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Report to Congressional Requesters:
United States Government Accountability Office:
GAO:
August 2007:
Securities And Exchange Commission:
Steps Being Taken to Make Examination Program More Risk-Based and
Transparent:
Securities and Exchange Commission:
GAO-07-1053:
GAO Highlights:
Highlights of GAO-07-1053, a report to congressional requesters.
Why GAO Did This Study:
After widespread unlawful trading practices surfaced in the mutual fund
industry in late 2003, the Securities and Exchange Commission (SEC),
through its Office of Compliance Inspections and Examinations (OCIE),
took steps intended to revise its examination process to better
identify and focus its resources on those activities representing the
highest risk to investors. More recently, some registrants raised
concerns about the lack of communication from SEC examiners about the
status of and results of examinations. This report (1) describes OCIE’s
revisions after 2003 to the examination approach for investment
companies and investment advisers; (2) discusses OCIE’s compliance with
its examination exit procedures; and (3) describes reforms OCIE
implemented since January 2006 to enhance, among other things,
communication with registrants. To address these objectives, GAO
analyzed OCIE examination data; planning documents and guidance;
interviewed OCIE officials; and gathered views of registrants.
What GAO Found:
Since the detection of mutual fund trading abuses in late 2003, OCIE
has shifted its approach to examinations of investment companies and
investment advisers from one that focused on routinely examining all
registered firms, regardless of risk, to one that focuses on more
frequently examining those firms and industry practices at higher-risk
for compliance issues. The effectiveness of OCIE’s revised approach
largely depends on OCIE’s accurately assessing the risk level of
investment advisers. The method that OCIE employs to predict the level
of risk for the majority of investment advisers has some limitations,
particularly in that this method relies on proxy indicators of
compliance risks without incorporating information about the relative
strength of a firm’s compliance controls. OCIE has taken steps to
assess the effectiveness of this method for predicting risk-levels and
to seek additional indicators of compliance risks. GAO continues to
believe that implementing GAO’s prior recommendation to obtain and use
compliance reports from firms—a source of information on the
effectiveness of their compliance controls—could potentially help OCIE
better identify higher-risk firms.
GAO’s review of investment company, investment adviser, and broker-
dealer examinations conducted from fiscal years 2003 through 2006 found
that examiners generally follow OCIE’s exit procedures for
communicating deficiencies to registrants and providing written notice
of the examination’s outcome, except in an estimated 9 percent of
investment company and investment adviser examinations where OCIE
directed examiners to forgo these procedures. These examinations were
part of a series of OCIE examinations that probed specific activities
across a number of firms and were initiated in response to the
widespread unlawful trading practices which had surfaced at that time.
In addition, GAO estimated that in 7 percent of broker-dealer
examinations, either examiners did not follow exit procedures or OCIE
officials were not able to provide evidence that they did.
OCIE has implemented several initiatives since January 2006 intended to
improve communication with registrants and other aspects of the
examination program. For instance, OCIE established a hotline for
registrants to receive comments or complaints, began requiring
examiners to contact registrants when examinations extend past 120
days, and implemented tools and protocols designed to reduce
duplicating examinations. GAO’s review indicated that examiners
generally complied with the new requirement to notify registrants when
an examination extends past 120 days. Comments from industry
representatives on OCIE’s initiatives suggested some concerns about the
hotline. Specifically, several registrants questioned the independence
of the hotline, as it is located within OCIE, and said that as a result
they would hesitate to use it.
What GAO Recommends:
GAO recommends that SEC consider relocating its registrant complaint
hotline to an independent office, such as an ombudsman function, within
the agency or within a division or office outside of OCIE. SEC
generally agreed and is taking steps to address the intent of the
recommendation.
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-1053].
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Orice M. Williams (202)
512-8678 or williamso@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
OCIE Revised Its Examination Approach to Target Higher-Risk Registrants
and Compliance Issues:
With Some Exceptions, OCIE Generally Applied Exit Procedures for the
Period We Reviewed:
OCIE Implemented New Initiatives Intended to Improve Communication and
Coordination:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Comments from the Securities and Exchange Commission:
Appendix III: GAO Contact and Staff Acknowledgments:
Figures:
Figure 1: Estimated Percentage of Investment Company and Investment
Adviser Examinations Where Examiners Conducted Exit Interviews and Sent
Closure Notifications, Fiscal Years 2003 to 2006:
Figure 2: Estimated Percentage of Broker-Dealer Examinations Where
Examiners Conducted Exit Interviews and Sent Closure Notifications,
Fiscal Years 2003 to 2006:
Abbreviations:
CCO: Chief Compliance Officer:
NASD: National Association of Securities Dealers:
NYSE: New York Stock Exchange:
OCIE: Office of Compliance Inspections and Examinations:
ORA: Office of Risk Assessment:
OIT: Office of Information Technology:
RADAR: Risk Assessment Database for Analysis and Reporting:
SEC: Securities and Exchange Commission:
SRO: self-regulatory organizations:
United States Government Accountability Office:
Washington, DC 20548:
August 14, 2007:
Congressional Requesters:
The authority of the Securities and Exchange Commission (SEC) to
conduct inspections and examinations of certain participants in the
securities industry is one of its most important tools in detecting
fraud and violations of securities laws. SEC exercises this authority
through its Office of Compliance Inspections and Examinations (OCIE).
In fiscal year 2006, OCIE conducted over 2,600 examinations of
investment companies, investment advisers, broker-dealers, and other
securities-related firms registered with SEC (registrants).[Footnote 1]
After widespread unlawful trading practices in the mutual fund industry
surfaced in late 2003, OCIE attempted to address concerns about the
effectiveness of its ability to detect such practices in its
examinations of registrants by revising its examination approach to try
to better identify and focus its limited resources on those activities
representing the highest risk to investors.[Footnote 2] To ensure
registrants understand and address weaknesses in compliance and
violations found during examinations, OCIE has formal exit procedures
for examiners to follow when communicating the findings of examinations
to registrants. However, some registrants--including investment
companies, investment advisers, and broker-dealers--have raised
concerns about OCIE staff's not communicating the status and results of
examinations. In May 2006, the SEC Chairman testified before the House
Financial Services Committee on recent changes to the examination
program, which were designed to further increase communication with
registrants as well as enhance pre-examination planning.[Footnote 3]
These reforms include a new procedure that, among others, requires
examiners to contact registrants when an examination extends 120 days
beyond the on-site visit and alert them to the status of the
examination.
This report addresses your interest in OCIE's progress toward more risk-
based examinations for registered investment companies and investment
advisers, implementation of recent initiatives in the examination
program, and efforts to communicate key examination information to
registrants and minimize disruption. Specifically, we (1) describe how
OCIE revised the examination approach after 2003 for investment
companies and investment advisers registered with SEC; (2) discuss
OCIE's exit procedures and the frequency with which examiners have
followed these procedures when conducting examinations; and (3)
describe reforms OCIE implemented since January 2006 to increase
communication with registrants and improve the examination program,
including how examiners complied with the new 120-day notification
requirement.
To address the first objective, we analyzed information obtained
through OCIE documents and interviews with OCIE and other SEC officials
on OCIE's revised examination approach for investment companies and
investment advisers and a new process for identifying risks in the
marketplace. We also observed a demonstration of the information-
technology application that OCIE uses to conduct its annual risk-
assessment process. To address the second objective, we reviewed OCIE's
guidance to examiners, interviewed OCIE officials on exit procedures,
and reviewed examination data. We selected two random samples of 129
examinations, one from the population of investment company and
investment adviser examinations and one from the population of broker-
dealer examinations completed during fiscal year 2003 through fiscal
year 2006. This process allowed us to project our results to the two
respective populations at the 95 percent level of confidence. All
estimates in this report have margins of error of plus or minus 8
percent or less. To address the third objective, we reviewed
memorandums from OCIE to the Commission and the revised examination
brochure, analyzed examination data related to the notification
procedure, interviewed officials from OCIE, and obtained the views of
various industry participants representing investment companies,
investment advisers, and broker-dealers. In determining the frequency
with which examiners complied with the new notification procedure, we
identified all closed examinations that lasted 120 days or more
conducted between July 31, 2006, the day the guidance was implemented,
and February 2, 2007, the day OCIE gave us the records. We reviewed all
13 examinations that met these criteria. In conducting our analyses of
examination data, we conducted a data reliability assessment of the
data OCIE provided us and determined it was reliable for our purposes.
We performed our work in Washington, D.C., between October 2006 and
July 2007 in accordance with generally accepted government auditing
standards. Appendix I provides a more detailed description of our scope
and methodology.
Results in Brief:
Since 2003, when SEC and state securities regulators discovered
widespread unlawful conduct in mutual fund trading by investment
advisers and other service providers, OCIE has revised its approach to
examining registered investment companies and investment advisers to
try to better identify firms with greater compliance risks as well as
emerging industry practices that may have potential compliance issues
and to target examination resources accordingly.[Footnote 4] More
specifically, in fiscal year 2005 OCIE shifted its focus from the
routine examination of all registered investment companies and
advisers, regardless of compliance risks, to the examination of "higher-
risk" firms--about 10 percent of the population--once every 3 years.
