SEC outlines exam priorities

The custody rule will continue to be an area of focus for the Commission in 2014.

The Securities and Exchange Commission (SEC) revealed its examination priorities for 2014 on Thursday, addressing both market-wide issues and those specific to particular asset classes, such as private equity firms.

“We are publishing these priorities to highlight areas that we perceive to have heightened risk,” said in a statement Andrew Bowden, director of the SEC’s Office of Compliance Inspections and Examinations (OCIE).

The market-wide priorities include fraud detection and prevention, corporate governance and enterprise risk management. The SEC singled out GPs who have never been previously examined (including new private fund advisors) as one of the top priorities for private equity.

Accordingly, the SEC will prioritize visiting newly-registered private fund advisors and GPs that have been registered with the agency for more than three years but have yet to undergo an examination. The SEC will target GPs it views as higher risk first, with risk status determined by factors including past exam deficiency letters, tips, complaints and referrals, Form ADV submissions and any material changes at the firm.

In November, Bowden was reported to have said about half of the “never-been-examined population” of registered investment advisors will face an exam this year.

The SEC currently has around 11,000 registered investment advisers under its purview. Roughly 4,000 of these advisors have yet to face an exam, according to SEC estimates. Private fund advisers make up about 40 percent of all registered investment advisers, which according to Bowden’s speech, means the SEC aims to inspect roughly 800 private fund advisors in 2014.

Last year Jane Jarcho, another senior figure in the OCIE, told PE Manager the SEC expects to inspect 25 percent of the roughly 1,500 newly registered private fund advisors.


Also high on the SEC’s agenda is compliance with the custody rule. SEC-registered private equity firms who have “custody” (or access to) fund assets must safe-keep them at an investment bank, broker-dealer or some other “qualified custodian”.

As a further safeguard, the custody rule subjects GPs to an annual surprise examination by an independent public accountant to verify their funds’ assets.
However, since a 2010 rule change, if a fund distributes audited financial statements to LPs within 120 days of the end of each fiscal year (180 days for fund of funds), the GP can avoid the hassle of a surprise exam (which most do).

The industry has fallen foul of this rule on more than occasion. Last month, the SEC sanctioned investment advisor Freedom One and its president, chief executive officer and chief compliance officer, Mark Wayne, for violations of the custody rule. Also failing to comply with the custody rule was Knelman Asset Management Group (KAMG) and its chief executive and chief compliance officer Irving Knelman.

This was despite the fact the SEC had released a risk alert earlier in the year, detailing common custody rule failings that GPs should address.

Marketing was also named by the SEC as an area of focus when conducting exams. The Commission will review the use and disclosure of performance figures, performance record keeping, and compliance oversight of marketing during the examination process.

The SEC did not return a request for further comment by press time.