2010 INVESTMENT ADVISER TRAINING SEMINAR

August 9, 2010

James Reese, CFESenior Staff Accountant

Office of Compliance Inspections and Examinations

U.S. Securities and Exchange Commission

Disclaimer

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees.

The views expressed herein are those of the author and do not necessarily reflect the views of the Commission, its Commissioners, or the staff.

Agenda

SEC’s Investment Adviser Examination Program

Risk Assessment Risk-Based Examinations Red Flags Q & A

Financial Reform Impact

The Commission’s examination program has created a multi-office taskforce to help coordinate with and dedicate resources to state regulators as a result of the financial reforms.

Investment Adviser Examination Program

Investment Adviser Examination Program

~450 Examiners Nationwide

~12,000 Investment Advisers

~800 Investment Company Complexes

~1,200 IA Examinations Conducted Each Year

Investment Adviser Examination Program

Examination Types Risk-Based Examinations of High Risk Firms

Higher Risk Business Activities Filing Data/Anomalies Previous Examination Changes in Operations Never Examined Surveillance of Information

Cause (Tips, Complaints, Referrals) Sweeps

Common Findings

Compliance Rule Policies and Procedures Annual Review

Disclosures and Reporting Inaccurate Filings

Personal Trading Code of Ethics

Performance and Marketing Misleading Materials Performance Calculations

Portfolio Management Internal Controls

Investment Adviser Examination ProgramOCIE’s Self Assessment

1. Placing greater reliance on risk assessment procedures and techniques to better identify areas of risk to investors, including working closely with our Division of Risk, Strategy, and Financial Innovation to develop better risk assessment algorithms and expanding risk-based scoping prior to exams;

2. Outlining a new “open architecture” system for staffing exams that will enable management to reach across disciplines and specialties to better match the skills of examination teams to the business models and risk areas of registrants;

3. More rigorously reviewing information about firms before sending examiners out to the field so that we can use our limited resources more effectively and target those firms with the greatest risks;

4. Enhancing the training of examiners and re-focusing on basics such as exam planning, tracking, and accountability;

5. Creating a sharable database of information on registrants of mutual interest to Enforcement, OCIE, and other regulators; and

6. Redesigning our exam team structure to ensure that managers spend additional time in the field at registrants.

Investment Adviser Risk Assessment

How do we select exam candidates?

Investment Adviser Risk Assessment

Analysisof Form

ADV Informat

ion

Exam History(i

es)

Additional

FilingData

3rd Party Data

Tips/Complai

nt/Referral

s

Regional

Office Input

Commission

Priorities/

Risks

Examination Candidate

Investment Adviser Risk AssessmentForm ADV Analysis

Assessment of Business Activities Average Account Size Ratio of Employees to Total Assets Side-by-Side Management of Accounts # of Investment Advisory Branch Offices % of Owners/Officers with Disciplinary History % of IA Reps with Disciplinary History Material Changes in Business Operations

Assets Custody Disciplinary History

Investment Adviser Risk AssessmentExam History

Poor controls/inadequate compliance structure Types of deficiencies

Additional Filing Data EDGAR

3rd Party Data Mostly marketing-oriented

Investment Adviser Risk AssessmentTips, Complaints, Referrals

External and internal

Regional Office Input Closer to Registrants

Commission Priorities Focus Areas Themes Trends

Risk-Based Examinations

Risk-Based Examinations

Identify Important Activities and Related Control and Supervisory Systems

Identify Activities that Present Greater Risks of Violations or Harm to Clients or Shareholders

Identify Areas from Previous Exam that Warrant Greater Scrutiny

Evaluate Potential Problem Areas

Risk-Based Examinations

Measuring Risk Higher Risk: High level of uncertainty that

problems/conflicts will identified and resolved

Lower Risk: Low to moderate level of uncertainty that problems/conflicts will be found and resolved

Risk-Based Examinations

What are the factors that should be considered to determine the level of control risk present in a firm?

Risk-Based Examinations

1. Is a firm’s process for identifying and assessing the problems and conflicts of interest that may occur in all of its activities effective and is that process likely to identify new problems and conflicts that may occur as the future unfolds?

