Fully Invested: SEC Requests

September 13, 2022
14:38 minutes

In this episode of Fully Invested, Ropes & Gray asset management attorneys Nicole Krea, Jessica Marlin, and Nicole Horowitz, and litigation & enforcement attorney Matt McGinnis introduce listeners to the contours and typical lifecycles of SEC examinations for registered investment advisers. They also discuss how these advisers can prepare for examinations in advance, which includes leveraging internal and external resources and preparing materials on an ongoing basis.


Jessica Marlin: Welcome to Fully Invested, a podcast series hosted by Ropes & Gray’s global asset management team. Drawing on the perspectives of over 1,400 attorneys from all areas of our practice, we provide insight into essential considerations associated with current and emerging asset management products. I’m Jessica Marlin, and today I’m joined by my Ropes & Gray colleagues Nicole Krea, Matt McGinnis, and Nicole Horowitz. On this episode, we will be discussing how to prepare for an SEC exam. We’ll first provide a short introduction on what to expect in an SEC exam, and then walk through some strategies to prepare before the SEC knocks on the door. Matt, maybe you can start off by telling us briefly about the basics of what to expect in an SEC exam, and how they even start?

Matt McGinnis: Sure—thanks, Jess. An SEC exam is the process by which the SEC’s Division of Examinations tests and seeks to understand the operations of an investment adviser, as well as the effectiveness of its compliance program, and where applicable, policies, procedures, and controls. I should note, just at the outset of this podcast, that while a variety of advisers are examined by the SEC, for purposes of today's conversation, we're really going to focus on registered private fund advisers and what they might experience in an exam.

First off: just a few details on the process. If you're going to be subject to exam, you should expect that the first step will be a phone call from the SEC to the chief compliance officer of the firm, giving the firm the heads-up that an exam will be beginning, and that it should expect a written document request within the next day or two. When you get that phone call, one initial step that you should take immediately, even without waiting for the document request, is to reach out to the outside counsel who regularly advises you on regulatory issues. The reason that is important is initial document requests at the beginning of an exam typically have a fixed timeline to respond, usually 14 days or two weeks. And as a result, it's important to make sure that you are beginning to marshal your both internal and external resources that are going to be necessary to collect and produce the information that the SEC requests at the outset.

As I mentioned, after that phone call, you should expect there will be an initial request list. The contents of that initial request list tend to vary a bit by exam, and can be both fairly targeted, and more often than not, fairly extensive. The first two weeks of the exam will then focus on responding to that request. And after that, the process for an exam and the timing for an exam often vary. Sometimes the next step will be a series of interviews or a single interview, sometimes it will be a series of document requests, and sometimes it'll be a combination of the two.

What we have seen over time is that the overall length of an exam can vary quite widely from one exam to another. Sometimes they can be relatively short—a couple of months—and sometimes they can extend several months or even longer. Although exams tend to be pretty broad in their focus and tend to focus on a variety of different issues that may affect a particular registered adviser, in some instances, you'll see that a specific issue, over time, becomes the focus of an exam, and that could be for a variety of reasons. Sometimes the SEC is at the outset focused on a particular issue, such as ESG, for example. And sometimes the SEC's exam has been prompted by a whistleblower complaint that you may or may not be aware of—more likely not aware of. Also, there could be times that during the context of an exam, a particular issue, problem, or challenge becomes evident to the client in connection with collecting and producing information in response to the requests. And in those instances, obviously the exam can take a different focus and have a different cadence altogether. The key here, of course, is that every exam is a little bit different. There are some typical steps you can expect, at least at the outset, but from there, things can vary quite widely.

Jessica Marlin: Thanks for that helpful background, Matt. Nicole Krea, what types of information does the SEC usually seek from investment advisers?

