RIA Compliance Blog
The SEC’s Division of Examinations recently released general guidance, in the form of a Risk Alert, for how the registered investment adviser examination program operates, how examination targets are selected, and how the scope of examinations is determined.
With over 15,000 investment advisers registered with the SEC, the SEC has developed a risk-based approach for determining what investment advisers are selected for examination and the depth of the subsequent exam. This risk-based process has allowed the SEC to examine approximately 15% of the registered investment adviser population over the last few years, even as the population of SEC registered has increased by 13% over the last three years.[1]
The risk-based approach takes into consideration the SEC’s published priorities and is designed to adjust and adapt as the market, advisory industry, and client trends shift. To help evaluate the potential pool of examination candidates, the SEC utilizes data modeling to analyze the vast sea of data available to it. The SEC’s data analytics pulls information from public filings such as the Form ADVs, third parties, and other regulators. Additionally, the SEC takes into consideration: tips, complaints, referrals, prior examination history, conflicts of interests, vulnerability of the adviser to market stress, supervisory concerns, material changes within the investment adviser, and the disclosure history of the firm.
The risk-based approach to the examination program also reflects the SEC’s published priorities. At the beginning of each fiscal year, the SEC publishes the examination priorities for the coming year, and these priorities are given a greater weight when analyzing an adviser’s operations.
The SEC will also consider how long the adviser has been registered. In recent years, the SEC has made an effort to inspect newly registered advisers within a year of registering with the SEC. The rationale for examining newly registered advisers is twofold: (1) it allows the SEC to make an initial risk assessment for the firm, and (2) it introduces the adviser to the SEC and the examination program.
Once an adviser has been selected for an examination, the SEC uses its risk-based approach to determine the general scope of the examination. Not all examinations are the same, but most examinations will cover certain foundational aspects of the investment adviser’s business, including advisory operations, disclosures, compliance program, conflicts of interests, custody and safekeeping of assets, portfolio management, advisory fees, brokerage practices, and best execution. The risk-based approach allows the SEC to efficiently request documents to address the foundational aspects of an advisory business but also reflects the relative risk created by the operations.
While not exhaustive, the SEC’s Risk Alert included an attachment of the Typical Initial Information Examiners Request of Investment Advisers. The actual document request will reflect the SEC’s risk determination of the advisory business, but the attachment provides a baseline for what advisers can expect when selected for an examination.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Investment Adviser Practice Group page for more information.
[1] Division of Examinations, Investment Advisers: Assessing Risks, Scoping Examinations, and Requesting Documents (September 6, 2023) at n.1.