SEC Reiterates its Intention to Examine a Significant Percentage of Never-Before Examined Registered Investment Advisers in 2014

March 5, 2014


On February 20, 2014, the SEC announced that its Office of Compliance Inspections and Examinations (OCIE) is launching a 2014 initiative directed at examining a significant percentage of investment advisers that have never been examined before, focusing on those that have been registered for three or more years. OCIE had previously announced that examining these advisers is a priority in 2014. The initiative includes two distinct approaches: risk-assessment and focused reviews. The risk-assessment may include a high-level review of overall business activities, with a particular focus on the compliance program and other key documents needed to assess the representations made on disclosure documents. The focused review concentrates on areas most important to protecting investors, namely compliance programs, filings and disclosures, marketing, portfolio management, and safekeeping of client assets.

While the February 20th initiative specifically excludes advisers to private funds which are being examined pursuant to the presence exam initiative launched by OCIE in October 2012, private fund advisers should not breathe a sigh of relief, given earlier statements made by OCIE in its Exam Priorities for 2014 released on January 9, 2014 in connection with its new initiatives under the Investment Adviser/Investment Company Program. According to the Priorities, “[t]he staff will continue the 2012 [presence exam] initiative to examine a significant percentage of the [private fund] advisers registered since the effective date of Section 402 of the Dodd-Frank Act. The five key focus areas of these examinations are:

  • marketing,
  • portfolio management,
  • conflicts of interest,
  • safety of client assets, and
  • valuation.”

Accordingly, all SEC-registered advisers who have never before been examined should be prepared to undergo an SEC examination in calendar year 2014.

SEC Hot Buttons in the Presence Exam Categories

Given the large number of investment advisers who may potentially need to be examined in 2014 and the staffing issues surrounding such a big endeavor, it is likely that the SEC, in most instances, will adopt a presence exam approach. Based on the numerous mock SEC audits that we have conducted and the actual SEC exams for which we have provided counsel to our clients, set forth below are some key SEC hot buttons within the various presence exam areas:


  • Compliance with applicable anti-fraud rules and SEC no-action and interpretive letters, including rules about cherry picking, net of fees presentations, puffery, index comparisons, use of testimonials, use/ownership of prior track records, case studies, pro forma/back-tested and model/composite presentations, and accuracy of disclosures
  • Compliance with private offering exemption rules (in the case of private funds) and the manner in which investors are solicited
  • Compliance with relevant record keeping rules
  • Broker-dealer status issues

Portfolio Management

  • Allocation of investment opportunities among multiple client accounts
  • Treatment of clients paying different types of fees or fee levels
  • Conflicting strategies in different client accounts

Conflicts of Interest

  • Investments by firm principals and allocation of investment opportunities with clients
  • Cross trades and principal transactions
  • Loans made to firm principals
  • Gifts received from service providers to the adviser or its clients
  • Code of ethics and personal trading procedures
  • Use of soft dollars for the benefit of the adviser or its personnel
  • Risk controls
  • Allocation of expenses to client accounts

Safety of Client Assets and Custody

  • Failure to recognize having custody of client assets, including due to access to client accounts and ability to make withdrawals or physical possession of assets
  • Failure to meet audited financial statement requirement
  • Failure to satisfy qualified custodian requirement


  • Subjectivity in valuation process
  • Valuation procedures for less liquid assets
  • Consistent application of valuation policies

What Steps Should Advisers Take

In anticipation of a likely 2014 SEC examination, never-before examined advisers may wish to consider undertaking most, if not all, of the following:

  • Review compliance policies and procedures with a particular focus on the presence exam categories and those other categories that the adviser may consider high risk given its business operations.
  • Document with full supporting backup any activities that could potentially raise issues on an exam.
  • Educate firm personnel through in-house and outside experts on the firm’s compliance policies and procedures and, as needed, target training to the right staff at the firm.
  • Consider undergoing a mock SEC audit, including possibly with the assistance of outside counsel or another firm, to review all or just certain aspects (i.e., just the presence exam categories) of the firm’s compliance program.
  • Continue to track new developments in the compliance area, including SEC and OCIE risk alerts, other relevant guidance, enforcement activity, as well as applicable communications from counsel and others.
  • Reflect promptly any new regulatory developments in the firm’s ever-evolving compliance program and communicate all updates to firm personnel.
  • Establish a “tone at the top” compliance approach that empowers the compliance team and causes the rest of the staff to adhere to the firm’s compliance policies.
  • Encourage an open dialogue within the firm to report possible compliance program violations to proper personnel.


If you have any questions regarding the SEC’s examination initiatives or compliance issues generally, please contact your Investment Management Group attorney at Seward & Kissel LLP.  The Firm also offers a range of compliance support services.