Most firms already fail SEC exams

Nov 14, 2005 @ 12:01 am

By Sara Hansard

WASHINGTON - The "vast majority" of Securities and Exchange Commission registered investment advisory firms receive deficiency letters after SEC examinations, and the new rule requiring that they have written policies and procedures is likely to make things even worse.

The rule will provide more possibilities for examiners to find violations and second-guess procedures, said David Tittsworth, executive director of the Investment Adviser Association in Washington, which represents SEC-registered advisory firms.

"Once you put something in writing, it's easier to violate than you might think," he said.

Once a firm has gone through an SEC exam and the exit interview conducted by field examiners, "the vast majority of you will receive a deficiency letter," Kevin Goodman, an SEC assistant regional director, told a group of chief compliance officers with investment adviser firms at a conference here last week. Mr. Goodman, who works at the commission's Pacific regional office in Los Angeles, was speaking at the SEC's first CCOutreach National Seminar for CCOs of investment advisory firms and mutual funds.

He added in a telephone interview that it is not alarming that an estimated 90% of advisory firms receive deficiency letters after SEC exams, "given the depth we try to go into."

Tighten controls

Deficiency letters can cover a wide range of compliance components, from clear-cut violations to controls that need to be tightened, or better disclosures that may need to be made to clients, he said.

"I would hope a lot of the deficiency letters would allow them to improve their internal controls or better disclose issues to clients," Mr. Goodman said.

Still, it can be costly to

hire lawyers and consultants to help resolve problems, said Mr. Tittsworth.

Given the ratcheting up of regulations and the increasing complexity of regulations in recent years, the high number of deficiency letters to advisory firms can be a problem if clients, or consultants acting as gateways for clients, demand to see them.

Although deficiency letters are not public, Mr. Tittsworth noted, "in the real world, it's the sort of thing that you have to be mindful of."

Indeed, he said, the most common violations cited by the SEC are inadequate policies and procedures or a failure to follow policies and procedures. Further, while few deficiency letters lead to enforcement cases, the number of enforcement referrals has been increasing, Mr. Tittsworth said.

In almost all cases, the firm is advised of any regulatory problems found by examiners during the examination process, Mr. Goodman said.

Rather than hasty responses from firms with assurances that the problems will be addressed quickly, the SEC prefers a "solid response" detailing actions already taken to address problems, said Kimberly Garber, branch chief of the commission's Forth Worth, Texas, district office.

However, Mr. Goodman said, in most cases, an advisory firm still will receive a deficiency letter, even if problems are corrected during the on-site exam, which can last several days. The SEC does that, he said, in order to ensure that it has a record of past problems in the event that future problems arise.

The commission also is collecting e-mail addresses for compliance officers so the agency can communicate directly with them, SEC officials announced at the conference.

The conference drew several hundred attendees, as investment advisory firms and mutual funds are facing increased regulatory compliance demands by regulators.

Investment advisory and mutual fund firms face new compliance regulations, including a requirement that each firm have a designated chief compliance officer.

Rising costs

At the same time as the SEC conference, the CFA Institute of Charlottesville, Va., and the Investment Adviser Association in Washington released a study showing that asset managers have significantly expanded, sometimes doubling, their compliance staffs and are spending more money on compliance to meet new regulatory obligations.

The group of investment advisory firms that appears to have experienced the greatest increase in costs are those managing assets of between $100 million and $1 billion, said Jeff Diermeier, president and chief executive of the CFA Institute.

In addition, compliance costs are expected to rise again in 2006, he said. "We can see for a number of firms, where they might have had one compliance person in the past, they might have had to double the number of people," Mr. Diermeier said.

However, he added, "I'm hoping that some of the increasing costs is of a one-time nature, but I don't know that for sure." All advisory firms, including small ones, must meet regulatory requirements and commitments they make to clients about how they manage their money and what their relationship will be with them.

"To the degree that this compliance effort is forcing some of those firms to think more carefully about those statements, that actually will provide more discipline and increase the professionalism of the firm," Mr. Diermeier said.


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