Office of Compliance Inspections and Examinations:
Highlights

OCIE conducts routine examinations as well as risk-targeted examinations, some of which are highlighted below. During inspections and examinations, examiners interview firm personnel, review the books and records of regulated entities, and analyze the entity's operations. In many cases, examinations include an on-site visit to the regulated entity’s offices. In addition, as a result of the office's new risk-based methodology, the staff also conducts examinations that do not include on-site visits. The goal of all examinations is to test the registrant's compliance with the federal securities laws and regulations. As a result of examinations, regulated firms often correct the deficiencies identified, and improve compliance controls to prevent them from reoccurring.

OCIE uses risk-based methodologies to focus resources on firms and activities that could pose the greatest risk to investors and the integrity of the markets. Higher risk firms are those that appear to engage in activities associated with emerging or resurgent risks or that simply manage or handle such large amounts of investor assets that if something should go wrong there could be significant harm to both investors and investor confidence. Higher risk activities include those where there are significant conflicts of interest coupled with weak or non-existent compliance policies and procedures to mitigate and manage those conflicts. Firms are often identified for examination based on an assessment of risk — that is, whether the firm, or an aspect of its operation poses risk. Examination scopes are also determined by analyzing risk areas — this means that an exam team may decide, after an evaluation of relevant risk factors, that certain parts of a firm or certain of its activities will be reviewed and not others.

The following are some highlights from previous years.

Broker-Dealer Examinations

The staff conducted reviews that focused on, among other things, the following areas:

1. Market Timing and Late Trading: Significant resources were devoted to dozens of special reviews to identify abusive and/or undisclosed market timing and late trading activities at investment company complexes, investment advisers, broker-dealers, transfer agents, and variable insurance providers.
    
2. Retail Bond Markups: The staff conducted a series of examinations of broker-dealers’ sales practices to determine if they are charging retail customers excessive markups or markdowns on corporate and municipal debt transactions. The staff examined the broker-dealers’ supervision, pricing, transaction reporting, and books and records.
    
3. Municipal Inter-Dealer Brokers: In conjunction with the NASD, the staff conducted examinations of inter-dealer brokers. The examinations focused on various aspects of the bidding process, markups on inter-dealer bond transactions, and record-keeping.
    
4. Consolidated Supervised Entities: The staff conducted examinations of several large broker-dealers that submitted applications to become consolidated supervised entities and become subject to an alternative net capital requirement. The examinations focused on internal controls and systems, procedures and practices for managing credit, market, operational and legal compliance risks, as well as audit and internal reporting.
    
5. Anti-Money Laundering Programs: The staff has worked in conjunction with the self-regulatory organizations to conduct both independent and joint anti-money laundering examinations. OCIE continued to review the compliance practices of broker-dealers with respect to all applicable anti-money laundering rules and requirements.
    
6. Section 529 Plans: The staff conducted a series of examinations of broker-dealers involved in the management and distribution of Section 529 College Savings Plans, focusing on customer suitability, customer disclosure regarding fees and expenses, and switching between plans or other products.
    
7. Structured Finance: The staff and the bank regulators examined eleven large financial institutions in order to evaluate their structured finance business. These exams focused on such areas as policies and procedures, risk management covering credit, market, operational, legal and reputational risks, as well as appropriateness; internal controls with regard to these types of transactions; and included specific transaction testing. Based on these examinations, proposed and final guidance was issued.
    
8. Best Execution: The staff conducted a number of examinations assessing execution quality.
    
9. Compliance Examinations: The staff conducted a series of examinations to evaluate large broker-dealers’ systems designed to meet their supervisory and compliance obligations. These exams have included reviews of affiliated broker-dealers within the broker-dealer complex to identify areas where compliance and supervisory functions cross legal entities.
    
10. Mutual Fund Sales Practices: The staff conducted a series of examinations of broker-dealers focusing on compensation and conflicts of interest related to their mutual fund sales practices. This included a series of examinations of broker-dealers’ revenue sharing and directed brokerage practices.
     
11. Variable Annuities: On June 9, 2004, OCIE issued a public report, "Joint SEC/NASD Staff Report on Examination Findings Regarding Broker-Dealer Sales of Variable Insurance Products", summarizing both sound and weak practices identified during SEC and NASD examinations of broker-dealers’ sales of variable insurance products, particularly with respect to suitability, sales practices, conflicts of interest, supervision, disclosure, books and records and training.
     
12. Internal Controls: The staff continues to conduct periodic reviews of large firms’ internal controls and risk management systems and procedures with respect to market, credit, operational, legal and reputational risks, as well as funding and liquidity. Examinations of large firms have also focused on anti-money laundering controls, data integrity, the effectiveness of business continuity plans, and the internal audit function.

