Methods for obtaining a successful US Securities and Exchange Commission (SEC) examination result
By Douglas Shulman, Director, Regulatory Compliance team, Kinetic Partners US LLP – Each General Counsel (GC) and Chief Compliance Officer (CCO) faces the innate pressure of preparing for an SEC exam and, ultimately, leading their firm to a successful result. The best method(s) for preparation are consistently discussed, and often debated, at roundtables and seminars.
Below is a summary of the key focus areas for each GC and CCO that should be addressed prior to the SEC’s arrival. Addressing these seven important areas will help lead to a successful exam result:
- Set a tone from the top: It is important to demonstrate that your principals and senior management are well-versed in the compliance program and are aware of the firm’s key compliance issues and risks.
- Core compliance documents: All core compliance documents should be in place and up to date. That includes the firm’s (i) compliance manual, (ii) code of ethics, (iii) risk log and (iv) forensic testing procedures.
- Forensic testing: Maintaining a compliance calendar that tracks your compliance testing program is essential. You must be able to demonstrate with documentation that you have consistently completed each forensic test and have met the stated requirements. The SEC will expect that you have conducted forensic tests in each core compliance area to identify and mitigate potential issues.
- Compliance staffing/resourcing: The SEC staff will want to see that the compliance team is empowered and has the skill sets to effectively carry out their responsibilities. You should expect that the SEC Staff will question your compliance team members on their (i) specific job functions and (ii) knowledge of the subject matters covered under their assigned tasks.
- Ability to produce materials: You will need to confirm your technology team is able and ready to produce large amounts of records. Firms should identify any potential systems issues that could cause delays in providing timely responses to data requests.
- Preparing employees/business units: It is important to prepare not only the Firm’s compliance staff for the exam, but also key personnel and heads of business lines. This should include preparing them for potential interviews with the SEC Staff and having them create presentations that can clearly speak to their specific area.
- Testing the Firm’s compliance program readiness: Pressure testing the compliance program and controls (e.g., through a mock audit) to ensure they address each rule/regulation relevant to the firm can prove invaluable during this process.
While there are additional variables that go into the success of an SEC exam, focusing on these seven key areas will certainly help your firm be prepared for when the SEC arrives.
When the SEC Arrives – Key Reminders for the Exam
After you have submitted your response to the SEC’s initial request letter and the SEC Staff arrives at your firm, there are a number of important items to keep in mind.
- It is critical to treat the SEC staff with professional courtesy for the entirety of the exam. This starts with setting the SEC staff up in a comfortable conference room and must continue for each interaction.
- You should make all efforts to meet the deadlines for SEC requests, and if doing so is not possible you should reach out to the SEC staff as soon as possible to discuss potential delays and request an extension. All requests for extensions should be made in writing and all SEC approvals should be documented.
- You must remember that the exam is a marathon and not a sprint. While your energy may be very high at the outset, fatigue may set in as the weeks, and possibly months, pass. The key is to be prepared for a long process and to prepare your employees for the prospect that the exam will not necessarily be over shortly.
- Lastly, it is essential that you keep your compliance program up to date during the exam. This may lead to longer hours and higher stress levels for your staff – and you may need to bring in additional resourcing to help field the workload. An exam may feel like a full-time job, but remember that you cannot forget your core compliance responsibilities.
The Exit Interview and Deficiency Letter
When you are at the end stage of your exam, the SEC Staff will set an Exit Interview with you. You should expect a list of deficiencies, and a subsequent deficiency letter, as the vast majority of exams result in the receipt of a deficiency letter.
During the Exit Interview, the SEC Staff will outline what they believe are the core deficiencies and issues identified during the exam. You may challenge any deficiency, but it may be wise to consult counsel and then contact the SEC Staff shortly thereafter if you have an issue or believe a deficiency to be incorrect.
After the Exit Interview, and prior to receipt of the deficiency letter, you should start working on remedying the cited deficiencies. You will want to make correcting any and all deficiencies a top priority for your firm. You should create a detailed action plan that addresses each deficiency, along with the core employees responsible for completing the task(s).
For longer term items that may take weeks (or even months) to address, it will be helpful to set out a clear action plan with documented deliverables. You will want the SEC to understand the timelines and deliverables for any project work – and you will be expected to fully deliver on all items and promises.
The key to successfully addressing a deficiency letter is (i) consistently working through each item, (ii) ensuring you can evidence your progress and (iii) the ultimate remedying of any issues. It is a “show your work" exercise and the SEC will want to see that your firm has dedicated time and resources to remedying their concerns.
The SEC will use this deficiency letter as a guide for their next exam, and if the issues are not remedied, your firm may be facing an enforcement action.
As Sun Tzu stated, “Every battle is won before it is ever fought.” Taking a methodical, pragmatic approach in your exam preparation will put your firm in a very strong position for your anticipated SEC exam. This approach will pay dividends from the time you receive the initial SEC request letter throughout the entire exam process.
 If your firm is facing a potential enforcement action, you will be notified by the SEC Staff and you should immediately seek the advice of counsel on how best to address this issue. You will have the opportunity to respond in writing to a Wells Notice and should seek legal advice for such matters and how best to respond to the SEC’s allegations.
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