From the remaining 90 percent of the population designated as "lower
risk," OCIE examines a small random sample annually. Under OCIE's
revised approach, "sweep" examinations, which target specific
activities across firms, and "cause" examinations, which target known
problems at an individual firm, are also a higher priority. The
effectiveness of OCIE's revised approach depends on its ability to
accurately assess the level of risk at individual investment advisers;
inaccurately categorizing firms as lower-risk could result in harmful
practices' going undetected.[Footnote 5] Since 2002, OCIE has assigned
risk ratings to investment advisers after evaluating their compliance
controls through routine examination. However, most firms have not yet
received this evaluation. To assign risk ratings to unexamined firms,
OCIE assesses publicly available information to identify risks inherent
in a firm's businesses, such as conflicts of interest. While these
variables may indicate areas of high risk, they do not provide any
information on the firm's policies or procedures for mitigating these
risks. OCIE's analysis of fiscal year 2006 data showed that the
accuracy of this methodology for predicting whether firms are higher-or
lower-risk has some limitations. OCIE officials said that they are
evaluating other potential indicators of compliance risks, such as
investment adviser performance, to improve their risk-rating
methodology and otherwise aid them in identifying higher-risk firms.
Implementation of our prior recommendation to obtain and review
documentation associated with the compliance reviews that firms must
conduct under SEC rules--a source of information on the effectiveness
of their compliance controls--could potentially help OCIE better
identify higher-risk firms as part of its risk-assessment
methodology.[Footnote 6]
Our review of investment company, investment adviser, and broker-dealer
examinations completed during fiscal year 2003 through fiscal year 2006
found that examiners generally applied OCIE's exit procedures, with the
major exceptions occurring during sweep examinations relating to mutual
fund trading abuses, instances where OCIE directed examiners to forgo
exit procedures. To communicate deficiencies to registrants, OCIE has
instituted specific exit procedures that include an exit interview,
which examiners use to inform registrants of deficiencies prior to the
close of an examination, and a "closure notification" letter, which
communicates the outcome of the examination. OCIE guidance allows
examiners to refrain from applying these procedures when they refer
their findings to the Division of Enforcement (Enforcement) and are
asked to forgo the exit interview, the deficiency letter, or both; or
when an examination results in no findings, in which case an exit
interview is not necessary. OCIE management also has directed examiners
to deviate from exit procedures under exigent circumstances, such as
during the extensive sweep examinations initiated to address the
widespread unlawful trading in mutual funds that surfaced in 2003 and
that included inappropriate market timing, among other
practices.[Footnote 7] Our analysis of a sample of investment company
and investment adviser examinations completed during fiscal year 2003
through fiscal year 2006 estimated that examiners conducted exit
interviews for 79 percent of the examinations completed during this
period. They did not conduct interviews in an estimated 12 percent for
reasons consistent with their guidance. In the other estimated 9
percent, OCIE directed examiners not to conduct exit interviews because
the examinations were part of ongoing sweep examinations related to
market timing. We also estimated that examiners sent either a
deficiency letter or a "no further action" letter in 87 percent of the
examinations. Examiners did not send closure notifications in an
estimated 11 percent because the examination was part of the ongoing
sweep examinations related to market timing and in 2 percent for other
guidance-related reasons. We did not find evidence that examiners sent
closure notification letters in the remaining estimated 1 percent, when
OCIE guidance indicated they should have been sent.[Footnote 8] We also
analyzed a sample of broker-dealer examinations and estimated that
examiners conducted exit interviews and sent closure notifications in
82 percent and 88 percent, respectively, of the total number of
examinations completed during the review period and did not conduct
these procedures in 11 percent and 9 percent, respectively, of
examinations for reasons consistent with OCIE's guidance. However, in
an estimated 7 percent of examinations, we did not find evidence of an
exit interview when OCIE guidance indicated one was warranted. This
estimate includes an estimated 3 percent of cases where OCIE officials
told us examiners conducted the interviews but did not document the
discussion.
OCIE generally followed its new procedure requiring examiners to inform
registrants of the status of examinations extending past 120 days, one
of a variety of new initiatives OCIE implemented to improve
coordination and communication among examiners, and with other SEC
divisions and registrants. Other examples include protocols and tools
to help examiners across SEC headquarters and regional offices
coordinate their examinations and avoid duplication as well as a
hotline for registrants to call with complaints or concerns about the
examination program. In reviewing OCIE examination data to determine
the extent to which examiners followed the 120-day requirement, we
identified 13 closed examinations to which this procedure was
applicable. In 12 of the 13, examiners either provided the notification
or had a guidance-related reason for not contacting the firm, such as a
request by Enforcement. To obtain the views of registrants on OCIE's
new initiatives, we contacted various industry participants
representing investment companies, investment advisers, and broker-
dealers. A number of registrants questioned the effectiveness of the
new hotline, as it is located within OCIE's Office of the Chief Counsel
and not in another SEC office or division that is independent of OCIE.
These registrants said they would hesitate to use the new hotline,
thereby limiting its effectiveness as a communication tool.
This report contains one recommendation designed to facilitate greater
use of OCIE's new examination hotline by relocating it to a division or
office that is independent of OCIE. We received comments on a draft of
this report from SEC, which are included in appendix II. In its written
comments, SEC agreed with our conclusions and noted that in response to
our recommendation, OCIE is developing a revised hotline where callers
can choose to speak with the Commission's Office of the Inspector
General, in addition to staff from OCIE's Office of the Chief Counsel.
SEC also provided technical comments on a draft of the report, which
were incorporated into the final report, as appropriate.
Background:
SEC oversees investment companies and investment advisers primarily
through OCIE; the Division of Investment Management (Investment
Management); and Enforcement. OCIE examines investment companies and
investment advisers to evaluate their compliance with federal
securities laws, determine if these firms are operating in accordance
with disclosures made to investors, and assess the effectiveness of
their compliance control systems. Investment Management administers the
securities laws affecting investment companies and investment advisers.
It reviews the disclosure documents that investment companies
registered with SEC are required to file with the agency and engages in
other regulatory activities, such as rule making, responding to
requests for exemptions from federal securities laws, and providing
interpretation of those laws. Enforcement is responsible for
investigating and prosecuting violations of securities laws or
regulations that are identified through OCIE examinations, referrals
from other regulatory organizations, and tips from firm insiders, the
public, and other sources.
OCIE conducts routine, sweep, and cause examinations to oversee
registered investment companies and investment advisers. Routine
examinations are conducted according to a cycle that is based on the
registrant's perceived risk. During a routine examination, OCIE
assesses a firm's process for assessing and controlling compliance
risks. In 2002, OCIE started to use a systematic approach for
documenting and assessing the effectiveness of investment advisers'
compliance controls.[Footnote 9] Based on that assessment, examiners
assign investment advisers risk-ratings indicating whether they are at
higher-or lower-risk for experiencing compliance problems. In a sweep
examination, OCIE probes specific activities of a sample of investment
companies and investment advisers to identify emerging compliance
problems in order that they may be remedied before becoming too severe
or systemic. OCIE conducts cause examinations when it has reason to
believe something is wrong at a particular registrant. Investment
companies and investment advisers can be candidates for cause
examinations if they are the subject of investor complaints, tips, or
critical news media reports.
SEC regulates broker-dealers in conjunction with National Association
of Securities Dealers (NASD) and the New York Stock Exchange (NYSE),
among others.[Footnote 10] NASD and NYSE are self-regulatory
organizations (SRO) with statutory responsibilities to regulate their
own members. As part of their responsibilities, they conduct
examinations of their members to ensure compliance with SRO rules and
federal securities laws. OCIE evaluates the quality of NASD and NYSE
oversight in enforcing their members' compliance through oversight
inspections of the SROs and broker-dealers. SRO oversight inspections
review all aspects of an SRO's compliance, examination, and enforcement
programs.[Footnote 11] Through broker-dealer oversight examinations,
OCIE re-examines a sample of firms within 6 to 12 months after the SRO
completed its examination.[Footnote 12] In addition to broker-dealer
oversight examinations, OCIE also directly assesses broker-dealer
compliance with federal securities laws through special and cause
examinations. Special examinations include sweep examinations and
internal controls risk management examinations of the 20 largest broker-
dealer firms. The Division of Market Regulation (Market Regulation)
administers the securities laws affecting broker-dealers and engages in
related oversight activities such as rule making. Both SEC's
Enforcement and the SROs' enforcement divisions are responsible for
investigating and disciplining violations of securities laws or
regulations by broker-dealers.
OCIE Revised Its Examination Approach to Target Higher-Risk Registrants
and Compliance Issues:
Since 2003, OCIE changed its examination program for certain
registrants including investment companies and investment advisers to
try to focus its examination resources on those firms and industry
practices with the greatest risk of having compliance problems. In
particular, OCIE went from routinely examining registered firms on an
established schedule to emphasizing the examination of higher-risk
firms. Accurate risk ratings of investment advisers are critical to
making this revised approach effective. However, to assign risk ratings
to firms that have not had their compliance controls evaluated through
routine examinations, OCIE uses proxy indicators for compliance risk
that do not incorporate information on the strength of the firm's
compliance controls, a limitation that OCIE has recognized. One
potential source of information that could be used to improve the
accuracy of risk ratings is the compliance reports that firms must
prepare and maintain on-site under rules that became effective in 2004
(Compliance Program Rules), but do not have to file with SEC.[Footnote
13] These reports include information on the quality of the firms'
compliance controls and any material weaknesses identified, which could
be useful to OCIE for risk-rating purposes if OCIE were able to review
these records regularly outside of routine examinations. Implementation
of a prior recommendation to periodically obtain and review these
compliance reports could potentially help OCIE better identify higher-
risk firms.
