OCIE Exam Process Overview

7/31/2019 OCIE Exam Process Overview

1/45

EXAMINATIONS BY THE SECURITIES AND EXCHANGE

COMMISSIONS OFFICE OF COMPLIANCEINSPECTIONS AND EXAMINATIONS

February 2012

I. EXAMINATIONS OF INVESTMENT ADVISERS,INVESTMENT COMPANIES, BROKER-DEALERS,

MUNICIPAL SECURITIES DEALERS, TRANSFER

AGENTS, CLEARING AGENCIES, SELF-REGULATORY ORGANIZATIONS, MUNICIPAL

ADVISORS, AND OTHERS

A. Executive Summary1. The Commissions Office of Compliance Inspections and

Examinations (OCIE) supports the SECs mission toprotect investors; maintain fair, orderly, and efficientmarkets; and facilitate capital formation by conductingexaminations through examination teams in the homeoffice in Washington, DC and in regional offices locatedin Atlanta, Boston, Chicago, Denver, Fort Worth, LosAngeles, Miami, New York, Philadelphia, Salt Lake City,and San Francisco. Collectively, the examination staff inthese offices carries out the Commissions NationalExamination Program (NEP) for investment advisers,

investment companies, broker-dealers, municipalsecurities dealers, transfer agents, clearing agencies, self-regulatory organizations (SROs), municipal advisors,and others.

2. The enactment of the Dodd-Frank Wall Street Reform andConsumer Protection Act of 2010 (Dodd-Frank Act),Pub. L. No. 111-203, 124 Stat. 1376, on July 21, 2010,expands the Commissions examination authority toinclude several additional types of entities/persons. Theseare discussed in more detail below.

3. OCIE has continued to implement the recommendations ofthe top-to-bottom self-assessment that it began in 2010of the strategy, structure, people, process, training and


2/45

2

technology improvements that should be made to the

examination program. The results so far of thisimplementation are discussed in more detail below.

4. The goals of the examinations conducted by staff in theNational Examination Program are to (1) improvecompliance, (2) prevent fraud, (3) inform policy, and (4)monitor firm-wide and systemic risk. When the staffconducts special examinations to gather information aboutareas of interest or concern to the Commission, thefindings of such examinations are occasionallysummarized in a public report.

5. Given the number of registrants and the breadth of theiroperations, the staff continues to focus examinationresources on those registrants and activities where staff inthe NEP believes that the investing public or marketintegrity is most at risk.

B. New Developments in 2011

1. Enforcement Actions Resulting from NationalExamination Program Referrals.As a result of close cooperation between the NEP and theDivision of Enforcement, a number of significant

enforcement actions were brought in 2011. These includecases that: stopped Ponzi schemes; highlighted materialdisclosure misrepresentations or omissions; identifiedundisclosed remuneration or hidden fees and expensescharged to investors; involved false and/or inflatedvaluations; and stressed the importance of effectivecompliance controls. Notable cases brought in FY 2011resulting from NEP examination referrals include:

Morgan Asset Management Inc. and Morgan Keegan &

Company Inc. The Commission, state regulators, andFINRA brought a settled action against Morgan Keegan

and its asset management affiliate in which MorganKeegan and its affiliate agreed to pay $200 million tosettle fraud charges related to subprime mortgage-backedsecurities. Two Morgan Keegan employees also agreed to


3/45

3

pay penalties for their alleged misconduct, and one was

barred from the securities industry. According to theSECs order, the case involved the false valuation ofsubprime MBS in five funds managed by Morgan AssetManagement from January 2007 to July 2007. TheCommissions Order found that Morgan Keegan did notemploy reasonable pricing procedures and publishedinaccurate daily NAVs, selling shares to investors basedon inflated prices. The case originated in an examinationby the Atlanta Regional Office.

SEC v. H. Clayton Peterson. The Commission brought aninsider trading action against a board member at Mariner

Energy, Inc., H. Clayton Peterson, and his son, DrewPeterson. The Department of Justice also announced thatClayton and Drew Peterson both pled guilty in New Yorkfederal court to one count of securities fraud and one countof conspiracy to commit securities fraud based on the sameconduct. The Commission alleged that Clayton Petersonlearned details about Mariner Energys upcomingacquisition by Houston-based Apache Corporation duringvarious board meetings, and that he then conveyed thenonpublic information to his son. Drew Peterson thenpurchased Mariner Energy stock for himself, his relatives,his clients, and a close friend. Drew Peterson also tipped

others, including a portfolio manager at a registeredinvestment adviser. The Commission alleged that theinsider trading by the Petersons and others generated morethan $5.2 million in illicit profits. This case originatedfrom a referral from the Denver and San FranciscoRegional Offices exam staff.

Securities and Exchange Commission v. Stifel, Nicolaus &

Co., Inc. The Commission brought an action chargingStifel, Nicolaus & Co. and registered representative DavidW. Noack with defrauding five Wisconsin school districtsby selling them allegedly unsuitable structured products.

The complaint alleges that the school districts contributed$37.3 million toward the $200 million investment andborrowed the remaining $162.7 million, and that the heavyuse of leverage and the structure of the synthetic


4/45

4

collateralized debt obligations (CDOs) exposed the

school districts to a heightened risk of catastrophic loss.According to the Complaint, the school districts ultimatelysuffered a complete loss of their investment andcorrespondingly suffered credit rating downgrades. Thecase resulted from a referral from the Chicago RegionalOffice exam staff.

SEC v. AXA Rosenberg. The Commission brought a settledaction charging three AXA Rosenberg entities (AR)with securities fraud for allegedly concealing a significanterror in the computer code of the quantitative investmentmodel that they use to manage client assets. The error

caused $217 million in investor losses. AR agreed to settlethe SEC's charges by paying $217 million to harmedclients plus a $25 million penalty, and hiring anindependent consultant with expertise in quantitativeinvestment techniques who will review disclosures andenhance the role of compliance personnel.

According to the SECs Order, senior management at ARlearned in June 2009 of a material error in the model'scode that disabled one of the key components formanaging risk. Instead of disclosing and fixing the errorimmediately, a senior AR official directed others to keep

quiet about the error and declined to fix the error at thattime. The SECs Order states that the SEC staff found thatthe error, which was introduced into the model in April2007, was eventually fixed for all portfolios. However,according to the Order, knowledge of the error was keptfrom AR's Global CEO until November 2009. AR thenconducted an internal investigation and disclosed the errorto SEC examination staff in late March 2010 after beinginformed of an impending SEC examination. AR disclosedthe error to clients on April 15, 2010. The case resultedfrom a referral from the Los Angeles Regional Officeexam staff.

SEC v. Francisco Illarramendi. The Commission broughtan action charging Illarramendi, a Stamford, Connecticut-


5/45

5

based investment adviser and related hedge fund entities,

with allegedly engaging in a multi-year Ponzi schemeinvolving hundreds of millions of dollars (probablyupward of $200 million). According to the Commissionsamended complaint, Illarramendi misappropriated assetsand used two hedge funds for Ponzi-like activities inwhich they used new investor money to pay off earlierinvestors. The case has also produced criminal charges bythe United States Attorney for the District of Connecticut.The fraud was first uncovered by Commission examinersduring a risk-based exam of an SEC-registered adviserwith which Illarramendi was affiliated. Despite efforts byIllarramendi to obstruct the examination and mislead the

staff conduct that led to a criminal charge of obstructionof justice the examiners and their colleagues in theEnforcement Division obtained evidence of the fraud.

SEC v. Tamman. The Commission brought anadministrative action against a lawyer for allegedlyaltering documents submitted to the Commission staff toconceal fraudulent conduct by his client, NewPointFinancial Services, Inc. Separately, the Commissionbrought an enforcement action against NewPoint for thealleged fraudulent offer and sale of over $20 million ofdebentures to over 100 investors. The case arose from an

unannounced cause exam of NewPoint that uncoveredboth the alleged fraud and the lawyers alleged effort toconceal it.