Nicole Krea:: Thanks, Jess. As Matt mentioned, information requested by the SEC in writing during the course of an examination will primarily come in the form of an initial request letter at the outset of an exam, and then a series of one or more—sometimes many—follow-up requests. The requests will ask for information that applies during a particular time frame. That time frame will be defined in the initial request letter—we refer to it as the “examination period.” It's usually a period of approximately two years prior to the exam initiation, but, as mentioned, that'll be defined in the initial letter. Initial request letters can really range in scope, length, and complexity. Sometimes the variations are based on different areas of focus for different examinations, sometimes it can be dependent upon the SEC regional office running the exam, and sometimes it's unclear why certain questions are posed. We've seen 15-question initial request letters—that’s often for new advisers or limited-scope exams. And we've also seen 90-question initial request letters.

Initial request letters will likely look for information, both in the form of existing documents and narrowed responses on a wide range of topics, and it'll likely include some or all of the following:

  • Organizational charts for the adviser and certain clients managed by the adviser
  • Information on clients managed by the adviser
  • Governing and disclosure documents for pooled investment vehicles
  • Information on compliance programs and risk management
  • Information on personnel and new hires and departures during the examination period—and that can include personal trading information for personnel.

Typically, there will be a request for policies, procedures, internal audits that are conducted. It can include client complaints, reporting and protection mechanisms in place, usually a violations log. And then there can be other requests related to specific areas of interest from the Staff, as appropriate to the adviser's business, such as issues regarding allocation of expenses, allocation of investment opportunities, valuation, advisory affiliates, ESG, marketing, custody, trading—you name it. I'll note that ESG is a particular topic of interest currently and we've seen a number of targeted requests for firm policies and procedures, disclosures and documentation relating to ESG.

Then, after the initial request list, there are typically some series of follow-up requests. It’s usually received over the course of several months, and the information requested on those varies even more materially from exam to exam, based on the issues on which the SEC has decided to focus on each exam as it unfolds.

Jessica Marlin: Thanks so much, Nicole. That was helpful. Nicole Horowitz, how do you know when the SEC is done with their exam, and what do they do when they finish their review?

Nicole Horowitz: Thanks, Jess. As part of the exam and the SEC's review of the materials and information produced in response to a request, as Nicole Krea was just describing, it may hold the preliminary readout on its findings and conclusions. Otherwise, if it didn't find any issues, which is fairly uncommon in our experience, you'll receive a no action letter—and as it sounds, that just means that you don't have to do anything else. Most often though, an adviser will receive a deficiency letter, which lists the issues varying in significance, depending on what the exam team found and identified. And typically, you'll have about 30 days to respond to that. In those cases, we assist clients in drafting deficiency response letters through which we explain to the SEC our positions on the issues listed and any remediation a client plans to engage in. Some examples of that remediation could be updating disclosures and fund documents, or creating new policies, or modifying policies and procedures that are already in place.

Matt McGinnis: Just to underscore one thing that Nicole Horowitz mentioned there, the client's and adviser's response to the deficiency letter is really a critical piece of advocacy in connection with this process. The deficiency letter will obviously give you a sense of where the SEC Office of Examination is with respect to potential deficiencies, but when you work with your outside counsel, you'll also be able to get a sense of the extent or significance of any issues that may be identified—and the response then becomes your opportunity to tell your story. To the extent that, for example, a disclosure issue may be identified, you can point to other disclosures. To the extent that a policy issue may be identified, you can point to the existing policies and procedures you might have. So, it's really critical that as part of this process, you work closely with your outside counsel to formulate the best response over that 30-day period when you're responding to the deficiency letter.

Nicole Horowitz: Of course, if there are larger issues, the exam team may refer this exam to enforcement, and this would require strategizing with your counsel on how to improve your positioning on those issues in advance of the enforcement team getting involved.

Jessica Marlin: That's a helpful process. So now, what's going to help us to prepare? Matt, once your clients start preparing, how would they do that?

