On September 6, 2023, the Securities and Exchange Commission (“SEC”) released a Risk Alert detailing the SEC’s examination selection process. The Risk Alert includes an attachment with the SEC’s typical initial request for documents and information which is useful for firms to have and evaluate in anticipation of an examination.
Key Takeaway(s): Helpful, but not earth-shattering by any means. Most of the information in the Risk Alert was already pretty well-known in the adviser community including the typical initial information and document request. The firm-specific risk factors represented the most compelling information within this particular Risk Alert, including the use of technology to help evaluate firm-specific and industry-level risk.
Examination Selection Process
Unsurprisingly the SEC starts the Risk Alert with a few caveats. First, the SEC says “given the size and variety of the adviser population” the SEC “utilizes a risk-based approach for both selecting advisers to examine and in determining the scope of risk areas to examine. The SEC proceeds to say the SEC’s risk-based approach is “dynamic.” From there the SEC provides a few details on the selection process separating out reasons the SEC may select an adviser to examine and firm-specific risk factors. What is clear from the firm-specific risk factors (below) is the SEC has embraced technology and utilizes the firm-level disclosure data (Form ADV and Form PF) in addition to industry-level information in the selection process.
Firm Selection
The reasons the SEC may select an adviser for examination include, but are not limited to:
- An adviser’s risk characteristics;
- A tip, complaint or referral; or
- The SEC’s interest in a particular compliance risk area (often referred to as “sweep exams”).
The firm-specific risk factors the highlighted in the Risk Alert the SEC considers are:
- Prior examination observations and conduct
- Supervisory concerns
- Tips, complaints or referrals
- Business activities of the firm or its personnel that may create conflicts of interest (e.g. OBAs, dual-registrants, affiliated broker-dealers)
- The length of time since the firm’s registration or last examination
- Material changes in a firm’s leadership or other personnel
- Indications the adviser might be vulnerable to financial or market stresses
- Reporting by news and media that may involve or impact the firm
- Data provided by certain third party data services
- The disclosure history of the firm
- Whether the firm has access to client and investor assets and/or presents certain gatekeeper or service provider compliance risks.
Once selected the SEC further tailors the scope of the examination. However, the SEC typically expects to review a firm’s operations, disclosures, conflicts of interest and compliance practices. Additionally, the core areas of review include custody and safekeeping of client assets, valuation, portfolio management, fees and expenses and brokerage and best execution.
How Trillium Can Help
The key to success is preparation. Trillium’s ongoing compliance support is designed to ensure clients are prepared for success when the SEC comes knocking. SEC examination support is included as part of the ongoing compliance support Trillium provides to clients. Trillium guides clients through the examination process by advising on process and document production, reviewing documents before production and providing documentation as needed from technology systems.