SEC v. Paul George Chironis. The Commission broughtan action charging that Chironis, a registeredrepresentative of a broker-dealer, allegedly churned twoaccounts owned by the Sisters of Charity one account forcare of nuns in assisted-living facilities and a secondaccount to support the nuns charitable endeavors.

Janney Montgomery Scott LLC (JMS). The

Commission brought a settled action charging that JMS, aPhiladelphia-based regional broker/dealer owned by PennMutual Insurance Company, allegedly failed to properlyestablish, enforce, and maintain policies and procedures


6/45

6

that were reasonably designed to prevent the misuse of

material, nonpublic information.

JMS agreed to be censured and to pay an $850,000 penaltyto settle the SECs administrative proceeding. It alsoagreed to cease and desist from committing or causing anyviolation of Section 15(g). The case resulted from areferral from the Philadelphia Regional Office exam staff.

SEC v. Raymond James Financial Services, Inc

(Raymond James). The Commission instituted andsettled an action with Raymond James and affiliatedentities, based on alleged misrepresentations and

omissions of material information in connection with thesale of over $2.4 billion in market value of auction ratesecurities to their customers. The SECs Order finds thatthe firm willfully violated Section 17(a)(2) of theSecurities Act of 1933. The Commission censuredRaymond James, ordered it to cease and desist from futureviolations, and reserved the right to seek a financialpenalty against the firm. Without admitting or denying theSECs allegations, Raymond James consented to theSECs order and agreed to, among other things, repurchaseover $280 million in market value of auction rate securities(the remaining securities held by its customers).

Direct Edge ECN LLC (Direct Edge). TheCommission instituted and settled an action against DirectEdge and its affiliates, comprising two electronicexchanges and a broker-dealer. According to theCommissions Order, Direct Edge is alleged to havecommitted violations of U.S. securities laws arising out ofweak internal controls that resulted in millions of dollars intrading losses and a systems outage. The SECs Orderinstituting administrative proceedings further stated that, intwo incidents in 2010 and 2011, various technological andhuman failures resulted in significant trade errors and

disruptions at the two exchange affiliates of Direct Edge,EDGA, and EDGX. The Commission also found that inresolving resulting overfilled trades in one of these


7/45

7

incidents, failures to mark orders as short, or mismarking

of orders as long occurred, violating the SECs RegulationSHO. On the other occasion, EDGX is alleged to havewaited approximately 24 minutes after a trading outage toremove its quotations from public market data, andviolated the SECs Regulation NMS by failing toimmediately identify its quotations as manual quotations.Direct Edge consented to an order censuring it and itsaffiliates and requiring them to cease and desist fromfurther violations of U.S. securities laws and to takeremedial efforts to strengthen their information technologysystems and controls and compliance procedures.

Pipeline Trading Systems LLC. (Oct. 24, 2011). TheCommission brought a settled action charging Pipeline andtwo of its top executives with failing to disclose tocustomers of Pipelines dark pool trading platform thatthe vast majority of orders were filled by a tradingoperation affiliated with Pipeline. According to the SECsOrder, Pipeline described its trading platform as acrossing network that matched customer orders withthose from other customers, providing natural liquidity.The SECs Order found that Pipelines claims were falseand misleading because its parent company owned atrading entity that filled the vast majority of customer

orders on Pipelines system. It said the affiliate, mostrecently known as Milstream Strategy Group LLC, soughtto predict the trading intentions of Pipelines customersand trade elsewhere in the same direction as customersbefore filling their orders on Pipelines platform. TheSECs Order found that Pipeline generally did not providethe natural liquidity it advertised. According to theSECs Order, Pipeline took certain steps to address theconflict of interest it created, including by paying theaffiliates traders using a formula that rewarded them inpart for giving favorable prices to Pipelines customers.The SECs Order found that Pipeline failed to disclose the

compensation formula or Milstreams activities to itscustomers or in its filings to the SEC. Pipeline agreed topay a $1 million penalty to settle the matter. Pipelinesfounder and chief executive officer, Fred J. Federspiel, and


8/45

8

its chairman and former chief executive, Alfred R.

Berkeley III, a former president and vice chairman of theNASDAQ Stock Market, each agreed to pay $100,000.

2. Self-Assessment of the NEP. As a result of therecommendations made by multiple task forces of staffand managers from all Regions, NEP staff in the home andregional offices embraced the following core principles toguide them as a team.

a. Risk-Based Approach: The NEP is committed tostrengthening its risk assessment processes so OCIEcan allocate the limited resources of the NEP to their

highest and best use.

The staff draws on numerous sources for identifyinghigher risk registrants and selected areas of focus.Sources include, among other things, tips, complaints,and referrals; analysis of outlier or aberrationalinformation provided to investors; prior examinationfindings; significant changes in registrants businessactivities; and registrant or registered representativedisclosures regarding regulatory and other actionsbrought against them. OCIE staff works with theDivision of Risk, Strategy, and Financial Innovation to

develop models to identify registrants with anomalouscharacteristics; registrants that do not meet certainthresholds for established financial metrics; registrantsthat exhibit high-risk sales practice patterns; andrelationships among registrants exhibiting similarcharacteristics. OCIE has established an Office ofRisk Assessment and Surveillance (ORAS) toevaluate risks across all of the markets and registrantcategories that are examined by the NEP, and ORAShas launched a range of risk assessment models andtools to strengthen its risk-assessment capabilities.ORAS now plays a central role in determining which

registrants to examine as well as the scope ofexaminations.

b. Teamwork and Collaboration: OCIE, working


9/45

9

through the home and regional offices, is fostering a

heightened culture of teamwork, collaboration, andconsultation across the NEP and the SEC morebroadly. This will enable the program to make thebest informed decisions possible as it sets newstandards and executes its mission. For example,OCIE has established regular monthly nationalteleconferences of examiners across regions and thehome office, new processes for communicating withthe Division of Enforcement about new or pendingexamination referrals, and mutual goal-setting betweenOCIE and the Divisions of Trading and Markets,Investment Management and Risk, Strategy and

Financial Innovation.

c. Ongoing Improvement and Accountability

: The NEPis continuing to set high standards and expectations forthe staff, and holds the staff accountable to each otherfor achieving goals and objectives, and then goingfurther. OCIE is also providing more and bettertraining to its examiners, including working on anexaminer certification program.

d. Focus

: The examination staff will seek to pursue thefacts where they lead, analyzing root causes, and

executing plans with discipline and focus.

e. Accomplishments to Date:

i. As discussed above, an enhanced risk-focusedexamination strategy was implemented.

During 2011 thefollowing accomplishments in implementing therecommendations of the self-assessment, amongothers, were achieved:

ii. Steps to improve teamwork and collaborationwith other SEC divisions and offices havebeen adopted, as well as steps to improvecoordination with regulatory partners,

including SROs.iii. Raised the level of dialogue with senior

management and boards of directors of anumber of registered entities.


10/45

10

iv. Raised the level of staff engagement and

transparency within the NEP through stepssuch as monthly video calls for the entireexamination staff nationwide, focus groups, anNEP newsletter, and greater training in anduse of SharePoint.

v. Enhanced industry engagement throughconferences and transparency initiatives suchas speeches, published sweep reports and riskalerts, improvements to our website,Webinars, and outreach programs.

vi. Developed a new national governancestructure for the NEP to strengthen oversight,

collaboration and decision-making. Thegovernance model includes seniormanagement from the home and all regionaloffices.

vii. Launched specialized working groups toconcentrate and grow expertise in thefollowing areas: New and Structured Products,Valuation, Equity Market Structure andTrading Practices, Fixed Income andMunicipal Markets, Microcap Fraud, andMarketing and Sales Practices.

ix. Introduced project-based staffing to enable

more dynamic resource allocation.x. Strengthened the examination process by

streamlining examination reports,collaborating with the policy divisions torecommend upgrading Forms ADV, BD, andFOCUS Part 5 to better capture riskinformation, and equipping examiners withappropriate technology tools.