Goal of Revised Examination Approach for Investment Companies and
Investment Advisers Is to Identify and Shift Resources to Higher-Risk
Firms and Compliance Issues:
Following the detection of mutual fund trading abuses in the summer of
2003, OCIE revised its examination approach for investment companies
and investment advisers. Specifically, OCIE shifted its examination
approach from one that focused largely on the routine examination of
all registered firms on an established schedule, regardless of risk, to
one that targets resources on firms and issues that present the
greatest risk of having compliance problems. Between 1998 and 2003,
routine examinations accounted for about 90 percent of the
approximately 10,400 investment company and investment adviser
examinations OCIE conducted. During this period, OCIE generally tried
to examine each firm at least once every 5 years.[Footnote 14] However,
the growth in the number of investment advisers, from 5,700 to about
7,700, and in the breadth of their operations did not allow OCIE to
maintain this routine examination cycle. Also, OCIE concluded that
routine examinations were not the best tool for broadly identifying
emerging compliance problems, because firms were selected for
examination based largely on the passage of time and not their
particular risk characteristics.
To address these limitations, OCIE implemented a new risk-based
examination approach in fiscal year 2005 that provides for more
frequent routine examination of investment advisers determined to be
higher-risk for compliance issues. Under this revised approach, OCIE's
goal is to conduct at least one on-site, comprehensive, risk-based
examination of all firms that have a higher-risk profile every 3 years.
From those firms designated as lower-risk, OCIE randomly selects a
sample each year to routinely examine. According to the 2007 "goals"
memorandum--OCIE's key planning document for communicating examination
priorities and guidance to examiners nationwide--OCIE targets more than
three times the amount of examination resources to the routine
examinations of higher-risk investment advisers (and their associated
investment companies) than to the routine examination of lower-risk
firms. Higher-risk firms represent about 10 percent of registered firms
and 51 percent of assets under management. OCIE also now targets
greater resources to sweep and cause examinations.
As part of its revised approach, OCIE began a pilot program in fiscal
year 2006 that uses dedicated teams of two to four examiners to provide
more continuous and in-depth oversight of the largest and most complex
groups of affiliated investment companies and investment advisers. As
of June 2006, OCIE officials said that a few select firms, representing
approximately $1.5 trillion, or 4 percent, of assets under management
in the United States, are currently participating in this voluntary
program. Because these firms have been in the program for less than 12
months, we were unable to evaluate the effectiveness of OCIE's
monitoring teams or this pilot. OCIE officials told us they plan on
adding a limited number of additional firms and corresponding
monitoring teams to the program by the end of 2007. Depending on the
results of the pilot, the officials tentatively plan to have at least
one and, perhaps, two monitoring teams in each field office.
To enhance OCIE's ability to identify and address emerging risks across
the securities industry, in 2004 OCIE implemented a process intended to
identify and map high-risk industry practices and compliance issues
across the securities markets, including investment companies,
investment advisers, and broker-dealers. SEC's Office of Risk
Assessment (ORA) initially developed this process for agencywide use.
In 2005, this process was automated, using a database application
called Risk Assessment Database for Analysis and Reporting
(RADAR).[Footnote 15] As used by OCIE, examiners in headquarters and
regional offices identified and prioritized various risks to investors
and registrants. OCIE staff then used RADAR to identify the highest-
risk areas designated by examiners and then develop and recommend
regulatory responses to address these higher-risk areas.[Footnote 16]
For example, OCIE officials said that they are addressing some risks by
conducting examinations on the related issues and other risks by
recommending that Market Regulation and Investment Management provide
new rules or interpret existing ones. In addition, as part of OCIE's
fiscal year 2007 goals memorandum, OCIE included information on the key
risks identified through RADAR for each registrant type. OCIE examiners
were directed to consider these risk areas as they plan examinations.
OCIE officials said that they have not yet formally evaluated the
effectiveness of RADAR for identifying new or resurgent compliance
risks, as they have been largely focused on developing RADAR and the
risk-assessment process itself. However, they said that the
implementation of their recommended regulatory responses, through their
own examination program and by other divisions and offices, would allow
them to validate the risks identified through RADAR. OCIE officials
said that they are considering developing a task force whose role, in
part, would be to track the outcome of what OCIE recommends for risks
entered in RADAR.
OCIE Is Taking Steps to Refine Its Method for Assessing the Compliance
Risk Level of Investment Advisers but Faces Challenges:
Accurately identifying compliance risk among registered investment
advisers is critical to OCIE's revised approach to examinations,
particularly for routine examinations. Because only a small number of
low-risk firms are selected for routine examinations in a year,
improperly categorizing investment advisers as lower-risk could lead to
harmful practices' not being detected on a timely basis. To determine
which firms are higher-risk and thus a priority for routine
examination, every year OCIE queries its examination database and
identifies those investment advisers that have been examined during the
past 3 years and assigned a compliance risk rating of "high,"
indicating that their compliance controls have been assessed as "weak."
These firms are automatically placed on the high-risk list and
scheduled for routine examination within a 3-year period. However,
because OCIE had only begun assigning risk ratings to firms in 2002
when it started using its risk-scorecard approach to evaluate
compliance risks at individual firms, it was unable to assign risk
ratings to all firms prior to revising the approach to routine
examinations in 2004. Approximately 70 percent of registered investment
advisers had not yet received a compliance risk-rating through a
routine examination before OCIE implemented its new approach. Further,
according to OCIE, its staff have not yet examined most of the more
than 4,500 new investment advisers that have registered with SEC since
fiscal year 2004.
To assign a risk rating for investment advisers that have never been
examined by OCIE, OCIE uses an algorithm to calculate a numeric "score"
for each firm based on certain affiliations, business activities,
compensation arrangements, and other disclosure items that pose
conflicts of interest.[Footnote 17] Examples include participation or
interest in client transactions, managing portfolios for individuals,
and receiving performance fees. OCIE determines the risk profile of all
registered investment advisers every year using the risk algorithm.
Those that are designated as higher-risk through this method are added
to the high-risk list and scheduled for routine examination within the
next 3 years. At the start of fiscal year 2006, OCIE officials said
they had identified about 10 percent of registered investment advisers
as higher-risk. Slightly more than half of these were firms that had
been routinely examined by OCIE within the last 3 years and given a
risk-rating of "high" and slightly less than half were rated as higher-
risk through the risk algorithm. A small percentage were firms OCIE had
classified as higher-risk because of their large size. OCIE
automatically designates the top 20 investment advisers according to
assets under management as higher-risk.[Footnote 18] According to OCIE
officials, these larger firms are a priority because of the number of
investors who could suffer adverse consequences as a result of any
compliance problems at these firms.
Although the risk algorithm allows OCIE to determine an investment
adviser's relative risk profile in the absence of a compliance risk
rating, it is potentially limited because it does not measure the
effectiveness of the investment adviser's compliance controls that are
designed to mitigate conflicts of interest or other risks that could
harm mutual fund shareholders. Rather, it relies on information that
serves largely as proxy measures of the firm's compliance-related
controls. OCIE has recognized these limitations and has taken some
steps to evaluate the effectiveness of this methodology. OCIE officials
told us they evaluate the accuracy of the risk ratings generated by the
risk algorithm by comparing the results of completed routine
examinations of firms initially presumed to be low-risk against the
examination's outcome. According to data generated by OCIE, 91 percent
of investment advisers that were initially rated lower-risk and
examined in fiscal year 2006 retained the lower-risk designation after
examination. OCIE officials said that they are reviewing the remaining
9 percent of examinations where the risk rating changed from lower to
higher to determine the reasons for the change and whether they can use
that information to improve the accuracy of the risk algorithm.
OCIE data also showed that 25 percent of all investment advisers that
were initially rated higher-risk and examined during fiscal year 2006
retained their higher-risk rating, while the remaining 75 percent were
reclassified as lower-risk. According to OCIE officials, one reason
that the accuracy rate for predicting higher-risk firms appears low is
that many of the firms on the higher-risk list, as previously
discussed, were classified as higher-risk as a result of a prior
examination. These firms likely took steps in the interim to improve
their compliance controls, so OCIE officials expected that these firms
would be rated as lower-risk after re-examination. However, the
officials said that there are also many firms that had ratings assigned
through the risk algorithm, and the fact that their ratings were
changed from higher-to lower-risk after the examination demonstrates
the limitations of the algorithm--it can determine which firms are at
higher risk for compliance problems, but does not indicate the
effectiveness of the firms' policies or procedures for mitigating these
risks.[Footnote 19]
To improve the accuracy of the risk-algorithm, OCIE initiated a sweep
examination during 2007 of a sample of recently registered investment
advisers that were identified as lower-risk and that had not yet been
subject to a routine examination by OCIE. These reviews are typically
targeted, 1-day reviews that allow examiners to obtain an initial
assessment of these recently registered investment advisers' conflicts
of interest, the related compliance policies and procedures these
advisors use to manage these risks, and the capabilities of the firms'
compliance and other personnel. OCIE anticipates that these limited-
scope visits will assist examiners in determining whether a recently
registered investment adviser's risk rating is accurate, and if it is
not, will allow them to assign a more accurate risk rating and
potentially identify additional information to refine the risk
algorithm. According to OCIE officials, thus far, examiners have
concluded over 225 of these reviews, with 85 percent of these resulting
in firms' remaining classified as lower-risk and 15 percent being
reclassified as higher risk and placed on a 3-year examination cycle.
The officials said that they plan to make these sweep examinations a
regular component of the examination program.
