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As the SEC ramps up the quantity and intensity of RIA examinations, it’s vital that advisers be prepared, or else they could face penalties and other sanctions. One of the most effective methods of preparing for an SEC exam is having a mock exam conducted on the firm’s compliance program. In this article, I explain what mock compliance exams are and seven tangible benefits RIAs can achieve from them. For an article discussing other best practices RIAs can follow to prepare for an SEC exam, click here.
What Is a mock compliance exam?
Before I explore the benefits, let's clarify what a mock compliance examination entails. A mock examination is essentially a rehearsal for the real SEC examination. It involves simulating the examination process, which typically commences with the issuance of requests for information and documents that are typically requested in an SEC exam. The advisory firm is then provided with time to produce such information requests. Following the firm’s response, the third party conducting the exam may interview advisory firm personnel to gauge their understanding of the firm’s compliance program and to address specific topics that may have raised concern when reviewing the information produced by the advisory firm. The third party conducting the mock exam may even come onsite to review the firm’s operations to determine if there are any red flags. Typically, the mock exam concludes with the issuance of a report highlighting the results of the exam, including any deficiencies identified as well as recommendations for enhancing the firm’s compliance program.
The principal goal of the mock exam is to identify weaknesses, gaps, or deficiencies in the investment adviser's compliance program and operations, allowing for corrective action before the real SEC examination.
Mock compliance examinations can take various forms, depending on the investment adviser's needs and objectives:
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Full mock exam: This comprehensive simulation covers all aspects of the SEC examination process, providing a holistic assessment of the firm's compliance readiness.
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Focused mock exam: In this scenario, the mock examination focuses on specific areas or issues that the investment adviser deems most critical or where the firm suspects potential weaknesses.
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Periodic mock exams: Some firms opt for periodic mock exams to continuously evaluate and enhance their compliance program, even between official SEC examinations.
What are the benefits of a mock compliance exam?
There are at least seven important benefits of having a mock exam conducted on an advisory firm’s compliance program, which I detail below.
1. It allows an advisory firm to identify gaps in the compliance program that can be rectified before the SEC comes in to conduct the actual examination of the firm. Although a firm’s compliance department may be quite diligent, when compliance departments are deep in the weeds of administering a compliance program, certain issues may be overlooked that a third-party compliance expert with a fresh perspective on the advisory firm and its compliance program may be able to identify.
On a related note, advisers who have retained a compliance consultant to assist with administration of their compliance program can utilize a mock exam to evaluate how their primary compliance consultant is performing.
2. Arranging for a mock examination can give advisory firms a feel as to the process of an actual SEC examination, which can often generate anxiety among firm personnel, particularly if the firm is experiencing an SEC exam for the first time. Anxiety may arise because advisory firms have a very limited amount of time to produce significant volumes of data and are subject to questioning during the exam process. Advisers who arrange for a mock exam can go through the exercise of the exam process on a trial basis before the real thing occurs, and this “practice” exam can help to reduce anxiety of firm personnel when the real exam takes place, which can ultimately enhance the performance of the firm during such an examination.
3. Mock exams can give advisory firms a good idea as to the types of information and documents the SEC will request during the exam process and whether the firm has retained such records in a fashion that allows for easy retrieval or production. Typically, the SEC will give advisory firms only one or two weeks to produce all the requested information and documents during the initial stage of an examination, and an adviser’s inability to produce such information and documents in a timely fashion may garner suspicion or concern from the exam staff.
An adviser who has gone through the mock exam process can become more familiar the documents and information that are likely to be requested and can reorganize such documents in a fashion designed for easier retrieval. If the mock exam identifies gaps in the adviser’s books and records, the adviser can remedy such gaps in documentation prior to the actual SEC exam. Certain derivative records, such as spreadsheets containing significant information about clients and their investment holdings, can be generated in response to the mock exam information request, and the advisory firm will have a head start on generating such records when they are requested by the SEC.
4. It can provide valuable training for an advisor’s staff as to how to interact with regulators during an actual SEC exam. Compliance experts can conduct mock interviews of firm personnel to evaluate how they respond during an examination and make suggestions on how to enhance their performance to help the firm put its best foot forward.
5. Mock exam interviews can help an advisory firm identify if there are gaps in employee knowledge about the firm’s compliance program. Any gaps identified can be rectified through enhanced compliance training conducted for the benefit of such firm personnel. Ultimately, mock exams can help firm personnel become more confident in responding during actual exam interviews.
6. Mock exams can result in valuable recommendations made by the examiner to enhance the advisory firm’s compliance program. These recommendations, when properly implemented, can help an advisory firm mitigate regulatory risk in advance of an actual SEC exam.
7. They demonstrate to the SEC staff that an advisory firm is serious about compliance. Mock exams can go a long way towards demonstrating to the SEC exam staff that a firm has a strong culture of compliance. As a result, the staff may ultimately be more sympathetic when certain deficiencies are identified when the actual SEC exam is conducted.
Conclusion
There are many tangible and intangible benefits of having a mock exam conducted on an adviser’s compliance program, and firms like Brightstar Law Group can conduct such mock exams for the benefit of advisers.
Richard Chen is a managing partner with Brightstar Law Group, a law firm that serves investment advisory firms by providing proactive business-minded solutions pertaining to corporate and securities law-related matters. Among other things, our firm provides counsel with respect to securities and compliance matters (including representation in SEC examinations), private fund formation, corporate formation and structuring, business transactions (including M&A and joint ventures), contract drafting and negotiation, employment law matters, operational due diligence, and succession planning. For more information, please visit our website at www.brightstarlawgroup.com or call us at 917-838-7398.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