3. New Governance of the NEP. As a result of the self-assessment, OCIE, working through the home and regionaloffices, adopted a new governance structure for the NEP

that includes an Executive Committee (with membersrotating on a staggered basis to ensure representation ofthe home and regional offices) and the following steeringcommittees:


11/45

11

a. Steering Committee on Peopleb. Steering Committee on Risk and Exam Processc. Steering Committee on Technologyd. Steering Committee on Compliance, Ethics, and

Internal Controls

4. New Positions

.

a. The NEP is continuing to recruit and hire SeniorSpecialized Examiners, who are practiced industryprofessionals with specialized experience in trading,portfolio management, valuation, complex products,

sales, compliance, and forensic accounting.

b. The NEP has conducted targeted hiring in thefollowing areas:

i. Clearing agenciesii. Swap markets

iii. Swap intermediariesiv. Tradingv. Fixed income

vi. Municipal advisorsvii. Private funds

5. The NEP has embraced project-based examinationteams so that exam teams may be drawn from all availableexaminers based on expertise, rather than from a singlebranch of examiners.

6. Impact of the Dodd-Frank Act. The Dodd-Frank Act hashad a significant impact on the NEP, increasing the NEPsexamination responsibilities in a number of ways. Theseresponsibilities include examinations of, among others,municipal advisors, investment advisers to certain privatefunds (including certain foreign domiciled advisers withUS investors), security-based swap dealers, security-based

data repositories, major security-based swap participants,and securities-based swap execution facilities. In addition,it has provided OCIE with authority to obtain records fromcustodians of investment company and investment adviser


12/45

12

client assets.

a. NRSROs

: The Dodd-Frank Act strongly enhanced theCommissions oversight with respect to nationallyrecognized statistical rating organizations(NRSROs). In particular, it called for the formationof an independent Office of Credit Ratings (OCR),which is required to examine each NRSRO at leastannually and issue an annual public reportsummarizing key findings from these examinations.OCIE has assigned examiners to details in order tocommence these examinations until requiredCongressional approval of the OCR occurs.

b. Clearing Agencies

: The Dodd-Frank Act requires theSEC to conduct annual examinations of clearingagencies over which the Commission is thesupervisory agency and that the Financial StabilityOversight Council has designated as systemicallyimportant.

c. Private Fund Advisers

: The Dodd-Frank Act requiresSEC registration and provides the SEC withexamination oversight of certain private fund advisers.

d. Municipal Advisors

: The Dodd-Frank Act requiresSEC registration and provides the SEC withexamination oversight of municipal advisors.

e. Security-Based Swap Dealers, Security-Based SwapExecution Facilities, Data Repositories, and MajorParticipants

: The Dodd-Frank Act requires SECregistration and examination oversight of, amongothers, security-based swap dealers, security-basedswap execution facilities, security-based swap datarepositories, and major security-based swapparticipants.

f. Mid-Sized Investment Advisers: The Dodd-Frank Actamended the Investment Advisers Act to raise theasset threshold for SEC registration of advisers to


13/45

13

$100 million (subject to certain other provisions

described below). The examination staff is workingwith the SECs Division of Investment Managementand state securities regulators on the transition of mid-sized advisers from federal to state oversight.

g. Custodians

: The Dodd-Frank Act authorized theCommission to examine records of persons havingcustody or use of the assets of registered investmentcompanies and advisers clients with respect to theextent such records relate to the custody or use of suchassets.

h. Rulemaking and Other Requirements

: The Dodd-Frank Act has mandated certain rulemaking by, amongothers, the Divisions of Investment Management andTrading and Markets that will impact the nature ofcertain examinations. The examination staff continuesto coordinate with these divisions on such rulemakingefforts.

The examination staff also gave substantial input toseveral studies mandated by the Dodd-Frank Act.These included reports to Congress on: the obligationsof investment advisers and broker-dealers, issued

January 21, 2011, as required by Section 913 of theAct; the need for enhanced resources for examinationsof investment advisers, issued on January 14, 2011, asrequired by Section 914 of the Act; and improving thecommon framework for designated clearing entity riskmanagement., issued jointly with the CFTC and theFederal Reserve Board on July 21, 2011, as requiredby Section 813 of the Act.

7. Training

. Beginning in 2009 and continuing through2011, the NEP has initiated significant reforms to itsexaminer training. It is maximizing its resources by

increasing expertise through enhanced training.

a. For example, the NEP has continued to strengthen theexpertise of its staff through enhanced training and by


14/45

14

enrolling its examiners in other certification programs

such as the Certified Fraud Examiner, CharteredFinancial Analyst, and Chartered AlternativeInvestment Analyst certification programs. OCIE isalso encouraging examiners to take Seriesexaminations offered by the Financial IndustryRegulatory Authority, Inc. (FINRA).

b. Through SEC University, all examiners and managersreceive extensive training in examination officesnationwide via classroom sessions and on-linetraining, and by live remote technology (i.e., telecastor webcast). There is core training for both new and

experienced examiners so that examiners arecontinually trained at all experience levels. OCIEscomprehensive training program focuses primarily onfraud detection, examination procedures, securitiesindustry topics (e.g., financial products, tradingstrategies, hot topics), securities rules and regulations,and electronic resources. Training is provided byprofessionals from, among others, the SEC staff, thesecurities industry, other securities and bankingregulatory agencies, academia, law enforcementagencies, accounting firms, and third-partyadministrators.

8. Risk Alerts and Sweep Examination Reports

: In fiscalyear 2011, the NEP issued a Risk Alert on master/sub-accounts and a sweep examination report on the sale ofstructured products to retail investors.

In fiscal year 2012 the NEP plans to issue a significantlygreater number of Risk Alerts and sweep examinationreports on a wide range of topics. These are intended toassist senior management, risk management, andcompliance officers to better perform their functions inestablishing, monitoring and updating critical risk

management and compliance programs.

9. Compliance Outreach Program for InvestmentAdviser/Investment Company/Broker-Dealer SRO Chief


15/45

15

Compliance Officers

.The mission of the ComplianceOutreach Program is to improve compliance by openingthe lines of communication between SEC staff, ChiefCompliance Officers (CCOs), and other senior officers ofregistered investment advisers, investment companies, andbroker-dealers. The program was redesigned in 2011 (itwas formerly called the CCOutreach Program) and theintended audience was expanded from CCOs to all seniorofficers in order to emphasize the importance ofcompliance throughout firms business operations. Theprogram is designed to provide a forum to discusscompliance issues in a practical way, to share experiences,and to learn about effective compliance practices. The

program features a number of events, including regionalevents at various locations across the country and nationalevents sponsored in Washington, DC.

a. Compliance Outreach Program for InvestmentAdvisers and Investment Companies

: This program,which is jointly sponsored by the NEP and theDivision of Investment Management, began in 2005.In 2011, the staff sponsored one interactive broadcastsession discussing valuation issues. The staff intendsto sponsor a National Seminar on January 31, 2012.

b. Compliance Outreach Program for Broker-Dealers:

The Compliance Outreach Program for broker-dealers,which is jointly sponsored by the NEP, the Division ofTrading and Markets, and FINRA, began in 2008. In2011, the staff sponsored a National Seminar in March2011. The staff plans to announce regional events for2012.

c. SRO Outreach Program: In January of 2012, OCIEwill be jointly hosting with TM an SRO OutreachConference. Topics include OCIE oversight of theSROs, such as the results of the baseline assessments

of the SROs, as well as the future of exams and anSRO communication plan. Technological bestpractices, including systems compliance, will also becovered, as will SRO oversight of regulatory service


16/45

16

agreements.

C. Statutory Authority

1. The Commissions statutory authority to conductexaminations is drawn from three statutes: the SecuritiesExchange Act of 1934 (Exchange Act), 15 U.S.C. 78a,et seq.; the Investment Company Act of 1940 (InvestmentCompany Act), 15 U.S.C. 80a-1, et seq.; and theInvestment Advisers Act of 1940 (Investment AdvisersAct), 15 U.S.C. 80b-1 et seq. As reflected below, theDodd-Frank Act amended certain provisions of thesestatutes, the result of which expanded the types of entities

subject to the Commissions examination authority.