Matt McGinnis: For better or worse, the answer to that question, Jess, is that clients should always be preparing for the possibility of an exam if you're registered. The reason for that is that once you are registered, you should expect that the Office of Examinations is typically going to look to conduct an exam every few years. Oftentimes it's every three, sometimes it can be less than that, sometimes it can be more—but the reality is that clients should always be prepared for the possibility of an exam occurring. To prepare for that, the most critical thing, of course, is to have a really tight compliance program from the outside. And if you have that compliance program, the overall exam process should run much more smoothly—and that is really focused not only on having the program in place, but having the adequate documentation of each aspect of your program, which is really where the exam is going to be focused. Another step that you can often take in preparing for an exam is to perform some form of mock exam, either with your outside counsel or perhaps with a compliance consultant. Nicole Krea, would you like to touch on that?

Nicole Krea: Thanks, Matt. Happy to discuss a little bit more on mock examinations. Mock examinations, whether done by an outside party or internally, can definitely be an important tool in preparing for an SEC exam. This can be helpful in both getting your internal team prepared to go through the process of document production and interviews—which, needless to say, can be a very in-depth and time-consuming process—and also in fleshing out issues that may come up in an examination prior to a live exam, which is always helpful. While it's difficult to know which way an examination can go, being as prepared as possible can help from both a substantive perspective, and quite frankly, just to reduce nerves going through the process.

Beyond a mock exam, when we think about marshaling internal and external resources for exam preparation, we also think it's really helpful in preparation for an exam to think about who on the team, again whether internal or external, is going to be in charge of certain portions of the exam process. For example, who will be the person tasked with coordinating internally and tracking the gathering of documents to respond to each item? Who might be tasked with coordinating with outside counsel to gather fund documents? Sparing yourself the step of figuring that out during an exam time can be really helpful. And ideally, you'll have multiple people involved in that process. So, for example, a main person responsible for preparing materials, a backup for that person in case that person's out of the office or leaves the firm in the interim period, and then another person or multiple people who will review the materials and ensure that they're complete and accurate. And this again is just very helpful to ensure you don't get surprised during production. Inevitably, just to say it, an exam begins when key people are out of the office or otherwise very tied up, which is why doing what you can to set yourself up in advance as much as possible can be extremely helpful.

Jessica Marlin: Thanks so much, Nicole. Nicole Horowitz, what types of materials can actually be prepared in advance?

Nicole Horowitz: As Matt said earlier, really you should be preparing on an ongoing basis, and there are a lot of materials that you can get set up so that you are not surprised when the exam begins. In fact, with certain materials, the SEC has the expectation that you're maintaining and updating them in the regular course. For example, you won't want to be pulling together at the last minute a violations or compliance exceptions log, a risk matrix, or a trade blotter in the format that the SEC will be expecting. It's just a lot of material to pull together quickly, and you can relieve stress from your compliance team and the organization more generally if you're ready with them. But to gather documents more generally, you'll need to think about the requests that you'll likely receive. As we've said, it really is dependent, but it doesn't hurt to get a list of the types of requests you might expect and start getting ready to fill those in. We keep some of those requests—and regulatory counsel generally do—as we see so many exams on a regular basis.

One specific type of material that's frequently included in an initial response and really allows the adviser to set the tone of the exam is a “day one deck.” That can largely be prepared in advance, when you're not under the gun and trying to figure out what you're going to include when you have limited time to do that. This provides an overview of the firm right at the beginning. We have many sample day one decks. Starting from something like that can really help in preparing that, even if you do have to change it later on.

As far as materials outside of the day one deck, we recommend thinking about how you'll properly organize those, including in folders saved to a specific place on your system by subject matter, and then you can reorganize them once you have the request by request number. It sounds sort of basic, but it's really important, because having materials organized when the request comes in just really smooths out the process when you only have a couple of weeks to pull them together.

Jessica Marlin: Thank you, Matt, Nicole, and Nicole for joining me today for this discussion. And thank you to our listeners—we appreciate you tuning in to the Ropes & Gray Fully Invested podcast series. Please visit our website at www.ropesgray.com/assetmanagement, or feel free to reach out to any of us at Ropes & Gray by email or phone for more information about SEC exams. You can also subscribe and listen to this Ropes & Gray series wherever you typically listen to podcasts, including on Apple and Spotify. Thanks again for listening.

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