What is the firm’s process for identifying and assessing the impact of possible problems and conflicts?

The risk identification process should cover all activities of a firm.

Risk-Based Examinations

2. Is a firm’s process for creating policies and procedures that address the need to mitigate and manage its potential problems and conflicts effective?

Is each risk addressed? Do the policies and procedures include quality

control, forensic tests, reporting of results and follow up?

How does the firm keep its policies and procedures current and comprehensive?

Risk-Based Examinations

3. Are policies and procedures implemented based on sound principles of management?

Have clear lines of responsibility for each risk area and related policy and procedure been assigned?

Is there a separation of functions? Is there any exception reporting? What is the escalation process?

Risk-Based Examinations

4. Review and Renewal Does the firm’s compliance program should

include policies and procedures that promote automatic processes for reviewing existing risk inventory and reviewing the factors found to be weak or ineffective?

Do business and compliance events trigger review and renewal process?

Are there plans provide for a continuous or rolling review and renewal of all activities not touched by events?

Risk-Based Examinations

Bottomline:

Are a firm’s risk management processes, its operating policies and procedures and its control processes likely to identify and resolve the problems and conflicts?

• If controls appear to be effective, risk may be low and examiners can rely on the controls and may limit any further testing.

• If controls are ineffective, risk may be high and examiners may need to conduct a more detailed review of an area or all areas.

• If maybe, controls in some areas may be effective in other areas ineffective and examiners may need to do further testing

Examination Red Flags

Examination Red Flags

Information doesn’t “make sense” given what we know or what is portrayed to the public Documents provided by Registrant Interviews conducted with personnel Information in the public domain

Websites News Articles Public Databases

Education Claims Can be verified with the Institution or via

National Student Clearinghouse Professional Work Experience

Can be substantiated (or contradicted) with news/media/press releases, CRD info, Bloomberg, etc.

Unrelated Work Experience Firm’s Website or Individual’s Webpage

Professional Licenses Can be verified directly with the

Organization/Association (E.g. CPA, CFA, CFP, etc.)

Red Flags: Credential Verification

Red Flags: ‘Legal’ History

Lawsuits, Regulatory Actions, Tax Liens Identify frequent ‘run-ins’ with the law Identify information within cases that

contradicts other data Regulatory History via CRD

Databases/Sources Westlaw, Lexis, CLEAR

Red Flags: Lifestyle Assessment Public Record Review of ‘Lifestyle’

Is the individual living outside his/her means? Identify individuals with several assets (cars,

boats, planes, real estate) Financial stress of assets (liabilities)

View bankruptcy filings Assessment of firm’s revenues

Databases/Sources Westlaw, Lexis, CLEAR, Web CRD

Red Flags: Other Business Activities Undisclosed Conflicts?

Related business that presents certain conflicts Co-located

Databases/Sources GoogleMaps, Westlaw, Lexis, CLEAR,

CRD/IARD, Internet, LinkedIn

Red Flags: ‘Negative’ Information Identification of any ‘negative’

information said about a firm/individual

Databases/Sources Internet

Red Flags: Other Considerations Unique Red Flags

Use of personal email addresses Yahoo, Google, Hotmail, etc.

No information found Time gaps in information Name changes (firm name and employee names) Multiple offices/locations for records

Red Flags: Consider Your Findings Is the due diligence consistent with

information provided by the firm? Marketing Materials

Website(s), pitch books, 3rd party data submission

Financials Payments to and revenue from

Other Disclosures to Clients Offering docs, contracts, prospectus, etc.

Red Flags: Caveats

Conducting Research on Individuals is Very Difficult False Positives Name Iterations

John Doe, Jon Does, Jonathan Doe, J. Doe JPMorgan, J.P. Morgan, JP Morgan, J P Morgan

Acronyms/Abbreviations Two Twelve Partners may manage the 212 Hedge

Fund Aston Martin Management Inc. vs. AMM Inc. Mario Brothers vs. Mario Bros. Energy Fund vs. The Energy Fund

Questions…?

Thank You