2. Examinations pursuant to the Exchange Act are authorizedby Section 17.

a. Section 17(a) of the Exchange Act, 15 U.S.C. 78q(a), states that the following entities shall makeand keep for prescribed periods such records [and]furnish such copies thereof . . . as the Commission, byrule, prescribes as necessary or appropriate in thepublic interest, for the protection of investors, orotherwise in furtherance of the purposes of this title.

(1) national securities exchanges;(2) members of national securities exchanges;(3) brokers or dealers transacting a business in

securities through the medium of a member of anational securities exchange;

(4) registered securities associations;(5) registered brokers or dealers;(6) registered municipal securities dealers;(7) registered securities information processors;(8) registered transfer agents;(9) nationallyrecognized statistical rating

organizations;(10) registered clearing agencies; and(11) the Municipal Securities Rulemaking Board.


17/45

17

b. The Commission has implemented this section byrequiring registered entities to produce copies ofrecords to Commission representatives upon request.

(1) Rule 17a-1(c) requires SROs to promptly furnishcopies of required records to any representative ofthe Commission.

(2) Rule 17a-4(j) requires brokers and dealers topromptly furnish legible, true, and completecopies of required records to representatives of theCommission.

c. Section 17(b) of the Exchange Act, 15 U.S.C. 78q(b), authorizes the Commission to conductreasonable periodic, special, or other examinations,of [a]ll records maintained by entities described inSection 17(a) (see above). These examinations maybe conducted at any time, or from time to time, asthe Commission deems necessary or appropriate inthe public interest, for the protection of investors, orotherwise in furtherance of the purposes of thischapter.

d. Pursuant to Section 17(b), when the Commissionexamines a registered clearing agency, registeredtransfer agent, or registered municipal securities dealer

for which it is not the appropriate regulatory agency,as defined in Section 3(a)(34) of the Exchange Act, 15U.S.C. 78c(a)(34), it also notifies the appropriateregulatory agency and engages in certainconsultations.

e. Section 13(h)(4) of the Exchange Act, 15 U.S.C. 78m(h)(4), authorizes the Commission to examinebroker-dealer records relating to large trader reporting.

Dodd-Frank Act Amendments

f. Clearing Agencies for Security-Based Swaps. Section763 of the Dodd-Frank Act added Section 17A(g) tothe Exchange Act, 15 U.S.C. 78q-1, to requireclearing agencies that perform the functions of a


18/45

18

clearing agency with respect to security-based swaps

to register with the Commission. As a registeredclearing agency, these entities are subject to theCommissions examination authority pursuant toSection 17(b) of the Exchange Act.

g. Security-Based Swap Data Repositories. Section 763of the Dodd-Frank Act also added Section 13(n)(1) tothe Exchange Act, 15 U.S.C. 78m, to requiresecurity-based swap data repositories to register withthe Commission, and amended the Exchange Act toadd Section 13(n)(2) to authorize the Commission toexamine such repositories.

h. Security-Based Swap Dealers and Major Security-Based Swap Participants. Section 764 of the Dodd-Frank Act amended the Exchange Act, 15 U.S.C. 78a et seq., by adding Section 15F(a) after section15E, 15 U.S.C. 78o-7, to require security-basedswap dealers and major security-based swapparticipants to register with the Commission. Section764 also amended the Exchange Act to add Section15(F)(f) to authorize the Commission to examine thesedealers and major security-based swap participants.

i. Security-Based Swap Execution Facilities. Section763 of the Dodd-Frank Act added Section 3D(a) to theExchange Act, 15 U.S.C. 78a et seq., to require thatfacilities for the trading or processing of security-based swaps must register as a security-based swapexecution facility or as a national securities exchange.

j. Other Individuals and Entities Involved in Security-Based Swap Transactions. Section 766 of the Dodd-Frank Act amended the Exchange Act, 15 U.S.C. 78a et seq., to add Section 13A to authorize theCommission to examine certain other individuals and

entities involved in security-based swap transactions.

k. NRSROs. Section 932 of the Dodd-Frank Actamended Section 15E of the Securities Exchange Act,


19/45

19

15 U.S.C. 78o-7, to require the SEC to establish an

independent Office of Credit Ratings, which mustadminister the rules of the Commission. Pursuant toDodd-Frank, the OCR must conduct exams of eachNRSRO at least annually and every exam must includea review of:

(1) whether the NRSRO conducts business inaccordance with its policies, procedures, andmethodologies;

(2) management of conflicts of interest;(3) ethics policies;(4) internal supervisory controls;(5) governance;(6) compliance officer activities;(7) complaints; and(8) policies governing post-employment activities of

former NRSRO staff.

3. Examinations pursuant to the Investment Company Act areauthorized by Sections 31 and 32.

a. Section 31(a) of the Investment Company Act, 15U.S.C. 80a-30(a), requires the following entities tomaintain and preserve records as prescribed by the

Commission:

(1) registered investment companies;(2) underwriters, brokers, dealers, and investment

advisers that are majority-owned subsidiaries of aninvestment company; and

(3) investment advisers (not majority-owned by aregistered investment company), depositors, andthe principal underwriters of investmentcompanies other than closed-end companies, inregards to their transactions with registeredinvestment companies.

b. Section 31(b) of the Investment Company Act, 15U.S.C. 80a-30(b), authorizes the Commission toconduct reasonable periodic, special, and other


20/45

20

examinations, of the records required to be

maintained and preserved pursuant to Section 31(a).These examinations may be conducted at any timeand from time to time. Section 31(b) also states thatanyone covered by the record keeping requirementsshall make available to the Commission or itsrepresentatives any copies or extracts from suchrecords as may be prepared without undue effort,expense, or delay as the Commission or itsrepresentatives may reasonably request.

c. Section 32(c) of the Investment Company Act, 15U.S.C. 80a-31(c), authorizes the Commission to

require accountants and auditors to keep reports, worksheets, and other documents and papers relating toregistered investment companies and to make themavailable for inspection by the Commission or anyrepresentative of the Commission as the Commissionmay prescribe by rule, regulation, or order.


d. Custodians of Investment Company Assets. Section929Q of the Dodd-Frank Act amended Section 31 ofthe Investment Company Act, 15 U.S.C. 80a-30, to

require that records of persons having custody or useof the securities, deposits, or credits of a registeredinvestment company that relate to such custody or use,are subject at any time, or from time to time, to suchreasonable periodic, special, or other examinations andother information and document requests byrepresentatives of the Commission . . . . If such acustodian is subject to regulation and examination by aFederal financial institution regulatory agency (e.g.,the Board of Governors of the Federal ReserveSystem, Federal Reserve), that custodian may satisfyany request for information by providing to the

Commission a detailed listing, in writing, of thesecurities, deposits, or credits of the registeredinvestment company within the custody or use of suchperson.


21/45

21

4. Section 31(b)(3) of the Investment Company Act statesthat the Commission shall exercise its inspection authoritywith due regard for the benefits of internal compliancepolicies and procedures and the effective implementationand operation thereof.

5. Examinations pursuant to the Investment Advisers Act areauthorized by Section 204.

a. Section 204 of the Investment Advisers Act, 15 U.S.C. 80b-4, authorizes the Commission to conductreasonable periodic, special, or other examinations,

of [a]ll records maintained by investment advisers.These examinations may be conducted at any time, orfrom time to time, as the Commission deemsnecessary or appropriate in the public interest or forthe protection of investors.


b. Advisers to Certain Private Funds(1) Section 403 of the Dodd-Frank Act amended

Section 203(b) of the Investment Advisers Act,

15 U.S.C. 80b-3(b), to eliminate the exemptionfrom registration for advisers of certain privatefunds. Section 402 of the Dodd-Frank Actamended Section 202(a) of the InvestmentAdvisers Act, 15 U.S.C. 80b-2(a), to defineprivate fund as an issuer that would be aninvestment company, as defined in Section 3 ofthe Investment Company Act . . . but for section3(c)(1) or 3(c)(7) of that Act.

