Third-party Examinations of Investment Advisers on the Horizon


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U.S. Securities and Exchange Commission (“SEC” or “Commission”) Chair Mary Jo White has made a number of public comments indicating that the SEC is considering former commissioner Daniel Gallagher’s recommendation to allow third-party entities to conduct examinations of registered investment advisers.

White stated that the staff has completed its recommendation to allow third-party exams and that a proposal is now with her fellow commissioners. She made these remarks during the Securities Industry and Financial Markets Association (“SIFMA”) annual conference in Washington, D.C., held on September 22, 2016.

While speaking to reporters, White elaborated that the commissioners could vote on whether to propose the recommended independent compliance reviews. It’s not clear, however, when the SEC, which currently has only three of its usual five members, would act. Two nominees to fill the SEC vacancies—Republican Hester Peirce and Democrat Lisa Fairfax—are awaiting confirmation from the Senate.

Program seeks more frequent audits of investment advisers

White’s comments follow recent statements by Diane Blizzard, Associate Director for Rulemaking at the Commission’s Division of Investment Management. Blizzard announced at the SEC Speaks conference in Washington, D.C., that her team is actively working on a proposal for how a third-party program could work to improve oversight of registered investment advisers.

The program’s obvious goal appears to be more frequent audits of SEC-registered investment advisers, the number of which has grown approximately 35 percent—from about 8,500 to nearly 12,000—in the past ten years.

SEC feeling pressure to increase number of exams

At the same time, the staff resources of the Office of Compliance Inspections and Examinations (“OCIE”) have not kept pace with this growth, and the SEC has been under political and public pressure to increase the volume of examinations conducted each year beyond the current ten percent sample of all registered entities. The SEC would like to increase the coverage rate to about 50 percent, and allowing for third-party exams is seen as one way to help the agency boost its own efforts.

Ironically, third-party exams are not among the three recommendations put forth by the SEC’s Division of Investment Management in the 2011 study conducted as required by Section 914 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The study instead discussed the following alternatives:

  • Imposing user fees on SEC-registered investment advisers to fund their examinations by OCIE
  • Authorizing one or more self-regulatory organizations (“SROs”) to examine, subject to SEC oversight, all SEC-registered investment advisers
  • Authorizing the Financial Industry Regulatory Authority (“FINRA”) to examine dual registrants for compliance with the Investment Advisers Act of 1940

A range of variables to be considered

The SEC has not yet provided details regarding the anticipated third-party review proposal. Proposed examinations could range from full SEC-type mock exams to more limited engagements in areas of specific concern. Other variables could include:

  • Applicable independence standards
  • Frequency of examinations
  • Cost and cost bearers
  • Qualifications of acceptable third parties
  • SEC’s oversight of those parties and whether the results of such reviews will be reported to the Commission or simply made available upon request during an SEC examination

Shifting resources from the broker-dealer side

The SEC has noted that the program would not be intended as a replacement for examinations currently conducted by OCIE, but rather serve as a supplement for improving overall compliance by registered entities.

The Commission has already demonstrated its commitment to increased examination frequency by shifting 100 broker-dealer examiners to the investment adviser side, making new hires and budgeting for 102 new dedicated IA examiners in fiscal year 2017.

Take proactive steps to prepare now

Despite the current lack of detail, advisers can and should take affirmative steps now to prepare for mandated third-party exams by engaging independent experts to conduct mock audits or compliance program reviews. It’s far better to remedy any issues identified by a friendly partner working for you, rather than under an imposed arrangement under which findings may be required to be reported to the Commission.