Measure" was the number of "Referrals to the Division of Enforcement from examination staff or the Division of Corporation Finance."

While actual target numbers were not specified in last yearís report, the semantics apparently spooked some in the industry. So this year, the SEC moved those measures to the back and described them as "indicators" that may be "useful in understanding the SECís activities." The numbers, cautioned the report, "should not be considered performance measures and do not include targets that the agency will strive to reach in future years." (Indeed, such numbers are now called "Indicators," rather than "Performance Measures.")

For the record, in the SECís fiscal 2005 year, 37 percent of all fund and adviser exams resulted in a "significant" deficiency. A significant deficiency, explained the SEC, is one that "may have caused harm to customers or clients of a firm, had a high potential to cause harm, or reflect[s] recidivist misconduct."

The SEC hasnít tracked the number of significant deficiencies in years past. But get this: "[b]ased on ancedotal evidence, it appears that the fiscal year 2005 levels are considerably higher than those of a few years ago."

With respect to enforcement referrals, 399 of all fund and adviser exams resulted in enforcement referrals in the SECís fiscal 2005. Compare that to 482 in fiscal 2004 and 171 in fiscal 2003.

Interestingly, a Office of Management and Budget report published in February 2006 indicated that OCIE has, in fact, set "targets" representing the percentage of examinations that it aims to have result in "deficiency letters requiring the registrant to take corrective action." However, OMBís assessment was conducted months before the publication of the SECís 2007 Performance Report. And, of course, itís an OMB report, not an SEC report. Itís a safe bet that the SEC now views the number of deficiencies as an "indicator," rather than a "performance measure."