(2) Section 404 of the Dodd-Frank Act amendedSection 204 of the Investment Advisers Act, 15U.S.C. 80b-4, to authorize the SEC to require

registered private fund advisers to maintaincertain records. The amendment also providedthat the records and reports of any private fundto which a registered private fund adviser


22/45

22

provides investment advice are deemed to be the

records and reports of the adviser.

The Dodd-Frank amendment to Section 204 alsorequires the Commission to conduct periodicexaminations of the records of private fundadvisers in accordance with a scheduleestablished by the Commission. The sectionfurther authorizes the Commission to conductat any time and from time to time suchadditional, special, and other examinations asthe Commission may prescribe as necessary andappropriate in the public interest and for the

protection of investors, or for the assessment ofsystemic risk.

(3) Section 403 of the Dodd-Frank Act amendsSection 203(b)(3) of the Investment AdvisersAct to repeal the previous private adviserexemption and instead create a new foreignprivate adviser exemption applicable to certaininvestment advisers located abroad (i.e., non-USadvisers). Advisers that do not meet all of thefollowing conditions for an exemption from SECregistration must now register: it has no place ofbusiness within the US; in total, it has fewer than

15 US clients and US investors in funds advisedby the firm; the US clients and US investors infunds advised by the firm have in aggregate lessthan $25 million in assets; it does not hold itselfout as an investment adviser in the US; and itdoes not advise a registered investment company(as defined by the Investment Company Act).

c. Mid-Sized Investment Advisers. Section 410 of theDodd-Frank Act amended Section 203A(a) of theInvestment Advisers Act, 15 U.S.C. 80b-3a(a), toraise the asset threshold for SEC registration to $100

million (subject to certain other provisions). Thissection provides an exception that permits (but doesnot require) such mid-sized investment advisers toregister as investment advisers with the SEC if this


23/45

23

section would require them to register with 15 or more

states. OCIE is working with the SECs Division ofInvestment Management and state securities regulatorson the transition of these investment advisers fromfederal to state oversight.

d. Custodians of Assets of Investment Advisers Clients.Section 929Q of the Dodd-Frank Act amended Section204 of the Investment Advisers Act, 15 U.S.C. 80b-4, to provide that records of persons having custody oruse of the securities, deposits, or credits of a registeredinvestment advisers clients that relate to such custodyor use, are subject at any time, or from time to time,

to such reasonable periodic, special, or otherexaminations and other information and documentrequests by representatives of the Commission . . . .If such a custodian is subject to regulation andexamination by a Federal financial institutionregulatory agency (e.g., the Federal Reserve), thatcustodian may satisfy any request for information byproviding to the Commission a detailed listing, inwriting, of the securities, deposits, or credits of theregistered investment adviser within the custody or useof such person.

6. Designated Financial Market Utilities. Section 807 of theDodd-Frank Act requires the Commission to conduct, onat least an annual basis, examinations of all designatedfinancial market utilities (FMUs) over which theCommission is the supervisory agency. Section 803(6) ofthe Act defines an FMU as any person that manages oroperates a multilateral system for the purpose oftransferring, clearing, or settling payments, securities, orother financial transactions among financial institutions orbetween financial institutions and the person. Eachannual examination of an FMU must make determinationsregarding:

a. nature and operations of, and the risks borne by, thedesignated FMUs of which the Commission is thesupervisory agency;


24/45

24

b. financial and operational risks that the designatedFMU presents to financial institutions, criticalmarkets, or the broader financial system;

c. the designated FMUs resources and capabilities tomonitor and control such risks;

d. safety and soundness of the designated FMU; ande. the designated FMUs compliance with the Act and

any rules and regulations prescribed under the Act.

II. INSPECTIONS AND EXAMINATIONS: THE PROCESSA. Overview

1. During examinations, the staff requests the entitys booksand records, interviews management and firm employees,and analyzes the entitys operations. In many, but not all,cases, examinations include an on-site visit to the entitysoffices.

2. Two of the goals of all examinations are to test theregistrants compliance with the federal securities laws and

regulations and determine safety of client assets.

3. Advance preparation for an examination is essential foreffective fieldwork. Advance preparation includesresearch in SRO records and other automated datalibraries, review of the registrants filings with theCommission, and identification of the risk areaswarranting review.

The staff continues to work on the examination after theyreturn to the Commissions offices following fieldwork.The examination team frequently consults with other staff

or other divisions concerning matters that arose during thefieldwork. Opinions of legal and accounting personnelmay be sought to ensure consistency, and preliminaryfindings of a particular examination may be compared to


25/45

25

those of similar firms.

B. Scope1. Examinations generally focus on risks presented by the

registrant. In some examinations, the staff focuses onparticular risk or risks that led to the examination. In otherexaminations, the staff seeks to identify risks requiringattention, and also seeks to obtain a more generalunderstanding of the entitys compliance and internalcontrol environment.

2. In most cases, the staff considers the quality of theregistrants compliance systems and its internal controlenvironment when determining the scope of theexamination and the areas to be reviewed.

C. Scheduling Fieldwork1. Depending on the nature of the examination, the staff will

often contact a registrant in advance before beginningfieldwork. Prior notice can range from a few days to a fewweeks. However, there are instances in which the staffconducts surprise examinations with no advance notice.

2. In some cases, the staff requests and reviews records froma sample of firms and then conducts on-site reviews of asub-set of the sample. A variety of methods are used forselecting the sub-set for on-site review.

D. Entrance Interviews1. Upon arriving at a registrants offices, the staff generally

requests an interview with responsible management. Thestaff uses this entrance interview to, among other things,learn more about the firm, and get a sense of thecompliance culture of the firm and the tone at the top.Information obtained during this interview also helps toidentify red flags and usually determines the tone and thefocus of the examination.


26/45

26

2. In the interview, the staff provides the registrant with twodocuments:

a. A brochure prepared by OCIE describing theexamination process.

b. A copy of SEC Form 1661, which containsinformation on the Freedom of Information Act, thePrivacy Act, and other applicable laws. Whenconducting a study or other review that involves theregistrants voluntary participation, a copy of SECForm 1662 is provided.

In addition, the staff shows identification cards. Thesecards certify that the staff members are, in fact,representatives of the Commission.

3. The substance of the entrance interview will be determinedby the nature of the examination. In general, theexamination staff will ask about the registrantsorganization, affiliations with other entities, operations,key personnel, supervisory systems, compliance systems,customers, sources of revenue, major liabilities, and so on.

4. Following the interview, the examination staff willfrequently ask for a tour of the registrants offices andoperations. For example, the staff may ask to observe howthe registrant handles an individual trade from the time theorder is received. As with the interview, observing theregistrants operations gives the staff some insight intohow the registrant conducts its business.

E. Document Requests1. Much of the staffs time when conducting fieldwork is

spent reviewing documents. The specific documents

requested will vary depending on the nature of theexamination. When the staff reviews records, they willtake reasonable steps to minimize disruption to theregistrants operations. Similarly, the staff is ready to


27/45

27

work with the registrant to set priorities for record

copying.

2. Registrants are often given a list of records the staffintends to review during the examination. Lists will varydepending on the nature and focus of the examination.

F. Questions1. The staff will frequently have questions while they review

the registrant's books and records. Registrants frequentlydesignate a liaison to the examination team, and, in thosecircumstances, the staff will direct questions to the liaison.

OCIE encourages registrants to educate the examinersabout their business to help the examiners understand thenature of the firm.

2. The staff may have questions of any type. They mayinclude very specific inquiries about the registrants recordkeeping or accounting practices. The staff sometimesraises more general questions about operations or practicesrevealed by the records.

3. The dialogue between the staff and registrants helps bothparties. Obtaining answers to their questions helps the

staff accomplish their mission. Answering questions helpsthe registrant explain itself to the staff. Candid andcomplete responses to the staffs questions may clarifymany matters that, at least initially, may appear suspicious.In addition, many questions are asked not because the staffsuspects wrongdoing, but because the examiners needmore information regarding certain records. Explainingmatters to the staff allows the process to continue. Limitedcooperation or answers on the part of the registrant maycreate an impression that the registrant has something tohide.