In addition, OCIE officials said that they are exploring ways to obtain
and use additional sources of information that will allow them to
further identify higher-risk firms.[Footnote 20] OCIE officials told us
they have purchased access to several commercial databases containing
information on various data points, such as the performance of
investment advisers, that OCIE does not otherwise have. OCIE officials
said that they are currently assessing the usability of these databases
for surveillance purposes, primarily to identify higher-risk firms. For
example, if a firm's reported performance is significantly higher or
lower than its peers, the officials said that performance could
indicate that the firm's business processes deviate from the norm and
require follow-up. Further, OCIE officials said that several OCIE and
Office of Information Technology (OIT) staff are working on a project
to identify other possible information sources that OCIE could use to
better monitor investment companies and investment advisers. OCIE
officials said that they are formalizing this effort by creating a
Branch of Surveillance and Reporting, which will have staff permanently
dedicated to the review and analysis of internal and external data
sources to identify compliance risks at registered investment companies
and investment advisers.[Footnote 21]
The accurate prediction of each investment adviser's risk-level is
critical to the protection of investors under the revised approach, as
some firms rated lower-risk may never be routinely examined within a
reasonable period of time, if at all, because of the sampling approach
being used.[Footnote 22] According to OCIE's review of 2006 examination
data, 9 percent of investment advisers currently classified as lower-
risk firms are actually higher-risk firms that should be scheduled to
be examined within the next 3 years. Among newly registered advisers,
the results of OCIE's targeted 1-day reviews show that the percentage
of firms inappropriately characterized as lower-risk appears to be
higher. OCIE's efforts to improve the capacity of the algorithm and
obtain alternative sources of surveillance information could increase
the likelihood that higher-risk firms will be identified and examined.
However, neither the risk algorithm nor the alternative information
sources OCIE is currently considering give OCIE any insights into the
effectiveness of a firm's internal controls for mitigating identified
compliance risks.
One potential source of information that might allow OCIE to assess the
effectiveness of firms' internal controls is the reports registered
investment companies and investment advisers are required to prepare at
least annually under the Compliance Program Rules.[Footnote 23] These
rules require firms subject to the rule to adopt written compliance
policies and procedures and review, at least annually, the adequacy of
such compliance controls, policies, and procedures and the
effectiveness of their implementation. Registered investment companies
must designate a chief compliance officer responsible for giving the
firm's board of directors a written report that, among other
requirements, addresses the operation of the compliance controls of the
investment companies and the controls of each of its service providers,
including its investment adviser, and each material compliance matter
that has occurred during the reporting period. Under the Compliance
Program Rules, each investment company and investment adviser is
required to maintain as part of its books and records any records
documenting the firm's annual review of its compliance controls. OCIE
staff currently review these compliance reports as part of the
examination-planning process to learn about compliance issues
identified by the firms and determine whether the firms have
implemented corrective action. Currently, the rule does not require
firms to submit the annual reports to the agency for its ongoing
review. We previously recommended that SEC obtain and review these
reports or the material weaknesses identified in them periodically
rather than solely in connection with a planned examination.[Footnote
24] OCIE officials noted that obtaining these reports on a regular
basis would require rule making by SEC. We continue to believe,
however, that using these reports outside of the examination process
could potentially allow OCIE to improve its ability to identify higher-
risk firms.
With Some Exceptions, OCIE Generally Applied Exit Procedures for the
Period We Reviewed:
Our review of investment company, investment adviser, and broker-dealer
examinations completed during fiscal year 2003 through fiscal year 2006
found that examiners generally applied OCIE's exit procedures. OCIE's
guidance on exit procedures gives examiners flexibility for
communicating deficiencies and outcomes of examinations to registrants.
These procedures include an exit interview, in which examiners inform
registrants of deficiencies before closing an examination, and a
closure notification letter, which communicates the outcome of the
examination. Under certain circumstances, these procedures may not
apply, such as when examiners refer their findings to Enforcement and
are asked to forgo any or all of the procedures. OCIE management also
has directed examiners to deviate from exit procedures under exigent
circumstances, most recently for certain sweep examinations conducted
during fiscal years 2003 through 2004 that addressed market timing and
other newly emergent, high-risk compliance issues. OCIE officials told
us that they did not inform the industry of their decision to forgo
exit procedures for many of these sweep examinations, a situation that
various industry participants told us confused the firms because they
did not receive information on the status or outcome of the
examination. We reviewed a sample of investment adviser and investment
company examinations and a sample of broker-dealer examinations
completed during fiscal year 2003 through fiscal year 2006. Based on
this review, we estimated that examiners generally applied exit
procedures. The exceptions were an estimated 9 percent of investment
company and investment adviser examinations that were part of the
market-timing and other related sweep examinations, as well as an
estimated 7 percent of broker-dealer examinations where examiners
either did not conduct these exit procedures or they did not provide
evidence that they conducted them.
OCIE Guidance on Exit Procedures Gives Flexibility to Examiners for
Communicating Examination Findings:
OCIE has instituted specific exit procedures that give flexibility to
examiners for communicating deficiencies and notifying registrants of
the outcome of examinations. Prior to closing an examination, the
guidance generally requires examiners to offer registrants an exit
interview to inform them of any deficiencies that examiners found.
According to a December 2001 memorandum, which formalizes OCIE's
guidance for conducting exit interviews, these interviews are to ensure
that registrants are informed of examiners' concerns at the earliest
possible time, give registrants an opportunity to provide additional
relevant information, and elicit early remedial action.[Footnote 25]
According to the guidance, OCIE's goal is to ensure that examiners
inform registrants of all deficiencies prior to sending written
notification of the examination findings, while at the same time giving
examiners flexibility as to when to communicate their concerns. If
examiners find deficiencies, they can communicate them either
informally during the course of the fieldwork while on-site at the
registrant, during a formal exit interview at the end of the on-site
visit, or in an exit conference call after they complete additional
analysis off-site.
The guidance directs examiners to document these discussions in the
examination's work papers and in the final examination report. OCIE's
guidance for exit interviews also permits examiners to take into
consideration the extent and severity of matters found during
examinations when determining whether to conduct an exit interview. For
example, when examiners refer a firm to Enforcement for securities law
violations, in some cases Enforcement staff will ask the examiners to
refrain from further discussions with the firm to protect the integrity
of the impending investigation.
OCIE officials also told us that if the examiners did not identify any
deficiencies to bring to the firm's attention once the on-site visit
and subsequent fieldwork were complete, they were not expected to
conduct formal exit interviews. Instead, examiners would let the firm
know at the end of the on-site visit that they had not found any
problems to date. If after completion of the off-site analysis, the
examiners still did not identify any deficiencies, the guidance directs
examiners to inform the firm of that fact prior to closing the
examination.
Examiners formally close an examination by sending a "closure
notification" letter to the firm. A closure notification letter can be
a no further action letter, which indicates the examination concluded
without any findings, or a deficiency letter, which cites any problems
found. While the examiners may issue a deficiency letter and also refer
some or all of the examination findings to Enforcement, in some cases,
as with exit interviews, Enforcement staff may ask the examiners to
refrain from sending a deficiency letter or exclude certain findings
from a deficiency letter.
OCIE Deviated from Exit Procedures for Certain Market-Timing and Other
Related Sweep Examinations, but Did Not Inform the Industry:
OCIE officials said that they only direct examiners to deviate from
established exit procedures when they believe it is in the best
interest of the examination program and under exigent circumstances,
such as during the period OCIE conducted sweep examinations of hundreds
of firms to gather information on market timing and other newly
emergent, high-risk compliance issues. OCIE officials said that in
consultation with Enforcement staff, they decided for several of the
market-timing and certain other concurrent sweep examinations to direct
examiners not to conduct exit interviews or send closure notification
letters. OCIE officials told us that they conducted these sweep
examinations largely over fiscal years 2003 and 2004. As discussed
later in this section, examination data we reviewed showed that some of
these examinations were not completed until fiscal year 2005 or fiscal
year 2006.
OCIE officials discussed the factors that contributed to their
decision. First, they said that OCIE staff and examiners in the
regional offices had little prior experience planning, conducting, and
reporting on sweep examinations of such large scale and on such complex
issues as market timing. At that time, OCIE did not have formal
protocols in place to guide examiners when conducting sweep
examinations. Second, the officials said that these sweep examinations
involved a prolonged production of documents, data, and e-mails by
firms and analysis of this information by OCIE and other SEC divisions
and offices over periods as long as a year or more. For example, OCIE
staff said that the review of initial documents provided by many firms
often did not reveal any deficiencies, but the review of more detailed
data a few months later did reveal deficiencies. OCIE officials said
that if they had conducted an exit interview or sent a no further
action letter based on the initial review of data, registrants would
have stopped sending documents to the examination staff. As a result,
the examiners would not have been able to detect the deficiencies that
such information would have revealed. Third, OCIE officials said that
to expedite the process for some groups of firms, they directed
examiners not to write individual examination reports, which would have
formed the basis for exit interviews and deficiency or no further
action letters. Rather, they asked examiners to write a global report
summarizing their findings.
Further, OCIE officials said that they did not inform the individual
firms targeted during these sweep examinations or the industry
generally of their decision to direct examiners to forgo exit
procedures. We obtained the views of various industry participants
representing investment companies, investment advisers, and broker-
dealers on OCIE's decision. Several registrants said that the lack of
communication during these sweep examinations was problematic and
unsettling, as often they were unsure of the status of the examination,
if they should be concerned about what OCIE was finding, or when they
could assume the examination was over. Other industry representatives
echoed these concerns and said that for any OCIE examination, early and
ongoing communication with the examiners regarding any deficiencies
identified, in addition to holding prompt exit interviews, is essential
for the examination process to be effective and efficient. First, the
representatives said that firms want to know immediately whether the
examiners have identified any deficiencies so they can begin to address
them as soon as possible. Second, if examiners identify deficiencies
early, it allows the firm the opportunity to clarify any potential
misinterpretations by examiners of the firm's policies, procedures, and
practices before a deficiency letter is sent.
