Uptick in SEC Exams? Four Ways To Ensure a Smoother Process

It is never fun when an investment manager is notified of an upcoming SEC exam. While the majority of these exams are routine, we are seeing a major uptick in activity as the SEC approaches the end of its fiscal year this month. To avoid trepidation and be prepared, it’s best to understand the process.

The SEC will focus on different aspects of an investment manager’s business depending on the type of strategy the manager employs. For example, for a private equity manager, the SEC may scrutinize how the manager allocates fees and expenses among their funds, co-investment vehicles and the management company, while determining if fees charged to the fund vehicles and investors are calculated correctly.  For managers of hedge funds, the exam may be looking for style drift, investment aggregation or allocation or other discrepancies between the fund mandate and its investments.  The SEC exam staff also takes routine examinations as an opportunity to learn about investment strategies to which they may not have had exposure, such as crypto and digital asset fund managers, and try to determine how, if at all, various rules and regulations under the Advisers Act may apply to the strategy.  

While there are various objectives by the regulators for these different investment managers, there are a few tips we believe transcend the type of investment firm that is undergoing the exam and can be helpful if your firm is on the other side of the SEC’s magnifying glass.

1. Have the right documents: Ensuring you have solid documentation of your compliance with applicable SEC Rules and Regulations and books and records to support your regulatory initiatives is fundamentally critical. Firms not having or being unable to access the right documentation is a serious issue that we are seeing across all strategies, from quant funds to private equity to crypto funds.  The firm must be diligent and careful about the information they are retaining. It is easy for a manager to “know” they have complied with the rules, but without the right supportive documentation (e.g., formal memoranda or logs instead of emails), it becomes harder to prove that level of compliance.
2. Use your “Day-One” presentation to your advantage: On the first day the Staff comes onsite or speaks with the firm’s key personnel associated with the compliance program to start the SEC exam, the firm being examined should present an overview of the firm to the Staff. This is an excellent opportunity for the CCO to develop a roadmap for the SEC to follow, providing background about the firm, its investment strategies and details about the strongest aspects of the firm’s compliance program. Everything you want the SEC to know about your firm that they may be confused about or not know from filings should be brought to light. It is human nature to hear someone tell you they are good at something and want to check it out. The “Day-One” presentation should be that time to tell the SEC about just that. The overview should emphasize the firm’s development of a comprehensive regulatory compliance program, as evidenced in the policies and procedures in the firm’s compliance manual and code of ethics.  If there is a particular set of policies that the CCO believes the compliance program has exceled as it relates to the firm’s regulatory responsibilities and obligations, then they should highlight those areas and add a brief explanation as to why these policies are areas of strength for the firm.  The same holds true for high regulatory risk areas associated with the firm’s investment strategy (for example, a private equity manager has implemented detailed fee and expense allocation policies and procedures) – again, if the CCO has incorporated into the compliance program comprehensive internal controls to address high areas of regulatory risk to which the firm may be exposed this should be presented as a key strength. The CCO will need to demonstrate that the firm has conducted a comprehensive risk assessment around these areas and has implemented the controls to mitigate that risk. The Day-One presentation is your primary chance to steer the direction of an SEC exam. Use it wisely.
3. Establish data protocols: With the rise of electronic documentation and automation, simply recording and storing information isn’t enough. In order to ensure ongoing compliance with the Advisers Act, managers must employ the right resources and expertise to establish appropriate data controls, manage and recognize the data. Without data control protocols, when the SEC comes knocking and makes a specific request, there may be difficulty getting information to the regulators in a timely manner.   This can prompt the Staff to question what is causing the delay and unnecessarily require the manager to provide information that is non-responsive to the SEC’s request.  This could inevitably open Pandora’s Box and have the SEC poking around in areas that it would not have been otherwise normally interested in. By inundating the SEC with onerous information, you increase the likelihood the Staff will flag something that they would have not scrutinized. Keep your data organized, easily accessible and updated pursuant to the firm’s compliance program and SEC requirements.
4. Get ahead of follow-up questions: Do not be afraid of a small deficiency. The SEC is expecting errors or oversights, but an investment management firm has to be prepared to talk about the findings without fear or negativity. It is natural to panic when the SEC makes an unexpected request, but if that request is related to an area already in the process of being rectified and shows no apparent conflicts of interest with the firm’s underlying mandate, be transparent. Unfortunately, no compliance program is perfect or will be left unscathed, but if you work constructively with regulators to get your program to where it needs to be and using feedback to have some organizational growth, it can be a good thing. The SEC should come away believing you understand what needs to be done and that you will do it.

Undergoing an SEC exam can be daunting, even grueling.  This is especially true when you do not understand what to expect during the examination process. The above tips can go a long way in easing some of that stress and being prepared when the SEC comes knocking on a manager’s door.

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Fizza Khan is founder and CEO of Silver Regulatory Associates

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The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group