4. In addition, if a registrant has a question, complaint, orconcern about the conduct of an examination, it is able tocontact either the staffs supervisor or the ExaminationHotline. The OCIE Examination Hotline, which was


28/45

28

instituted in 2005, offers the registrant a choice to speak

with either a senior-level attorney in OCIEs Office of theChief Counsel in Washington, DC, ora staff member inthe SECs Office of Inspector General. The Office ofInspector General is an independent office within the SECthat conducts audits of Commission programs andinvestigates allegations of employee misconduct. TheHotline number is (202) 551-EXAM, or (202) 551-3926.

5. On occasion, the staff experiences serious intimidation orobstruction by a registrant during an examination. As ameans by which to promote a positive cooperativeenvironment and to prevent intimidation or obstruction

from detracting from our work, OCIE established aninternal Hotline that examination staff and theirsupervisors may call if the issue cannot be resolved in theusual course. The Hotline is answered by senior-levelattorneys in OCIEs Office of the Chief Counsel inWashington, DC.

G. Exit Interviews/Exit Conference Calls1. To foster and ensure the earliest possible implementation

of corrective actions with respect to problems identifiedduring an examination, the staff typically conducts an exit

interview and/or exit conference call as part of theexamination process.

2. Before leaving the offices of a registrant, the staff willconsider conducting a preliminary exit interview with aregistrant. The staff frequently requests the attendance ofregistrant personnel with personal knowledge about orresponsibility for the entitys operations, such as the ChiefCompliance Officer or General Counsel. During exitinterviews (or at an earlier time during fieldwork), the staffmay discuss some or all of the deficiencies that wereidentified. During an exit interview, the staff also obtainsagreement on any outstanding document or information

requests and a schedule for providing such information.3. When most work on an examination has been completed

but before a deficiency letter is sent, if such a letter isappropriate, the staff generally offers registrants the


29/45

29

opportunity to participate in an exit conference (this could

occur via conference call). During such meetings or calls,the staff generally brings all deficiencies identified duringan examination to the attention of the registrant. Duringan exit conference, the registrant may bring to the staffsattention information that is helpful to the examination,such as facts not known by the staff and/or the existence ofadditional documents or information. The staff willconsider any information provided during an exitconference and whether such information alters anyexamination findings. This process also provides theregistrant the opportunity to advise the staff of correctiveactions or improvements undertaken or planned by the

firm.4. Registrants responses to concerns in an exit

interview/conference call are not intended to substitute fortheir written responses to deficiency letters. Registrantsare asked to inform the staff in writing of how they haveremedied, or plan to remedy, the deficiencies identified,including deficiencies that the registrants orally stated hadbeen or would be corrected.

H. ResultsAn examination concludes when the staff determines theaction that should be taken as a result of the findings. Possible

outcomes of an examination include:

1. Some examinations conclude with no findings ofdeficiencies and no further action by the staff. In thesecircumstances, registrants are provided with a brief letterinforming them that the examination has been closed.Registrants should note that this letter is not a clean billof health and should not be viewed as such. The staffonly indicates that no deficiencies were identified duringtheir examination.

2. The staff may identify compliance deficiencies or internalcontrol weaknesses. If this is the case, the staff generally

will provide the registrant with a deficiency letteridentifying the problems, asking the registrant to takeremedial steps, and requesting that the registrant provide awritten response. Examinations often conclude with a


30/45

30

deficiency letter.

3. When the staff identifies compliance deficiencies orinternal control weaknesses that appear too serious for adeficiency letter alone, but do not yet warrant referral tothe enforcement staff, they may hold a special meeting orconference call with the registrant to emphasize theseriousness of the staffs findings. The staff will discussthe registrants compliance problems, and the remedialsteps the registrant intends to take. This is followed upwith a deficiency letter.

4. When the registrants compliance or internal controlfailures are serious, such as when the staff believesinvestor funds or securities are at risk, the staff may refer

the matter to the Division of Enforcement. The Divisionof Enforcement then determines whether to investigate thematter further and ultimately whether to recommend anenforcement action to the Commission. Each year, casesagainst regulated entities constitute a significant portion ofthe Commissions enforcement actions. Many of thesecases are derived from the examination programsenforcement referrals. Examinations of broker-dealersmay also be referred to the appropriate SRO for furtherinvestigation.

5. Where examinations identify recurring problems or gaps inregulatory coverage, the staff generally raises such issues

with another office or division in the SEC, such as theDivision of Trading and Markets or the Division ofInvestment Management. In these instances, a deficiencyletter might be provided to the registrant. The staff mayalso provide additional support to the Commissions otherregulatory operations.

III.CURRENT ISSUES AND 2012 PRIORITIESOCIE has improved its risk assessment procedures andtechniques to better identify areas of risk to investors. Suchimprovements include requiring routine outreach to third

parties such as custodians, counter-parties, and customersduring examinations to verify the existence and integrity ofclient assets managed by the firm; and conducting more


31/45

31

rigorous reviews of firms before the examiners enter the

premises.

In addition to expanding upon the way the NEP selectsregistrants to be examined, the Program has identified specificstrategic areas on which to focus when examining firms.

A. Select Areas of Focus1. Investment Company/Investment Adviser

Examinations

Consistent with the NEPs Strategic Objectives, in Fiscal

Year (FY) 2012, the staff will emphasize a risk-basedexam strategy, aiding in the implementation of Dodd-Frank requirements, enhancing collaboration within theCommission and with other regulators; and implementorganizational and process improvements. In FY2012,focus areas include the following priorities, among others:

a. Complex Entities. Staff will examine for the risks andpractices associated with the SECs rapidly growingcomplex registrant population. Review areas mayinclude:(i) Newly registered, private fund advisers that may

be unfamiliar with the Federal securities laws.(ii)Complex relationships in the private equity space.(iii)Model risk of quantitative investment decision,

order routing, and trade execution models utilizedby various industry participants.

b. Sales Practice of New or Risky Products. The staffwill review for the sale or recommendation ofinappropriate investments by advisers. Among theareas of concern:(i) The retailization of complex investments and

smaller, niche-type products (e.g., structured

products, reverse convertibles bonds, alternativemutual funds, leveraged ETFs).


32/45

32

(ii)Aggressive marketing of retirement/seniorproducts and investments marketed as beingsafe.

(iii)Portfolio management activities that may increasethe risk of investor loss or harm.

(iv)Lack of due diligence performed on underlyinginvestment vehicles/managers and any undisclosedconflicts and/or fee arrangements.

(v) Valuation practices and any conflicts that exist inthe pricing process.

c. Fund Governance.The NEP will evaluate practices oroversight weaknesses that may increase the risk of

shareholder loss or harm, such as:(i) Mutual funds investing in a manner that is

inconsistent with fund disclosures or engaging inactivities that may pose higher risk.

(ii)Directors failing to satisfy fiduciary duties.(iii)Systemic compliance breaches and processing

issues that may have a significant impact on fundinvestors.

d. Compliance, Supervision, and Risk Management. TheNEP will assess the appropriateness of complianceprograms and risk management processes relative to

business operations to identify potential weaknessesthat raise investor protection concerns, such as:(i) Effects of cost-cutting, mergers and acquisitions,

and aggressive business strategies to make up forlosses and revenue cuts.

(ii)Lack of oversight of outside business activitiesand weak compliance of remote locations, branchoffices, and independent contractorrepresentatives.

(iii)Dual and affiliated registrants transitioning broker-dealer customers into advisory clients.

(iv)Ineffective compliance and risk management withrespect to complex investments and/or investmentstrategies.


33/45

33

e. Fraudulent Activities/Safety of Assets.The NEPcontinues its initiative to identify fraudulent, abusive,and manipulative activities surrounding the safety ofclient assets. Areas of focus include:(i) Custody arrangements that increase the potential

for misappropriation of assets.(ii)Ponzi schemes or ponzi-like schemes.(iii)Manipulative activity, such as front-running and

insider trading.(iv)Cyber security risks associated with malicious

hacking and fraudulent schemes.

f. Performance and Advertising. The NEP will assessperformance characteristics and marketing practicesthat have been associated with an increased risk ofmisrepresentations and investor harm. For example:(i) Aberrational performance that may be indicative

of abusive valuation.(ii)The use of solicitors to attract new clients,

particularly when non-cash compensation is usedby advisers.

