SEC Releases 2013 Examination Priorities

On February 21, 2013, the Securities & Exchange Commission released its examination priorities for 2013. The 13-page release can be found here. The highlights for investment advisers are as follows:

Custody Counts. The first (of 12) risk and policy areas identified by the Commission for advisers concerns compliance with custody requirements. Recent OCIE exams have identified failures to comply with the letter and spirit of the custody rule. Staff will check to ensure that managers recognize when they have custody, whether managers are complying with the "surprise exam" requirement, whether the "qualified custodian" requirement is being satisfied, and other related matters. Advisers may want to double-check their ADV disclosures in advance.

Conflicts of Interest Related to Compensation Arrangements. Many funds pay finders and brokers for their help in raising capital. SEC staff will review financial and other records (presumably including PPMs, slide decks, other offering materials, ADVs Parts I and II, and financial records such as ledgers) to check on the adequacy of disclosure and proper arrangements. Investment advisers must remain aware of the guidelines for appropriate finders' activities, appropriate activities for employees who are also involved in the capital markets side of the business, and proper documentation and disclosure of these business relationships.

Marketing/Performance. OCIE staff will, as always, focus on advertised performance. Managers should be vigilant concerning their disclosures (substantive accuracy and proper presentation). Deficiencies can be avoided by disclosing results properly.

Allocations. Some managers simultaneously manage mutual fund money and private investment capital (the latter paying performance fees). Such managers should expect strict scrutiny by the staff of the conflicts presented by the different financial incentives and should review in advance their disclosures and business activities. 

Governance. As in past years, "tone at the top" counts and the Staff will confirm that  mutual fund boards  receive full and accurate disclosure from management and are conducting reasonable reviews of (a) contract approvals, (b) oversight of service providers, (c) valuation of fund assets, and (d) assessments of expenses or viability. The Staff has a new focus on whether boards are receiving disclosures and conducting oversight of payments made to distributors and intermediaries (revenue sharing, shareholder servicing, sub-TA).

The examination release identifies new and emerging issues as well, including the following:

New Advisers. With 2000 new registered investment advisers, the staff has developed a new coordinated national examination initiative. A substantial percentage of new advisers should anticipate examination in the next two years (in the past, new advisers, depending on their assets, could be registered for a decade or more without being inspected). We encourage all advisers to be prepared for an inspection. Use your internal and external compliance and legal resources to get your records in order.

Affiliated Broker-Dealers. If a manager also has an affiliated broker-dealer, anticipate a coordinated and joint exam with the broker-dealer program. Such managers should ensure that their disclosure documents adequately address the real and potential conflicts presented, and should develop appropriate policies, procedures and guidelines. And, once reduced to writing, managers should regularly ensure their business practices follow the written guidelines. All too often, compliance documentation is put on a shelf and does not become part of the business.