Seven practical tips when preparing for a regulatory examinationArticle added by David Millar on October 27, 2009
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David Millar

Joined: August 21, 2010

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Long before a registered investment advisor is on the radar for an examination by the Securities and Exchange Commission (SEC) or another regulator, it should prepare for the inevitable. The minute a firm opens its doors, it guarantees that a regulator will walk through them to examine its policies and procedures. Here are some practical, everyday tips that will help make the eventual examination go more smoothly.
    1. Hot issues of the day. It is extremely important to keep up with the latest issues surrounding the financial industry and, in particular, the world of the investment advisor. Knowing the hot issues of the day can save a firm both time and energy prior to an examination. For example, this year's headlines include multiple Ponzi schemes and frauds. These headlines should trigger an internal examination of a firm's financials, due diligence practices, and custodian relationships. These are a central focus of all examinations. The examiner will want to know how the firm makes money and to whom it pays money. A review of all vendors and solicitors agreements is all but guaranteed during an examination. The examiner will also closely scrutinize where clients' money is kept. In recent examinations, the SEC has requested a list of account numbers from a firm's custodian and matched them with the records of the firm. Additionally, the SEC has followed client deposits to ensure the money is where the advisor says it should be.

    2. Updated policies and procedures. One would think this topic has been exhausted, but it has not. At least weekly, the SEC fines advisors for not having policies and procedures for a new business line. It is supremely important to have up-to-date policies and procedures that reflect all aspects of the firm's business. It is just as important to test those policies and procedures to ensure they work.

    3. Review past examination letters. Perhaps the most important action to take is correcting past deficiencies or taking corrective actions suggested by the regulators. Before conducting an advisor's examination, a regulator will conduct due diligence on the firm. The first piece of information reviewed is any past examinations by that regulator. This will result in the first questions of the new examination. Thus, it is vitally important to correct any previously noted deficiencies, and just as important to ensure those defects do not or have not occurred again.

    4. Document, document, document. The daily practice of documenting reviews, meetings, and other actions provides a solid foundation for not just a compliance program, but operations activities, as well. For example, during an examination, it is common for the examiners to dig into particular client accounts, such as all clients with more than 50 percent of liquid net worth in one particular advisor fund. The examiner may think the allocations are unsuitable. A well documented file with notes from the client meetings (an operations activity) can easily answer regulatory questions; however, this situation could play out negatively if client meeting notes are not required to be kept. It is much easier to show the examiner written notes than to try to explain a memory of a conversation that happened six months ago. In a firm's daily practices, documenting activities can save time and effort during the examination.

    5. Open an account with your firm. A simple and valuable way to test the effectiveness of a firm's policies and procedures is to open your own account with it. This allows you, a new client and account holder, to receive everything a client receives, which is also an excellent test of the firm's procedures. You should receive at least: the annual offer for the firm's disclosure documents; the firm's annual privacy notice; and regular statements. If you do not receive these documents and all other information required by the policies and procedures manual, a deficiency exists; one the regulators will likely find it during an examination.

    6. Use Google every six months. At a recent compliance conference, the SEC acknowledged that they research advisors prior to examinations by using Google. Typically, they Google the firm name and its principals in order to better understand its business. By using this same technique on all of its employees, at least semi-annually, a firm can monitor and control what information is being presented by its employees. This is extremely important in the age of social networking sites such as Facebook and Twitter. Posts on these Web sites frequently contain false return claims, out-of-date advertising, or other unsubstantiated claims. Firms that post performance advertising on Web sites should be extra diligent in ensuring that the information is current. It is uncomfortable to sit across from a regulator who has a piece of old, out-of-date and non-compliant advertising that he just downloaded from an active Web site that the compliance department didn't know existed.

    7. Conduct a mock examination. A mock examination by a third party could simulate examination conditions and prepare staff for an actual regulatory examination. Most compliance consultants have access to recent SEC examination request lists, have been through multiple SEC examinations, or have been an SEC examiner. These experiences assist in knowing where to dig to find potential deficiencies that can be rectified prior to an actual examination.
Simply put, the best way to prepare for a regulatory audit is through everyday practices. These small steps can make a big difference in how an investment advisor is perceived by an examiner. It is very powerful to be able to show the work a firm has put into its policies and procedures, as opposed to just speaking about it. Taking the time to do the little things now, and not when the examiners show up, will help make a regulatory examination go a lot more smoothly.

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