2. Broker-Dealer ExaminationsThis program emphasizes eight broad themes to provide a

risk-based focus to the program and also to assist inselecting particular broker-dealers for examination. Sincebroker-dealer examinations may involve activities byenterprises with related entities registered in multiplecapacities and acting in concert (e.g., broker-dealer,investment adviser, transfer agent, etc.), examinationactivities will be coordinated as appropriate.

Some of the areas of focus include:

a. New issue diligence. This is based on certainweaknesses that the staff has noted in due diligence

policies and procedures in connection with privateplacements and new issuances of municipalsecurities.


34/45

34

b. Supervision of broker-dealer employees. This isbased on staff observations of weak supervision atsome firms that are dually registered as broker-dealers and investment advisers (among otherbusiness models) and in situations where firmsregistered representatives recommend complexand/or structured products and high commissionproducts, such as private placements.

c. Fraud. The staff will continue to focus on uncoveringactivity designed to defraud investors, such as ponzischemes and problematic activity based on tips,complaints and referrals (TCRs) and other sources

of information. Examiners may target firms and/orregistered representatives (RRs) with specificgroups of customers that tend to fall prey tofraudulent affinity group schemes, such as seniors,and ethnic or religious communities. The staff willcontinue to conduct asset verification reviews todetect instances of fraud.

d. Unregistered Activities. Entities that avoid properregistration under the Federal Securities laws ormisuse limited exceptions to securities registrationrequirements pose potential risks to fair and orderly

markets as well as to the investing public. Whenappropriate, the examination staff may conductvoluntary inquiries at unregistered entities where afraud is suspected. In particular, the staff intends tofocus on the misuse of master-sub accounts as a wayto avoid registration and therefore regulation ofpotentially harmful and fraudulent activities, such asexcessive margin debt, money laundering, insidertrading, and market manipulation.

e. Trading Risks: The staff intends to focus on certaintrading risk areas, specifically those related to

Alternative Trading Systems (ATSs), Exchange-Traded Funds (ETFs), and High Frequency Tradingfirms.


35/45

35

f. New Regulatory Risks: The staff intends to examinefirms for their supervisory and compliance proceduresrequired under the new rules, related to the DoddFrank Act, or otherwise. In addition, the staff willfocus on certain other potential high level risks,including the new Market Access Rule.

g. Large Firm Risks. Large and complex firms maypose significant risk to the various markets and to theircustomers, due to their size, complexity andconnectivity with other large firms and financialinstitutions. As a result, the staff is adopting anenhanced and collaborative approach to both

monitoring and examining large firms. The staffsfocus on large firms will be risk-based and generallytargeted on particular businesses or products orparticular functions/processes at firms.

3. Market Oversight ProgramMarket Oversight is responsible for examining certainSROs and other entities to ensure that they complywith applicable federal securities laws and rules andthe SROs own rules. As of September 2011, thepopulation subject to oversight by Market Oversightincludes 15 national securities exchanges, FINRA,

MSRB, PCAOB, and SIPC. The priorities in FY2012in this area include:

a. Risk Assessment Examinations based on SROAssessments. Based on prior risk examinations ofSROs, Market Oversight has established a baseline forcomparing the effectiveness of compliance programsacross the SROs. We will be using that assessment toinform our exam plan and conduct risk targeted examsat certain SROs.

b. Enhanced Oversight of FINRA. Market Oversightwill continue to enhance the oversight of FINRA, withparticular consideration given to the areas outlined inDodd-Frank Section 964 and the recommendations ofthe Boston Consulting Group study related to SRO


36/45

36

oversight. The results of the Dodd-Frank Section 964

review will assist Market Oversight in identifyingspecific areas or risks at FINRA that may warrantreview in future exams.

c. Examinations of Potential New Registrants. During2012, Market Oversight anticipates the need to makeadjustments to its exam plan depending on the additionof new registrants to its registrant population. Forexample, it is possible that additional entities mayregister as exchange-based SROs. Also during 2012,in the event that the Commission adopts final rules forsecurity-based swap execution facilities (SB SEFs)

requiring registration with the Commission, MarketOversight would take on the responsibility withinOCIE for conducting examinations of SB SEFs.

4. Credit Rating Agencies

a. During FY 2011, an Office of Credit Ratings wascreated within OCIE to manage the annualexaminations of National Statistical RatingOrganizations (NRSROs or credit rating agencies)required under the Dodd-Frank Act.

b. On September 30, 2011, OCIE staff issued its firstannual report, required under the Dodd-Frank Act,summarizing its observations and concerns arisingfrom the examinations of the ten credit rating agenciesregistered with the SEC as NRSROs and subject toCommission oversight.

c. The report notes that despite changes by some of theexamined credit rating agencies to improve theiroperations, Commission staff identified concerns ateach of the NRSROs. These concerns includedapparent failures in some instances to follow ratingsmethodologies and procedures, to make timely and

accurate disclosures, to establish effective internalcontrol structures for the rating process, and toadequately manage conflicts of interest. The reportnotes that the staff made various recommendations to


37/45

37

the NRSROs to address the staffs concerns and that in

some cases the NRSROs have already taken steps toaddress such concerns.

5. Clearance and Settlement Program ExaminationsThe Clearance and Settlement Program currently overseestransfer agents and clearing agencies. In addition, Security-based Swap Data Repositories will also be part of thisprogram once these entities begin to register with theCommission as required under the Dodd-Frank Act (which

is anticipated sometime within FY 2012).

The priorities for the Clearance and Settlement Programcurrently include:

a. Transfer Agent Program. Examinations focusing onnewly established or registered transfer agents to helpdetermine if these transfer agents are complying withtheir regulatory obligations, transfer agents thatservice microcap securities to assess and help deterpotential frauds, plans or services conducted bytransfer agents that allow direct securities purchase oroption plans for issuers to evaluate if the transferagents are operating within the boundaries of theregulatory requirements, and transfer agents that havesecurities and funds in their possession as part of theirservices to determine that the transfer agents areappropriately safeguarding shareholders assets.

b. Clearing Agency Program. Examinations focusing onrisk management practices, control functions (e.g.,internal audit, compliance) and risks identified bychanges in the processing environment, throughongoing monitoring efforts, or information sharingwith other divisions/offices or regulators.


38/45

38

c. Security-based Swap Data Repository Program Untilthese entities begin to register with the Commission,the staff will be actively participating in reviewingdraft rules and standards to provide the examinationperspective, assisting with reviewing registrationmaterial, and developing the elements of theexamination program.

6. Coordination with Other Regulatorsa. OCIE has intensified coordination efforts with

domestic and foreign regulators and the regulated

community.

b. The staff at the home office and in the regional officesperiodically holds national and regional summitmeetings with the SROs and state securities regulatorsto discuss issues and concerns regarding registrants,current regulatory developments, and upcomingexamination schedules.

c. State securities regulators periodically attendvideoconference training programs sponsored byOCIE. In addition, the examination staff in

headquarters and the regional offices provide trainingto the states based on special requests. Additionally,the staff speaks at many state securities conferences.

d. The staff in the home office and the regional officescontinues to assist law enforcement agencies,including the United States Attorneys offices and theDepartment of Justice, in bringing criminal actions.

e. Examination staff has also worked with foreignregulators on a number of matters and has conductedcoordinated examinations with foreign regulators of

investment advisers and investment companiesregistered with the SEC, as well as in otherjurisdictions.