Investment Advisers

The staff conducted reviews in the following areas, either through stand-alone reviews or as an element of routine examinations:

1. Market Timing and Late Trading: Significant resources were devoted to dozens of risk-focused reviews to identify abusive and/or undisclosed market timing and late trading activities at investment company complexes, investment advisers, broker-dealers, transfer agents, and variable insurance providers.
    
2. Best Execution: During routine examinations, the staff focused on advisers’ trade placement practices and obligations to seek best execution of client trades. Advisers’ duty of best execution requires them to periodically and systematically evaluate the services received from broker-dealers and used to execute client trades. Examiners focused on the processes advisers used to comply with this requirement.
    
3. Performance Advertising Claims: Due to the staff’s concerns regarding the accuracy of advisers’ claims and the maintenance of advisers’ performance records, examiners focused on reviewing performance numbers, calculations, and related disclosures to ensure that representations made by advisers were not false and misleading.
    
4. Contingency Planning: The staff focused on policies and procedures adopted by investment advisers that consider the potential impact of disasters on an adviser’s operations, its ability to comply with regulatory requirements, and its ability to continue to operate in ways that are consistent with disclosures that have been made to clients.
    
5. Allocations: The staff focused on the conflicts of interest inherent when clients of advisers have differing compensation structures, or other arrangements in which the adviser may have an incentive to improperly allocate investment opportunities. This conflict is particularly evident in situations involving side-by-side management of hedge funds, large customers, and family members.
    
6. Misappropriation of Customer Assets: The staff continued to focus on advisers’ control procedures designed to prevent the misappropriation of client assets. Staff continued to focus particular attention on compliance with the amendments to the advisers’ custody rule that were adopted by the Commission in September 2003.
    
7. Personal Securities Trading: The staff conducted reviews of personal trading to assess internal controls and policies for monitoring employee trading, including a review of insider trading policies established pursuant to Section 204A and Codes of Ethics established pursuant to Rule 17j-1. Particular emphasis was placed on recent market timing and late trading scandals in which fund and adviser employees’ engaged in abusive personal trading in mutual funds that their firms advised.
    
8. Pension Consultants: The staff reviewed the activities of pension consultants that advise pension plans and other large investors as to which money managers the investor should retain. OCIE initiated a risk-focused review in order to evaluate the conflicts of interest that could affect the advice pension consultants give to their clients, and the disclosure of these practices.

Investment Companies

The staff conducted reviews in the following areas, either through stand-alone reviews or as an element of routine examinations:

1. Market Timing and Late Trading: Significant resources were devoted to dozens of risk-focused reviews to identify abusive and/or undisclosed market timing and late trading activities at investment company complexes, investment advisers, broker-dealers, transfer agents, and variable insurance providers.
    
2. Investment Company Pricing Procedures: The staff focused on investment company fair valuation procedures employed by funds with various objectives, including international, high yield, and small capitalization funds. For example, the staff reviewed the following: changes to fair value procedures adopted by fund boards within the past few years to reflect industry guidance and/or in response to recent market timing and late trading scandals; funds’ implementation of fair valuation procedures during select periods; and funds’ procedures to assess fund pricing reasonableness.
    
3. Payments to Obtain Business: The staff conducted several risk-focused reviews to identify undisclosed payments by service provider in attempts to obtain business opportunities with investment company complexes. In addition, the staff focused on the disclosures to fund boards and the policies and procedures related to the consideration and approval of contracts with such service providers.
    
4. Fund Expenses: The staff closely evaluated the fund expenditures to probe for misuse, including any existing arrangements that benefit the adviser or an affiliate, any undisclosed side arrangements that provide for benefits to accrue to the adviser or an affiliate, or any other arrangements that may disadvantage funds and/or their shareholders. The staff focused particular attention on the disclosure of these arrangements to the funds’ boards.
    
5. Money Laundering Prevention: The staff evaluated whether registrants’ policies and procedures are appropriate in light of their business, their customers and whether they are likely to identify suspicious activities. The staff reviewed whether funds, fund transfer agents, and advisers had adequate procedures to monitor the activities of their customers to identify suspicious activity that could indicate money laundering.
    
6. Disaster Recovery Planning: The staff reviewed policies and procedures adopted by fund boards and investment advisers that consider the potential impact of disasters on an entity’s operation, its ability to comply with regulatory requirements, as well as its ability to continue to operate in ways that were consistent with prospectus disclosures.
    
7. Proxy Voting: The staff focused on proxy voting policies and procedures during routine inspections. Specifically, staff reviewed policies and procedures to ensure that proxy voting disclosures were consistent with votes cast.
    
8. Selective Disclosure: The staff reviewed funds’ policies and procedures to evaluate whether portfolio information was being selectively disclosed.

http://www.sec.gov/about/offices/ocie/ocie_highlights.shtml