In the wake of the market-timing and other related sweep examinations,
OCIE officials said they expect examiners to follow standard exit
procedures for all sweep examinations, i.e., to conduct exit interviews
to discuss any deficiencies, send deficiency or no further action
letters, and make referrals to Enforcement as appropriate. In March
2006, OCIE issued formal guidelines for initiating, conducting, and
concluding these examinations. As part of the guidelines, OCIE
clarified that it expected sweep examinations to follow the same
procedures as for other types of examinations. OCIE officials said that
these expectations were reinforced with the issuance of an updated
examination brochure (described in more detail below) in July 2006,
which examiners are to provide registrants when beginning any
examination and which details the exit procedures.
Examiners Generally Applied Exit Procedures during Review Period, with
Some Exceptions Noted:
Based on our review of a sample of investment company and investment
adviser examinations and a sample of broker-dealer examinations
completed during fiscal year 2003 through fiscal year 2006, we
estimated that examiners generally applied exit procedures, with some
exceptions. The exceptions were an estimated 9 percent of investment
company and investment adviser examinations that were part of the
market-timing and other related sweep examinations, as well as an
estimated 7 percent of broker-dealer examinations where examiners
either did not conduct these exit procedures or they did not provide
evidence that they conducted them. In conducting this analysis, we
analyzed examination data from two random samples of 129 examinations
each, drawn from (1) the population of 8,107 investment company and
investment adviser examinations and (2) the population of 3,044 broker-
dealer examinations completed during fiscal year 2003 through fiscal
year 2006. These samples allowed us to project the results of our
review to the population of all investment company and investment
adviser examinations and to the population of all broker-dealer
examinations completed during this period at a 95 percent level of
confidence.
We estimated that examiners held exit interviews to discuss
deficiencies found in 79 percent of the investment company and
investment adviser examinations completed during the review period (see
fig. 1). In addition, examiners did not conduct these interviews for
reasons allowed under OCIE's exit interview guidance in an estimated 12
percent of the examinations. For example, in some cases examiners did
not find any deficiencies during the examination and so were not
required to conduct an exit interview. Instead, they were only required
to inform the firm that they did not find any deficiencies and later
send a no further action letter closing the examination.[Footnote 26]
Other reasons for not conducting exit interviews included referrals to
Enforcement, where Enforcement staff directed the examiners to forgo
the interviews, and other circumstantial reasons.
We estimated that for the remaining 9 percent of examinations,
examiners did not conduct exit interviews because these examinations
were part of the market-timing and other related sweep examinations
where OCIE directed examiners to forgo these interviews, even though
deficiencies were found.
Figure 1: Estimated Percentage of Investment Company and Investment
Adviser Examinations Where Examiners Conducted Exit Interviews and Sent
Closure Notifications, Fiscal Years 2003 to 2006:
[See PDF for image]
Source: GAO analysis of SEC examination data.
Note: Percentages may not add exactly because of rounding. All
estimated percentages in this table have margins of error of plus or
minus 8 percent or less.
[A] Examiners were not required to conduct a formal exit interview
because they did not find any deficiencies during the examination.
[B] Examiners referred deficiencies found to Enforcement, whose staff
requested that examiners forgo conducting the exit interview, sending a
deficiency letter, or both.
[C] Other reasons include more circumstantial reasons OCIE examiners
did not conduct exit interviews or send closure notifications. For
example, in one case, the firm did not produce requested documents in a
timely manner during a sweep examination conducted by headquarters
staff, and the examination team closed the exam and referred the firm
to a regional office, which began a new examination. We did not request
additional information on the new examination.
[End of figure]
We also analyzed the frequency with which examiners sent closure
notifications to investment companies and investment advisers and
estimated that examiners sent either a deficiency or a no further
action letter in 87 percent of the examinations completed during the
review period. The predominant reason for the higher rate of closure
notifications sent compared with exit interviews conducted was that
examiners sent no further action letter to firms when no deficiencies
were found.
Examiners did not send closure notification letters in an estimated 11
percent of examinations (14 of the 129 examinations we reviewed)
because the examinations were part of the market-timing and other
related sweep examinations and OCIE had directed examiners not to send
any letters. We found that of these 14 examinations, 11 concluded in
fiscal year 2004, 2 concluded in fiscal year 2005, and 1 concluded in
fiscal year 2006. Examiners did not send closure notifications for
allowable reasons in an estimated 2 percent of examinations, and in an
estimated 1 percent, we found no evidence that closure notifications
were sent and no legitimate reason why they should not have been sent.
For the population of broker-dealer examinations, we estimated that
examiners conducted exit interviews and sent closure notifications in
an estimated 82 percent and 88 percent, respectively, of examinations
conducted during the review period (see fig. 2). Examiners did not
conduct exit interviews or send closure notifications for reasons
allowable under OCIE guidance, such as related to referrals to
Enforcement, in an estimated 11 percent and 9 percent, respectively, of
the examinations.
Figure 2: Estimated Percentage of Broker-Dealer Examinations Where
Examiners Conducted Exit Interviews and Sent Closure Notifications,
Fiscal Years 2003 to 2006:
[See PDF for image]
Source: GAO analysis of SEC examination data.
Note: Percentages may not add exactly because of rounding. All
estimated percentages in this table have margins of error of plus or
minus 8 percent or less.
[A] Examiners were not required to conduct a formal exit interview
because they did not find any deficiencies during the examination.
[B] Examiners referred deficiencies found to Enforcement, whose staff
requested that examiners forgo conducting the exit interview, sending a
deficiency letter, or both.
[C] "OCIE officials believed interviews conducted, but not documented,"
refers to those cases where OCIE officials believed that examiners
conducted exit interviews, but were not able to provide documentation
of them.
[End of figure]
In an estimated 7 percent of examinations, we did not find evidence of
an exit interview when OCIE guidance indicated one was warranted.
However, this estimate includes the 3 percent of cases where OCIE
officials told us they believed examiners conducted the interviews but
did not document the discussion. For the other estimated 4 percent, we
found no evidence that exit interviews were held and no legitimate
reason why they should not have been held. In addition, we found no
evidence that closure notifications were sent in an estimated 3 percent
of examinations and no legitimate reason why they should not have been
sent.
OCIE Implemented New Initiatives Intended to Improve Communication and
Coordination:
OCIE has implemented several initiatives since January 2006 designed to
improve internal and interagency coordination and communication with
registrants. For instance, OCIE has undertaken efforts that include
developing tools and protocols to avoid duplication of examinations and
forming interdivisional committees intended to improve referrals to
Enforcement. Other initiatives include establishing a "hotline" for
registrants and formalizing a new requirement to notify registrants
when an examination extends past 120 days. Our review indicated that
examiners generally complied with this new notification requirement.
Some industry participants who provided their views on OCIE's
initiatives expressed hesitations about using the new hotline.
Specifically, several participants questioned the independence of the
new hotline, because it is located within OCIE's Office of the Chief
Counsel and not in another SEC office or division.
OCIE Has Recently Implemented Initiatives to Increase Communication
with Registrants and Improve Interagency Coordination:
In May 2006, the SEC Chairman testified before the House Financial
Services Committee on several reforms designed to improve pre-
examination planning and increase the transparency of SEC's examination
program. We found that OCIE has generally implemented the following
reforms and additional protocols and tools that are intended to improve
coordination across SEC headquarters and regional offices and with
other key SEC divisions.
* To minimize the number of firms selected for multiple sweep
examinations and to provide advance notice to the commission regarding
planned sweep examinations, OCIE developed a formal review and approval
process for sweep examinations that is detailed in the March 2006 sweep
examination guidance previously discussed. As part of this guidance,
OCIE field examiners and OCIE staff are directed to submit a list of
firms to OCIE management that they propose to include as part of the
sweep examinations. OCIE management is responsible for comparing the
list of proposed firms against a master list of firms subject to
ongoing or recently completed sweep examinations to ensure that that
the firms are not bearing an undue share of examination focus, given
the nature of their business and OCIE's risk assessment. Once OCIE has
approved the proposed sweep examination and the targeted firm, the new
guidance directs OCIE to provide the proposal to Market Regulation,
Investment Management, or Enforcement for notification and to obtain
comments. Finally, OCIE is to provide the Commission an information
memorandum summarizing the proposed sweep examination and its
objectives. The memorandum directs staff to allow the Chairman and
Commissioners time to review the memorandum and ask questions before
commencing the sweep examination. We reviewed four of these
memorandums, which discussed the time frames for the sweep, the issues
OCIE planned to investigate and the methodology it would use, and the
firms it planned to include.
* SEC, NASD, and NYSE have developed a database, maintained by NASD,
which collects data on examinations conducted by SEC, NYSE, and NASD on
170,000 broker-dealer branch offices. OCIE officials said that
examiners are now using this database when planning examinations to
avoid dual examinations of the same branch office (with the exception
of the broker-dealers selected for review as part of SEC's oversight
program of the SROs). Further, as part of the pilot program for
assigning permanent monitoring teams to the largest investment company
and investment adviser complexes, each firm's monitoring team is
responsible for conducting all examinations related to the firm,
including examinations at branch offices in different areas of the
country. OCIE officials said that prior to the implementation of this
program, examiners from different regional offices would conduct
separate examinations of the firm's branch offices, which resulted in
duplication and imposed a burden on the firm.
