Are you a Prime Target for SEC EXAMS? Determining your Risk Quotient and How to Prepare.

A common question that investment advisers often wonder is: When is the next time the U.S. Securities and Exchange Commission (“SEC”) will examine me?

The answer to this often lies in the risk quotient tied to the firm.

When the last time the adviser was examined, new products and service offerings, and tips, referrals and complaints all factor into this. The SEC has a risk-based approach to determining when advisers should be examined which also can be driven by new rules and resources available to the SEC staff to conduct registrant examinations.

Out of all the SEC registered investment advisers (“RIAs”) in the United States, in 2023, approximately 15% of RIAs were examined.

Which RIAs have a higher risk profile? There are several characteristics of advisers who are a prime target for SEC examinations.

• Dually registered advisers are considered higher-risk due to the potential for conflicts of interest.
• Private fund advisers are considered higher-risk due to more complex investment strategies used, performance fee conflicts of interest, and investor disclosure requirements.
• Advisers who manage crypto or other digital assets are considered higher-risk due to regulatory oversight concerns, client disclosures and market volatility.
• RIAs that have custody of client assets are considered higher-risk because of the advisers’ heightened fiduciary duty to clients due to safeguarding and holding client assets.
• RIAs with recent changes in leadership can be considered higher-risk due to the change in management and impact on business operations.

RIAs that meet the above criteria can proactively address the concerns of the SEC and ensure they maintain a strong compliance program that is transparent and thorough. RIAs who fall into the high-risk category should be aware of the extra scrutiny that comes with the high-risk, high-reward nature of their business structure. Maintaining a year-round effort towards compliance will make examinations a smoother process.

SEC examinations are a necessary part of our business. Having a solid understanding of your potential compliance issues and maintaining a tight-compliance ship, as well as keeping up with new and amended regulations, is key to staying ahead of the curve. However, many RIAs don’t know what they don’t know, and that is where most of the issues arise.

To prepare, there are several things you can do.

1. The SEC provides a list of Examination Priorities each year, which for 2024, can be seen here: https://www.sec.gov/files/2024-exam-priorities.pdf. Review carefully and focus on these hot topics.
2. The US Securities and Exchange Commission (SEC) Division of Examinations (EXAMS) publishes Risk Alerts throughout the year to provide advisers with guidelines and information on areas of compliance to focus their attention. The goal of these Risk Alerts is to remind advisers of their regulatory obligations and provide them with the opportunity to address any issues. See https://www.sec.gov/compliance/risk-alerts for more information.
3. Conduct a mock SEC exam. JLG performs mock SEC exams and tests the readiness of firms – from mock interviews to document production, and getting ready to make a positive impression, JLG assists firms so that they can have a positive exam experience.

If you have questions on how to prepare for an SEC examination or for more information on our mock SEC exam services, feel free to give us a call at 619.298.2880 or email [email protected].