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Richards Concerned About Inconsistencies in Deficiency Letters and the Law 

At a recent IA Week and Investment Adviser Association conference, Lori Richards, the director of the SEC's Office of Compliance Inspections and Examinations, said she was disheartened by criticism that there is sometimes a divergence in the staff deficiency letters and the law or legal interpretations from the Divisions of Investment Management or Market Regulation. The staff has a responsibility to make sure that it is applying consistent and accurate interpretations of the law, she said. She urged firms to notify the staff of any instances of divergence with examination findings and applicable law. Richards added that a lot of behind-the-scenes communication occurs with the divisions to ensure that the examinations are consistent with the law and current interpretations. She said she is committed to addressing the criticisms.

Richards reported that most of the examinations find areas in which advisers have not fully complied with the Investment Advisers Act. About 81% of the 2006 examinations of over 1,300 advisers resulted in a nonpublic letter from the staff seeking corrective action, she said. About 6% of the examinations uncover serious violations that are referred to the enforcement staff for further investigation. Richards advised that many of the enforcement actions that are brought each year against funds or advisers are the result of these referrals.

Richards said the staff's job is not to make policy, but to examine for compliance with existing laws and rules. The staff does not have a minimum number of examinations that must result in enforcement referrals. The training is extensive and includes coordination with other divisions, including with those who write the rules.

Richards said the staff must use sound and consistent judgment when examining firms for compliance with the SEC's new compliance rule. The compliance rule, which requires firms to have compliance policies and procedures, is a principles-based rule, according to Richards. The rule requires sound judgment by the examiners and by those who design the compliance programs, she said.

Richards discussed the merits of the SEC's CCOutreach Program, which assists chief compliance officers with the challenges they encounter. The compliance community has made clear that it needs practical information about specific compliance mechanisms that work, she said. At the CCOutreach events, examiners share information with CCOs about the types of deficiencies they have encountered, as well as policies and procedures to address the problem areas.

Richards outlined the most common deficiencies that were found in the 2006 examinations, which included information disclosure, reporting and filings. The staff found inaccurate or incomplete disclosures, untimely filings and the untimely delivery of information to clients, according to Richards.

The staff also found deficiencies with respect to the compliance rule, including manuals that did not address a firm's risk or listed risks that did not exist at the firm. Some manuals established procedures that the firm did not follow.

Another problem involved personal trading by advisory firm personnel, including deficient codes of ethics, trading that was not reported or reviewed, and improper allocations of securities to personal or proprietary accounts.

The staff also found problems in performance advertising and marketing, including the omission of relevant disclosure, and problems in information processing.

Richards said this year's examinations will include the issues that arose last year, but will also focus on possible insider trading, brokerage arrangements, best execution and soft dollars, allocations of trades, personal/proprietary trading by advisers, pricing and valuation, controls to prevent the theft of client funds and information, and supervision.