* To improve coordination with other key SEC divisions, OCIE officials
said they have designed a new training program for fiscal year 2007
that is designed to educate examiners about rules affecting investment
companies, investment advisers, and broker-dealers. The four scheduled
courses are taught by Investment Management and Market Regulation staff
and focus on rules that are new or about which examiners have frequent
questions in the course of conducting examinations for compliance with
these rules. Second, OCIE and Enforcement have established
interdivisional committees in headquarters and the regional offices in
late 2006 and 2007 to bring more transparency and consistency to the
decisions made to pursue OCIE referrals to Enforcement about investment
companies, investment advisers, and broker-dealers. According to joint
guidance issued by OCIE and Enforcement in November 2006, the
responsibilities of these committees include discussing new referrals
to understand their strengths and weaknesses and reviewing those
examinations referred to Enforcement that have not resulted in an
investigation or enforcement action. In headquarters, these committees
also include staff from Investment Regulation and Market Regulation,
whose role is to provide insight with respect to referrals that involve
novel fact patterns or applications of the law.
OCIE has also taken the following measures that are intended to improve
communication with registrants.
* In January 2006, OCIE established an examination hotline where
registrants can call or e-mail anonymously to ask questions about their
specific examinations or other issues, lodge complaints, or make
comments. To preserve anonymity of the registrants, OCIE does not keep
a formal log of calls and e-mails to share with OCIE management
although staff take notes on the calls. OCIE officials told us that
examples of complaints and concerns to date have included duplicative
requests, complaints about examiners, and questions about public
statements made by OCIE officials about the examination program. We
discuss registrants' views of the effectiveness of the new hotline
later in this section.
* In July 2006, OCIE began requiring examiners to contact registrants
when examinations extend beyond 120 days to discuss the status of the
examination, the likely schedule for completion, and the date of the
final exit interview. Previously, OCIE officials told us that examiners
had no notification requirement but as a best practice, tried to
contact the registrant if the examination extended beyond the usual 90
days it took to complete most examinations. However, because of the
increasing complexity of firms and the increased emphasis on sweep
examinations, both of which require additional analysis on the part of
examiners and can increase the time needed to complete an examination,
OCIE decided to formalize this practice so that firms would be fully
aware of the status of the examination. We discuss the extent to which
examiners complied with the new notification requirement later in this
section.
* OCIE officials said that they have made more information publicly
available on the examination program and current compliance issues. In
July 2006, OCIE issued a revised examination brochure, which provides
more detailed information to registrants about the examination process,
including the 120-day notification procedure and exit procedures.
Later, in January 2007, SEC issued a guide, prepared by OCIE, to assist
broker-dealers in their efforts to comply with anti-money-laundering
laws and rules. Finally, in June 2007, OCIE issued its first Compliance
Alert letter to chief compliance officers (CCO) of investment companies
and investment advisers as part of its CCO outreach program.[Footnote
27] These letters, which OCIE officials said they plan to issue twice a
year, are intended to describe areas of recent examination focus and
certain issues found during investment company, investment adviser, and
broker-dealer examinations.
Examiners Generally Followed OCIE's New Procedure to Notify in 120 Days
Where Applicable:
We reviewed OCIE examination data to determine the extent to which
examiners followed the new 120-day notification procedure for
investment company, investment adviser, and broker-dealer examinations
and determined that examiners generally followed this procedure where
applicable since its implementation on July 31, 2006. As previously
discussed, OCIE implemented the new 120-day notification procedure to
better inform registrants of the status of examinations that would not
be completed within 120 days. OCIE has directed examiners to contact
the firm on or about the 120th day after the completion of the on-site
visit to discuss the status of the examination and the likely schedule
for completing the examination and conducting an exit interview. OCIE
officials said that this procedure largely was intended to address
those instances when an examiner left the firm after the on-site
portion of the examination and did not have further contact with the
firm while conducting subsequent analysis. OCIE examiners are
instructed to call the firm in these cases to update the firm on the
examination and should document the discussion in a note to the
examination file. However, OCIE officials said that sometimes an
examination will extend beyond 120 days because OCIE is waiting for the
firm to produce documents or data. In those cases, the firm knows that
the examination is still ongoing and examiners are not expected to call
on or about the 120th day.
We identified a total of 13 closed examinations that had lasted 120
days or more in the period between the date OCIE implemented the new
procedure (July 31, 2006) and the date OCIE provided us its records
(February 2, 2007). These 13 cases included 10 investment company and
investment adviser examinations and 3 broker-dealer examinations. In 7
of the 13 examinations, examiners either contacted the firm on or
around the 120th day of the examination or otherwise already had
ongoing communication with the firm because they were waiting for
documents or other data from the firm. In 5 of the 13 examinations,
examiners did not provide 120-day notification for allowable reasons.
For example, in two of these five cases, the examiners referred their
findings to Enforcement staff, who asked the examiners to cease contact
with the firm. In the other three of these five cases, further contact
was not warranted, either because the firm decided to withdraw its
registration or the examiners only reviewed available data about the
firm in SEC's offices and never contacted the firm to open a formal
examination. In the last of the 13 examinations, examiners did not
contact the firm on or about the 120th day.
Comments from Industry Participants on OCIE's New Initiatives Revealed
Concerns about the Independence of the New Hotline:
We contacted various industry participants representing investment
companies, investment advisers, and broker-dealers to gather their
views on OCIE's recent initiatives. They generally expressed support
for these initiatives, but some expressed hesitations about using the
new hotline. More specifically, several registrants viewed the new
hotline as a positive step by OCIE to provide an additional channel of
communication, and at least one registrant reported finding the hotline
very useful. However, others expressed concern about the independence
of the staff that operate the hotline, because, as previously
discussed, OCIE's hotline is staffed by attorneys in OCIE's Office of
the Chief Counsel. Other industry participants questioned the utility
of the hotline as a tool for addressing issues that are of concern to
them. For example, they said that they often have concerns about the
interpretation of SEC rules by examiners during examinations. They said
that when these issues arise, they would like OCIE to consult with
Market Regulation --the SEC division that writes and interprets the
rules for broker-dealers--to ensure that examiners interpret these
rules appropriately. However, they said that they do not perceive that
this consultation currently occurs, and as a result, have doubts that
calling the hotline would result in an effort by OCIE to obtain
clarification. Further, they said that it is important to resolve
concerns about rule interpretations while an examination is ongoing and
obtain the views of Market Regulation early on, before the exit
conference occurs or a deficiency letter is sent. Similarly, another
group of registrants thought that OCIE was unresponsive to their past
concerns and did not see the hotline as a valuable tool for addressing
these concerns.
OCIE officials told us they decided to locate the hotline in their
Office of the Chief Counsel because this office is the ethics office
for OCIE. OCIE managers thought it was important to keep the hotline in
a centralized location, as an issue could arise that involved any one
of OCIE's examination programs (such as the programs for investment
companies and investment advisers or broker dealers). In addition,
according to OCIE officials, the Associate Director and Chief Counsel
reports directly to the OCIE director, and therefore the Chief
Counsel's Office can exercise a great deal of institutional autonomy
when determining how to handle the calls or e-mails received. As
discussed earlier, OCIE officials said the Chief Counsel's Office does
not keep a formal log of contacts, to better preserve the anonymity of
registrants. Finally, the officials said that the issues that
registrants bring to them may be legally sensitive, so it made sense
that the Chief Counsel's office evaluates them first to determine how
to best address them.
In contrast to OCIE, NASD has created an Office of the Ombudsman to
receive and address concerns and complaints, whether anonymous or not,
from any source concerning the operations, enforcement, or other
activities of NASD. The Office of the Ombudsman is an independent
office within NASD that reports directly to the Board of Directors. As
part of its responsibilities, the Office of the Ombudsman also provides
summary information on the development of trends based on complaints,
which may support resulting system change. By locating the hotline in
an office or division that is independent of OCIE, OCIE could lessen
registrants' concern about the independence of that staff who operate
the hotline and thus encourage greater use of it. Besides assisting
callers with any complaints, the independent office could periodically
summarize information from complaints and concerns for OCIE, while
preserving the anonymity of the contacts. Such information could allow
OCIE management to identify and respond to any trends in this
information and potentially improve the examination program.
Conclusions:
In the aftermath of the widespread trading abuses that surfaced in the
mutual fund industry in late 2003, OCIE has taken steps to make its
approach to examining investment companies and investment advisers more
risk-based. While such an approach may provide a basis for OCIE to
allocate its limited resources to examine firms that are designated as
higher risk for compliance problems, the effectiveness of the program
largely depends on OCIE's ability to accurately determine the risk
level of each investment adviser. Since many firms rated lower-risk are
unlikely to undergo routine examinations within a reasonable period of
time, if at all, harmful practices could go undetected if firms are
inappropriately rated as lower-risk. The risk algorithm that OCIE
employs to predict the level of risk for the majority of investment
advisers is potentially limited in that it relies on proxy indicators
of compliance risks without incorporating information about the
relative strength of a firm's compliance controls, information that is
critical to assessing a firm's risk level. OCIE has recognized this
limitation and has started to take steps to enhance the effectiveness
of the risk algorithm to accurately predict risk levels by seeking
additional information that could improve OCIE's ability to identify
higher-risk firms. Based on fiscal-year-2006 data, OCIE's internal
assessment showed that the risk algorithm has a 91 percent accuracy
rate for predicting lower-risk ratings but appears to have a lower
accuracy rate when considering newly registered investment advisers.
Further, the accuracy rate for higher risk firms was 25 percent--in
part because the risk-rating did not incorporate information on the
firms' ability to mitigate the compliance risks identified. The results
of these initial analyses indicate that continued assessing and
refining the risk algorithm is warranted. As we have previously
recommended, one potential source OCIE might consider, as it continues
to enhance its methods that assess risk, is the documentation
associated with the compliance review that firms must conduct under the
Compliance Program rules. We recognize that SEC would first have to
require that firms submit these reports to SEC through rule making.