39/45

39

f. OCIE has entered into arrangements with the FederalReserve and the New York State Department ofBanking to increase coordination and informationsharing regarding registered clearing agencies subjectto joint or overlapping jurisdiction.

g. OCIE has worked with representatives of the NationalAssociation of Insurance Commissioners andindividual state insurance commissions to identifyareas suitable for increased coordination.

h. Examination staff works with representatives from theDepartment of Treasury and the Federal Reserve on a

number of issues related to market events and the on-going credit crisis, and works with the Department ofLabor in connection with the SECs MOU with thatagency.

i. As a result of the mandates under the Dodd-Frank Act,the SEC and other regulators are working together, asappropriate, to implement the changes required by theAct and sharing information as necessary.

B. Fiscal Year 2011 Examination Results1. Investment Company Inspections

a. In fiscal year 2011, the staff completed numerousinspections of investment company complexes,including third-party administrators. Most of theseinspections were risk-based or cause examinations.The majority of these risk-based or cause inspectionsrelated to issues that included: compliance oversight;brokerage arrangements, trading, and execution;conflicts of interest; portfolio management; internalcontrols; pricing of fund assets and valuation; personaltrading; disclosures and filings; performance

representations; and misappropriation of fund assets.

b. Topics covered in an investment company inspectionincluded, but were not limited to:


40/45

40

(1) regular reconciliation of custodial records withfund and investment advisers records that resolveall discrepancies;

(2) evaluating whether information that is created,recorded, maintained, and reported is accurate andprotected from unauthorized alteration anddestruction;

(3) safety of clients funds and assets;(4) fund asset pricing and fund NAV calculations;(5) personal trading of access persons;(6) order placement practices consistent with seeking

best execution and disclosures;

(7) accuracy and fairness of fund performanceinformation;

(8) fund corporate governance; and(9) independent, third-party control over periodic

account statements to clients.

c. Enforcement ReferralsThe matters referred to the Division of Enforcementmost commonly involved the following issues, amongothers: breach of fiduciary duty, corporate governance,false and misleading disclosures, and conflicts of

interest.

2. Third-Party AdministratorsApproximately half of all mutual fund complexes usethird-party administrators to perform their accounting andadministrative functions. During fiscal year 2011, theexamination third-party administrators remained a featureof the program as an adjunct to its mutual fund oversightfunction.

3. Variable Insurance ProductsIn response to continued growth in variable insuranceproduct assets and the emergence of new channels ofdistribution, examinations of variable life and annuity


41/45

41

contract separate accounts remain a feature of the

examination program.

4. Investment Adviser Examinationsa. In FY 2011, the staff completed numerous investment

adviser examinations. The staff focused on:compliance oversight; adviser adherence to fiduciaryprinciples; misstatements or material omissions indisclosure documents and filings; investment offeringfraud/fraud in pooled investment vehicles; conflicts ofinterest; portfolio management (i.e., insider tradingand front-running); performance and advertising

issues; asset verification; and valuation.

b. Topics covered in an investment adviser examinationincluded, but were not limited to, reviewing whether:

(1) blocked trades and initial public offerings areallocated fairly and are consistent withdisclosures;

(2) client assets are priced accurately;(3) information that is created, recorded, maintained,

and reported is accurate and protected fromunauthorized alteration and destruction;

(4) portfolio management decisions are consistentwith client mandates;(5) clients' funds and assets are safely maintained;(6) the firm maintains a strong compliance culture;(7) the firm's control systems are subject to override

by control persons; and(8) performance information provided to clients is

presented fairly.

c. Enforcement ReferralsThe matters referred to the Division of Enforcement

most commonly involved: misappropriation of clientfunds, conflicts of interest; breach of fiduciary duty,misrepresentations to investors (including misleadingdisclosures); offering unregistered/fraudulent


42/45

42

securities; and material compliance program

deficiencies/failures.

5. Broker-Dealer Examinationsa. In fiscal year 2011, the staff conducted numerous

examinations of broker-dealers inspections of SROspursuant to a risk assessment of a particular firm,business line or product.

b. Some key accomplishments include:(1) Broker-dealer examination efforts haveidentified the sale of millions of dollars of

micro-cap securities through false andmisleading statements, and resulted inemergency temporary restraining orders tofreeze assets, as well as trading halts and/orfines. The microcap review demonstrates thebenefits of a recent OCIE development,specialization groups that focus on specificsubject matters such as microcap securities.

(2) Developing new securities swap examinationmodules for swap market participants.

(3) Conducting examinations of some of the mostsophisticated algorithmic trading firms usingnew analytic capabilities.

(4) Publication of a sweep report regarding the saleof structured securities products to retailinvestors.

(5) Input on Commission rulemaking in the Dodd-Frank process, as well as other rulemaking,including:

i. Rules under Title VII covering swapdealers;

ii. Registration of municipal advisers;iii. The Volcker Rule restricting proprietarytrading by certain financial institutions;iv. Development of the proposed new

consolidated audit trail rules;


43/45

43

v. Development of the new large traderreporting rules; and

vi. Informing the external business conductrules applicable to swap trading underDodd-Frank.

c. Topics covered in a broker-dealer examinationincluded, but were not limited to:

(1) reserve formula and net capital computations;(2) proper accounting for, and safekeeping of,

customer funds and securities;(3) internal controls issues, including trading risk

management, credit risk management, operationaland legal controls, and internal auditing;

(4) supervision;(5) sales practice issues, including suitability,

churning, misrepresentations, cold calling, andunauthorized trading;

(6)order handling and execution; and(7) underwriting and distribution issues.

d. Enforcement ReferralsThe most common problems referred to the Divisionof Enforcement were those related to fraudulenttransactions, misrepresentations and omissions,employment of manipulative and deceptive devices,inadequate supervisory practices, inadequateinformation barriers, unregistered distributions ofsecurities, and unsuitable transactions.

6. Clearance and Settlement Program.In fiscal year 2011, the staff completed several risk-basedexaminations, cause or referral examinations, and special

examinations of registered transfer agents and clearingagencies.It also provided the examination perspective onrule-writing teams with other divisions drafting rules andstandards regarding security-based swap data repositories,


44/45

44

and developing the elements of an examination program.

Other achievements included:

a. As part of ongoing monitoring of clearing agencies,had continual dialogue with clearing agencies andother regulators throughout the period leading up toextending the federal debt ceiling and includingthrough market reaction to the credit downgrade ofU.S. government bonds.

b. Developing new securities swap examination modulesfor swap market intermediaries.

c. Participating with other divisions in rulemakingrelated to Title VIII of the Dodd-Frank Act (Payment,

Clearing and Settlement Supervision).d. Played a principal role within the Commission in

preparing a recent report to Congress under Title VIIIof the Dodd-Frank Act, jointly with the CFTC and theFederal Reserve Board, on improving the commonframework to identify risks within and acrossdesignated clearing entities as well as to assess riskmanagement at those designated clearing entities.

7. Nationally Recognized Statistical Rating OrganizationsThe Dodd-Frank Act requires the Commission to establish

an independent Office of Credit Ratings, to administerthe Commissions rules with respect to credit ratingagencies registered as NRSROs. The specific duties ofthis new office include annual examinations of eachNRSRO and an annual report summarizing theexaminations.

The Commission has not yet received requiredCongressional approval to establish the office. However,OCIE and the Commissions Division of Trading andMarkets (TM) have worked closely together to achievethe offices goals. In particular, OCIE has created an

office within the NEP for NRSRO examinations. Thisoffice, with help from examiners from other OCIEexamination areas and from members of TMs NRSROmonitoring unit, successfully completed the first set of


45/45

45

annual examinations of each NRSRO, and the

Commission approved publishing the staffs summaryreport of those examinations.

8. Market Oversight InspectionsOversight inspections of SROs are generally conducted ona risk assessment basis. In fiscal year 2011, the staffconducted inspections of SROs pursuant to a riskassessment of a particular SRO or a particular SROregulatory program. Rather than inspecting an entire SRO,the staff generally focused on a specific regulatoryprogram. These inspections test the SROs' compliance

with their regulatory duties.

In FY 2011, the Market Oversight program also completeddevelopment of risk profiles of each of the 21 nationalsecurities exchanges and SROs, enabling NEP tounderstand risks within each, and among the exchanges asa group.

Documents

OCIE Exam Process Overview