Issue Date: January 22, 2001

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Shop Talk: SEC Encounters: Tips for a Smooth Inspection

From the editors of IA Week

It happens every five years. SEC adviser inspections, whether for-cause, routine, or part of one of the Commission's notorious sweeps, are now more frequent and can panic adviser compliance staff - or not.

Gene Gohlke, associate director of the SEC's Office of Compliance Inspections and Examinations (OCIE), offers simple advice: be prepared.

This year won't hold many surprises, Gohlke advises. Inspectors will continue to focus on best execution, window dressing, portfolio pumping, and performance advertising. Fund advisers should be careful to keep personal trading records for access persons, he said, and examine them for conflicts of interest - a rule that was phased in over more than a year. "We'll be asking the firm to explain what it is they do with the information they get," he said. "The commission didn't just impose that rule to make extra work for firms."

With that in mind, advisers should strive to run a clean shop, and be organized, so when the inevitable letter comes from inspectors for a regulatory checkup, they will be able to respond to questions and produce proof they are in compliance.

Advisers frequently leave examiners sitting in the reception area while they scramble to retrieve documents, and that doesn't make a good first impression, Gohlke said. There is no excuse for the delay, he added. Unless they are conducting a surprise inspection, the Commission generally will send a letter weeks in advance asking that advisers compile a variety of records. "It would be helpful if at least a substantial percentage [of requested documents] would be available and organized when we arrive so we can start," he told IA Week.

The Commission often requests lists of firm's access persons, affiliated entities, client trades, advertisements, and copies of client contracts. The SEC prefers electronic copies of documents if possible, especially for voluminous client trade records, he added.

And advisers need to designate a staff person as the SEC liaison, preferably a compliance officer or legal staff person. "It makes the whole interaction go smoothly," Gohlke said.

Because the SEC has limited inspection resources, first impressions can count for a lot, said Kirkpatrick & Lockhart attorney Richard Marshall. Firms that appear disorganized only prolong inspections and increase their risk of getting a deficiency letter, he said.

Plan. The easiest way to avoid problems, of course, is to find and fix problems before regulators ever notify you of an inspection. "Once the inspection starts, there's virtually nothing you can do to control the process," he said.
Control. Appoint a contact person. Make sure you understand what the SEC would like to know. Brief staff on the importance of the SEC interviews.
Advocacy. If you feel inspectors have mistakenly targeted you, explain why - calmly. If they are right, put forward mitigating factors to reduce penalties.
Speed. Get inspectors in, then get them out.
Truth. Never lie, and honor promises you make to the SEC.
Confidentiality. Request confidentiality, and know your rights under the Freedom of Information Act.

Richard Levan, a former SEC enforcement official now with the Philadelphia office of Drinker Biddle & Reath, recommends mock inspection interviews to prep adviser staff. These can be done internally or through a consulting firm or law firm, he told IA Week. "It's hard to get clients to do it," he said. "But those who have are uniformly grateful for having gone through the experience."

Other tips for a clean inspection, according to Levan, include:

Keeping an up-to-date compliance manual.
Designating an area for the inspection interview. Choose a comfortable room, with a conference table and chairs - and no copy machine. Advisers should designate a staff person to copy forms, so they know exactly what the SEC will be examining.
Advising receptionists on what to do if a regulator appears, for either an announced or unannounced visit.
Not speaking "off the cuff" during the exam. Be polite and professional, but not too talkative.
Obtaining business cards of the SEC staff inspecting you.
Being careful to produce documents the SEC requests, and making sure you have good reason to refuse to hand over documents.
Keeping a record of all documents given to inspectors.
Following up on any promises to produce more documentation or information for SEC inspectors.
Maintaining the integrity of documents the SEC inspected.
Avoiding detailed written memos to staff about the exam, as they likely will not be exempt from the next inspection.

When the inspection is over, advisers can expect to wait 90 days for word on how it went, SEC's Gohlke said. If an adviser succeeds and gets a letter saying the exam is over and there are no violations, advisers should not take that as a clean bill of health for their shops, Gohlke added. That can lead to sloppy compliance and deficiency letters during the next exam.

Levan agreed. Such complacency can lead to half-hearted compliance programs, he said. "I cannot tell you how many clients have told me they didn't have to make a change because they had been doing something that way and the SEC had never complained," he said. "It's one of toughest things for lawyers counseling clients."

Categories: Inspections | ShopTalk | Examinations: Best Practices