However, we continue to believe that using them could potentially allow
OCIE to improve its ability to identify higher-risk firms. As part of
the revised examination approach, OCIE has also implemented a process
intended to identify, map, and develop regulatory responses to high-
risk industry practices and compliance issues across the securities
markets, although it has not yet developed a formal approach to
evaluate the effectiveness of this process for identifying new or
resurgent compliance risks. Implementing the task force that OCIE is
currently considering could facilitate such an assessment.
Our review found that OCIE examiners generally followed OCIE guidance
for conducting exit procedures during the period reviewed, with a major
exception for market-timing and other related sweep examinations
conducted largely over fiscal years 2003 and 2004, with a few
concluding in fiscal year 2005 and fiscal year 2006. OCIE directed
examiners to forgo these exit procedures. OCIE guidance provides
management and examiners flexibility in determining when and how to
communicate deficiencies to registrants and is responsive to
Enforcement's directives. However, by not providing the industry any
notice or explanation of the decision to forgo these procedures for
certain market-timing and other related sweep examinations, OCIE
unnecessarily created concern and confusion for some registrants during
this difficult time. Going forward, OCIE has directed its examiners to
follow standard exit procedures for all sweep examinations.
Since January 2006, OCIE has generally implemented a number of
initiatives to improve coordination and communication. Ongoing
monitoring and reassessing of these initiatives by OCIE is important to
ensure that they are achieving their intended objective. For example,
OCIE's procedure to notify firms when examinations continue beyond 120
days could help mitigate the uncertainty firms told us they experience
when examiners leave the firm and do not update the firm on the status
of examinations for long periods of time. While our review of 13
examinations revealed general compliance with this notification
procedure, OCIE must ensure that examiners continue to adhere to the
requirement in the future. Another new initiative, the examination
hotline, could give registrants an effective means to communicate
concerns or complaints about the examination program, but several
registrants reported reluctance to use it because the hotline was
located in and staffed by OCIE. Their concerns about OCIE's receiving
their complaints or concerns included a perceived lack of impartiality.
Locating the hotline in a division or office that is independent of
OCIE could encourage greater use and increase effectiveness. Further,
this new office could analyze the contact information and give OCIE
management with information summarizing trends generated from analysis
of complaints or inquiries, information that OCIE could use to improve
its examination programs.
Recommendations for Executive Action:
To encourage registrants to communicate their concerns, questions, or
complaints to SEC about the examination process, we recommend that the
SEC Chairman explore relocating the hotline to an independent office
such as an ombudsman function within the agency or within a division or
office that is independent of OCIE and, as part of the responsibilities
of this office, consider requiring it to give OCIE management summary
information on the development of trends resulting from complaints or
inquiries.
Agency Comments and Our Evaluation:
SEC provided written comments on a draft of this report, which are
reprinted in appendix II. SEC also provided technical comments, which
were incorporated into the final draft as appropriate. SEC noted in its
comment letter that while an important benefit of the current
establishment of the hotline is that it provides immediate access to a
member of senior OCIE management, it also wants to encourage calls from
anyone who has a question or concern about an examination. As a result,
SEC stated it is taking steps to revise the hotline in order that
callers can choose to speak with the commission's Office of the
Inspector General, in addition to staff from OCIE's Office of the Chief
Counsel. In taking this step, SEC believes it is preserving the
benefits of the current system while responding to our recommendation.
As agreed with your office, unless you publicly announce the report's
contents earlier, we plan no further distribution of this report until
30 days after the date of this report. At that time, we will send
copies of this report to the Chairmen of the Committee on Financial
Services and its Subcommittee on Capital Markets, Insurance, and
Government Sponsored Enterprises, House of Representatives; and other
interested committees. We will also send a copy of the report to the
Chairman, Securities and Exchange Commission. We will make copies
available to others upon request. The report will also be available at
no charge on our Web site at [hyperlink, http://www.gao.gov].
If you or your staff have any questions regarding this report, please
contact Orice M. Williams at (202) 512-8678 or williamso@gao.gov.
Contact points for our Offices of Congressional Relations and Public
Affairs may be found on the last page of this report. GAO staff who
made major contributions to this report are listed in appendix III.
Signed by:
Orice M. Williams:
Director, Financial Markets and Community Investment:
List of Congressional Requesters:
The Honorable Spencer Bachus:
Ranking Member:
Committee on Financial Services:
House of Representatives:
The Honorable Deborah Pryce:
Ranking Member:
Subcommittee on Capital Markets, Insurance, and Government Sponsored
Enterprises:
Committee on Financial Services:
House of Representatives:
The Honorable Richard H. Baker:
House of Representatives:
The Honorable Vito Fossella:
House of Representatives:
[End of section]
Appendix I: Scope and Methodology:
To better understand the Office of Compliance Inspections and
Examination's (OCIE) revisions to the examination approach for
investment companies and investment advisers after 2003 and the process
OCIE implemented to better identify compliance risks across the
securities markets, we obtained and analyzed information from OCIE on
its revised examination approach for investment companies and
investment advisers and a new, examiner-driven process for identifying
emergent or resurgent systemic risks to investors and SEC registrants.
Specifically, we reviewed OCIE's internal planning documents, a
memorandum from OCIE to the Commission, and data OCIE generated as part
of an internal evaluation on its methodology for assessing compliance
risk at investment advisers. We did not verify these data. We also
observed a demonstration of the information technology application OCIE
uses to conduct its annual risk-assessment process, reviewed prior GAO
reports, and interviewed OCIE and other Securities and Exchange
Commission (SEC) officials.
To identify OCIE's exit procedures and assess the frequency with which
examiners have followed these procedures when conducting investment
company, investment adviser, and broker-dealer examinations, we
reviewed OCIE's guidance to examiners and interviewed officials from
OCIE and industry participants representing investment companies,
investment advisers, and broker-dealers, and analyzed examination data.
We focused our analysis on these registrants because they comprise over
95 percent of all SEC registrants and OCIE expends most of its
examination resources on these entities. We analyzed broker-dealer
examinations separately from investment company and investment adviser
examinations because the two examinations areas have different types of
examinations and are managed separately within OCIE.
We obtained data from OCIE on all investment adviser, investment
company, and broker-dealer examinations completed during fiscal year
2003 through fiscal year 2006. We chose to review this period because
it included a time when OCIE did not require examiners to apply their
usual exit procedures for certain sweep examinations as well as periods
when OCIE said that it applied the exit procedures to most
examinations. We selected random samples of 129 examinations each from
the population of 8,107 investment company and investment adviser
examinations and the population of 3,044 broker-dealer examinations.
This sample size allowed us to project our results from these two
samples to the two respective populations at the 95 percent level of
confidence. All estimates have margins of error of plus or minus 8
percent or less. To determine the extent to which examiners conducted
exit interviews and sent closure notifications in our samples, we
reviewed the electronically available examination reports and, where
necessary, asked OCIE for additional documentation from the examination
files. The results of our analysis for each of these two registrant
types are limited to estimates of this combined 4-year time frame. In
conducting our analysis, we conducted a data reliability assessment of
the data OCIE provided us and determined they were reliable for our
purposes.
To identify OCIE's recent initiatives to increase communication with
registrants and improve the examination program, including the
frequency with which examiners have followed OCIE's new notification
requirement for examinations that continue longer than 120 days, we
reviewed documentation obtained from OCIE, including memorandums to the
Commission, internal OCIE guidance, and the revised examination
brochure. We also analyzed examination data related to the 120-day
notification procedure and interviewed officials from OCIE and the
industry participants previously discussed. In determining the
frequency that examiners have complied with the new 120-day
notification procedure, we obtained data from OCIE of all of the
investment adviser, investment company, and broker-dealer examinations
conducted between July 31, 2006, the day the policy was implemented,
and February 2, 2007, the day OCIE gave us the records. We identified
all closed examinations that lasted 120 days or more, thus triggering
the 120-day notification requirement. Because there were only 13 closed
examinations where the procedure was applicable, we reviewed all of
them. We first reviewed the electronically available reports for
evidence of the notification and, in those cases where we did not find
evidence, asked OCIE for additional documentation from the examination
files. In conducting our analysis, we conducted a data reliability
assessment of the data OCIE provided us and determined they were
reliable for our purposes.
We conducted our work in Washington, D.C., between September 2006 and
July 2007 in accordance with generally accepted government auditing
standards.
[End of section]
Appendix II: Comments from the Securities:
United States:
Securities And Exchange Commission:
Washington, D.C. 20549:
Office Of Compliance:
Inspections And Examination:
August 3, 2007:
Ms. Orice M. Williams:
Director, Financial Markets and Community Investment:
United States Government Accountability Office:
441 G St., NW:
Washington, DC 20548:
Re: Securities and Exchange Commission; Steps Being Taken to Make
Examination Program More Risk-Based and Transparent (GAO-07-1053)
Dear Ms. Williams:
We thank you for your report presenting the results of your audit of
the examination program of the Securities and Exchange Commission
("Commission"). As you note in the report, conducting examinations is
one of the Commission's most important tools in detecting fraud and
violations of securities laws for the protection of investors. As you
note, in fiscal 2006 the Commission conducted over 2,600 examinations
and inspections of investment companies, investment advisers, broker-
dealers, and other registered securities-related firms. We applaud your
findings that overall, steps have been taken to make the Commission's
examination program more risk-based and transparent. Our ongoing
commitment is to maintain excellence in the Commission's examination
program for securities firms registered with the Commission, for the
protection of investors.
