GAO urges shift in SEC examinations

Sep 26, 2005 @ 12:01 am

By Frederick P. Gabriel Jr.

NEW YORK - Congressional investigators are calling on the Securities and Exchange Commission to shift resources from oversight of Washington-based NASD and the New York Stock Exchange to its own mutual fund inspection program.

The SEC's policy of conducting routine inspections of many broker-dealers six to 12 months after they have been scrutinized by one of the self-regulatory organizations is a waste of the commission's limited resources, according to a report released Monday by the Government Accountability Office.

The SEC broker-dealer examinations "provide limited information on the adequacy of SRO oversight and impose duplicative regulatory costs on the securities industry," the report stated.


In 2004, 34% of the 736 broker-dealer examinations conducted by the SEC were "oversight examinations," meaning they were intended to double-check the thoroughness of recent exams by the SROs.

But more often than not, those examinations did not yield their intended results. That's because SEC examiners often focused their own inspections on different aspects of the broker-dealers' operations, and they often did so over a dissimilar time period.

"The SEC often cannot attribute a violation it finds to a problem with the SROs' examination period," the GAO report stated.

The report mirrors the findings of a study released by the GAO in 1991. Known as the General Accounting Office back then, the office recommended that the SEC adhere to a policy of directly testing SRO examination methods.

This time, it's going even further.

"We recommend that the agency assess its methodology for conducting broker-dealer-oversight examinations and whether some portion of the resources currently devoted to these examinations could be better utilized to perform mutual fund examinations," stated the report.

In a July 7 letter to the GAO, Lori Richards, the director of the SEC's office of compliance, inspections and examinations, defended the SEC's oversight exams.

"Oversight examinations allow us to detect violations that might not otherwise be detected," she wrote.

In fact, said Ms. Richards, 95.6% of the SEC's oversight examinations over the previous 32-month period turned up additional violations by the broker-dealers, and 19.4% warranted referral to the SEC's enforcement division.

"By conducting oversight examinations as independent compliance reviews, we obtain a results-oriented view of the SRO examination program," she added. "We can assess not just whether the SRO's procedures were followed, but more importantly, whether the SRO's procedures need to be modified or enhanced."

The GAO report also criticized the SEC over the fact that its risk-based approach directs inspectors to focus on the biggest fund companies and on those where they already have uncovered problems. Such an approach, the report states, is likely to overlook many small fund groups.

In fact, "lower risk" fund companies might not be inspected for more than 10 years, said the report.

"Although the SEC is seeking to focus its resources on higher-risk advisers and funds, as well as higher-risk activities, the resources trade-offs it made in revising its oversight approach raise significant challenges," said the report.

The SEC shifted from its five-year inspection cycle to the risk-based approach in 2003 after Eliot L. Spitzer, the New York attorney general, uncovered widespread fund trading abuses.

"The SEC is seeking to utilize its valuable, limited resources in the most effective manner by focusing on the activities and firms that pose the greatest risk of compliance failures that could harm investors," said SEC spokesman John Nester.


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