At ACA, we understand that preparation is key, especially when facing the complexities of SEC examinations. Our AdviSEColumn provides insights from former SEC examiners and co-heads of ACA’s SEC Mock Exams team, Robert Baker and Michele Foldenauer, to provide you with a perspective into the regulator’s exam process.
Dear ACA, what advice would you give to firms preparing for an SEC exam today?
Michele Foldenauer: Firms preparing for an SEC exam should start by conducting a thorough self-assessment to identify potential weaknesses in compliance programs and addressing the weaknesses in a timely manner. Employees should be prepared to articulate what their duties are and how they perform them, along with the applicable policies and procedures.
While not required by all exam teams, an overview presentation of the business with coverage of key risk areas and how the risks are mitigated goes a long way in impacting how the exam teams may view the compliance program and develop their risk scoping for the exam.
Finally, simplify responses to production items and offer to provide more detailed information on a call where there is an opportunity to better understand what the exam team is looking for if the question is not understood.
Robert Baker: First, do an opening day deck. If you aren’t asked for it, then offer it. And offer to do it either right at the beginning of fieldwork or even a couple of weeks before. It’s a great opportunity to introduce your firm and its staff, explain the risks that don’t apply to the firm, and how the firm is doing a great job trying to control the risks that do apply. It makes everything more efficient for both sides.
Prepare written responses for almost every document request list item. It’s especially important to do this if there are any assumptions made.
Ask a question if something is unclear. A common example is the agenda for fieldwork. Some examiners will provide a tentative agenda as that is certainly best practice for all involved.
Do your best to follow instructions when completing template forms like requests for trade blotters and initial positions. The staff needs these in the right format to run their National Exam Analytic Tool’s (NEAT) algorithms. (For those who do not know what NEAT is, it flags certain trades such as trades with high commissions, trades before significant market events, and potential Rule 105 violations. ACA’s Market Abuse Surveillance technology is based on it.) You are better off trying to avoid wasting the staff’s time with unnecessary follow-up questions. Examiners are humans, and avoiding sloppiness in the document production signals a firm does not have sloppiness in the areas being examined.
Make rolling productions and communicate with examiners about where things stand in the production. A typical initial request letter asks for documents in approximately two weeks, but almost no firm produces all documents for a large document request in two weeks. That said, it’s better for firms to produce the readily available documents, like compliance policies, the annual review, fund offering documents, and trade blotters, within that timeframe and then communicate that they need a little more time on the documents that require summaries of information or significant time from finance staff. Examiners will have a wide range in how lenient they are in document production timing, but no examiner appreciates following up with a firm that is tardy and uncommunicative. Since the same examiner is deciding whether and what to put in a deficiency letter, it’s good practice to do your best to prevent this.
Almost every request seeks a log of compliance violations. It is unusual for a firm not to have some technical violations around code of ethics, such as trades that would have been approved but were not submitted in advance for pre-clearance. If your firm reports no such violations, the staff will probably spend more time trying to determine if the code of ethics is being enforced. These types of technical violations do find a way into deficiency letters, but I think it is more common where the examination staff identifies the violation, and it is not identified in a violations log. I used to like to say that if we found the violation, we should put it in the letter. But if the firm found the violation and remediated it on its own, then we should strongly consider not including it in the deficiency letter.
When the Private Fund Rule was vacated by the Fifth Circuit, the court also vacated a change to Rule 206(4)-7 (the Compliance Rule) requiring that an annual review be in writing. But that does not mean the examination staff no longer expect the annual review to be summarized in writing. If a firm asserts privilege over the written product, then it is going to face a lot of questions to prove the annual review was performed and what it consisted of. Firms should, of course, follow whatever advice they are getting from attorneys around the written form of the annual review, but firms should also know that the staff will not simply move on when nothing is produced.
Finally, with the change in administration, many firms will have an opportunity to avoid an enforcement referral by remediating deficiencies, including those that resulted in investor harm. There were always a couple of commissioners who would challenge staff making an enforcement recommendation from an examination referral as to why the conduct was not left to remediation in the examination. Those commissioners are now part of the SEC’s majority. The challenge will now be how to do this in a compressed time frame as the examination staff won’t give unlimited extensions for responding to a deficiency letter (usually 30 days). Most of the time, you can see a significant deficiency taking shape from supplemental requests sent after fieldwork. If it seems clear the staff is heading toward a deficiency that requires remediation, a firm can start thinking about possible remediation before it receives the deficiency letter.
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