As you report, in recent years, with the growth in the number and
activities of securities firms, we've worked hard to develop a variety
of risk assessment tools, including a risk-algorithm for investment
advisers, compliance risk-ratings based on examinations, a program-wide
risk analysis and action process, and expanded usage of commercial
databases and other sources of information. In addition, as you report,
we have been actively developing mechanisms for testing the
effectiveness of our risk assessment tools, including random
examinations of firms scored low-risk, and a sweep review of recently-
registered investment advisers that had been scored low-risk and had
not been examined by the Commission. We are also piloting other
approaches to oversight, such as monitoring teams for selected
entities. We are continuing to identify and consider other sources of
information and data that could assist us in further refining our risk
based programs, including compliance reports of investment advisory
firms, as well as other information. In this respect, we believe that
important new information will be derived from advisers' Form ADV Part
2 when it is filed with the Commission.
As you also report, our program has a very high level of compliance
with our internal standards of practice governing exit interviews and
closure notifications. Indeed, your analysis shows that exit interviews
and closure letters were issued consistent with our internal guidelines
and management guidance in between 96% and 100% of the examinations
sampled. Specifically, compliance with our internal standards was fully
documented (in 79-88% of all examinations), the standard was met but
without documentation (in 3% of broker-dealer examinations), compliance
was waived for allowable reasons (in 2-12% of all examinations), and
compliance was waived by management directive in the exigent
circumstances of the market-timing related reviews initiated in 2003
and 2004 (in 9-11% of fund and adviser examinations). While compliance
with our internal standards with respect to exit interviews and exam
closure letters was very high, we are nonetheless putting in place
system modifications to our internal examination tracking system
(STARS) that we believe will ensure both better documentation and
maximum consistency with our internal guidelines with respect to
providing exit interviews and exam closure letters.
Additionally, as you report, in recent years we have undertaken a
number of new initiatives to enhance our transparency and
communications with the registered community, and to improve inter-
agency coordination. We are pleased that industry representatives
expressed support for these initiatives, and we believe that enhanced
communications with securities firms have served to help improve
attention to compliance in the securities industry. As you note, our
CGOutreach program and our ComplianceAlerts provide compliance
professionals with useful information that they can use to improve
their compliance programs to avoid violations.
Finally, as you note in your report, in 2006, we established a hotline
so registrants can quickly contact a senior member of our management
with any questions or concerns about an examination -- the goal of the
hotline is to improve our responsiveness to the firms we examine by
giving them immediate access to a member of the program's senior
management, We are pleased that registrants told you that they viewed
the hotline as a positive step to provide an additional channel of
communications. In your report, you recommend that we consider
relocating the hotline to an independent office. While we believe that
an important benefit of the current hotline is that it provides
immediate access to a senior examination manager, we want to encourage
calls from anyone who has a question or concern about an examinations.
Therefore, we are developing a revised hotline system, in which callers
will be able to choose to speak either with staff in the Commission's
Office of the Inspector General or staff in the Office of Chief Counsel
in the Office of Compliance Inspections and Examinations. We believe
this responds to your recommendation and also preserves the benefits of
the current system.
We appreciate GAO's attention to these issues.
Sincerely,
Signed by:
Lori Richards:
Director:
[End of section]
Appendix III: GAO Contact and Staff Acknowledgments:
GAO Contact:
Orice M. Williams (202) 512-8678 or williamso@gao.gov:
Staff Acknowledgments:
In addition to the contact named above, Karen Tremba (Assistant
Director), James Ashley, Rudy Chatlos, Nina Horowitz, Stefanie Jonkman,
Christine Kuduk, Marc Molino, Omyra Ramsingh, and Barbara Roesmann made
key contributions to this report.
[End of section]
Footnotes:
[1] SEC regulates investment companies and investment advisers under
the Investment Company Act of 1940, the Investment Advisers Act of
1940, the Securities Act of 1933, and the Securities Exchange Act of
1934. The Investment Company Act and the Investment Advisers Act
requires certain investment companies and investment advisers,
respectively, to register with SEC and thus subject their activities to
SEC regulation. Broker-dealers are required to register with SEC and
are subject to SEC regulation under the Securities Exchange Act of
1934.
[2] We discussed SEC's response to the surfacing of these widespread
abuses previously. See, for example, GAO, Mutual Fund Industry: SEC's
Revised Examination Approach Offers Potential Benefits, but Significant
Oversight Challenges Remain, GAO-05-415 (Washington, D.C.: Aug. 17,
2005) and GAO, Mutual Fund Trading Abuses: Lessons Can Be Learned from
SEC Not Having Detected Violations at an Earlier Stage, GAO-05-313,
(Washington, D.C., Apr. 20, 2005).
[3] Protecting Investors and Fostering Efficient Markets: A Review of
the S.E.C. Agenda Before the H. Comm. on Financial Services, Statement
of Christopher Cox, Chairman, Securities and Exchange Commission, 109th
Cong. 45-46 (2006).
[4] Compliance risks refers to the propensity of an SEC registrant to
be in violation of federal securities laws and regulations or, where
applicable, the rules of a governing self-regulatory organization.
[5] OCIE assigns risk ratings to investment advisers, but not
investment companies. Many investment companies have few employees and
rely on investment advisers to perform key functions such as providing
management and administrative services. When OCIE examines an
investment adviser, it generally examines related investment companies
concurrently. OCIE officials estimated that about one-third of
registered investment advisers have received applicable risk ratings
from an examination as of September 2006.
[6] Currently, the use of these reports is limited to the routine
examinations of investment companies and investment advisers, where
OCIE examiners review the reports as part of the examination planning
process to learn about compliance issues identified by these firms. See
GAO-05-313, p. 35, for previous discussion of these reports and our
related recommendation.
[7] Other compliance issues that surfaced during this time included the
late trading of fund shares and the misuse of material, nonpublic
information.
[8] Percentages do not add exactly to 100 percent due to rounding.
[9] Prior to 2002, routine examinations typically focused on discrete
areas that staff viewed as representing the highest risks of compliance
problems that could harm investors.
[10] In July 2007, after the completion of our fieldwork, NASD and the
member regulation, enforcement and arbitration functions of NYSE
consolidated to become the Financial Industry Regulatory Authority.
[11] OCIE undertakes SRO inspections in order to evaluate whether an
SRO is (1) adequately assessing risks and targeting its examinations to
address those risks, (2) following its examination procedures and
documenting its work, and (3) referring cases to enforcement
authorities when appropriate.
[12] OCIE also conducts surveillance examinations, which are generally
broker-dealer oversight examinations that occur slightly more than 12
months after the examination.
[13] Rule 38a-1 applies to registered investment companies, including
business development companies. See 17 C.F.R. §§ 270.38a-1 (2006). Rule
206(4)-7 applies to registered investment advisers. See 17 C.F.R
§275.206(4)-7. Prior to the adoption of these rules, investment
advisers were already subject to requirements to maintain written
compliance polices and procedures in certain areas. See Compliance
Programs for Investment Companies and Investment Advisers, 68 Federal
Register 74714, 74715 n. 14 (Dec. 24, 2003) (adopting release), for a
list of such requirements.
[14] During 2003, OCIE began to address these concerns by establishing
a 2-, 4-, or 5-year examination cycle based on the size or risk level
of the investment adviser. However, this cycle was not fully
implemented before OCIE made significant changes to its examination
program for investment companies and investment advisers as described
in this section.
[15] OCIE developed the RADAR application in conjunction with staff
from the Office of Risk Assessment (ORA) and OIT. In 2005 and 2006,
RADAR was a database application; in 2007, OCIE and OIT staff enhanced
RADAR to make it a Web-based application.
[16] OCIE officials said that the risks entered into RADAR by SEC
examination staff and managers are based on information learned during
examinations and constitute non-public information.
[17] The risk algorithm, developed by OCIE and the Office of Economic
Analysis, is a formula using values of various factors to derive a
relative ranking for the firm's compliance risk.
[18] Combined, these 20 investment advisers have $8.9 trillion in
assets under management, about 28 percent of all registered investment
advisers' assets under management.
[19] OCIE officials said that the composition of the higher-risk risk
firms examined reflected the composition of the total firms rated
higher-risk at the start of fiscal year 2006, in that slightly more
than half were firms that had received a higher-risk rating through
routine examination and slightly less than half had received higher-
risk rating through the risk algorithm.
[20] In 2005, SEC considered the development of a surveillance program
for OCIE to gather and analyze additional information from investment
companies and investment advisers outside of the data collected in
OCIE's usual examination and reporting process. However, OCIE officials
told us that SEC decided to postpone this effort, which would have
imposed potentially significant costs for SEC and firms and required
formal rule making to implement, in favor of obtaining access to third-
party databases.
[21] OCIE officials told us they are planning to staff the new Branch
of Surveillance and Reporting with a branch chief and four analysts.
[22] OCIE officials said that when preparing to generate the random
sample of investment advisers rated as lower-risk, they first remove
from the universe those firms that were selected and routinely examined
the previous year.
[23] 17 C.F.R. §§ 270.38a-1 and 275.206(4)-7 (2006).
[24] GAO-05-313, 35.
[25] Prior to the December 2001 memorandum, examiners were not required
to offer an exit interview.
[26] Several of the examinations in our sample which resulted in no
deficiencies were market-timing and other related sweep examinations
where OCIE officials told us that in many cases examiners did not
provide any indication of the outcome of the examination regardless of
whether any deficiencies were found.
[27] SEC implemented the CCO Outreach program in 2005. The program is
jointly sponsored by OCIE and Investment Management and is designed to
enable the Commission and its staff to better communicate and
coordinate with the CCOs of investment companies and investment
advisers.
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