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Essentials of SEC Audits of Investment Advisors

March 4, 2013

Since the Madoff scandal, revisions to the procedures of the Office of Compliance Inspections and Examinations (OCIE) and the new registration requirements for investment advisors have changed the focus and frequency of SEC audits.  The following is an overview of what a registered investment advisor can expect regarding a SEC audit or examination.


The Commission particularly is interested in auditing investment advisors that have custody of client funds, are newly registered or are associated with investment products the SEC deems as high risk.  Under the OCIE’s risk factor analysis, hedge fund firms are two or three times more likely to be deemed high risk than more conventional asset management firms and are likely to be audited more frequently. Also, the OCIE intends to visit newly registered advisors within 12 months of registration.  In October 2012, the Commission issued a letter to all newly registered investment advisors regarding such examinations, which it termed “presence exams”. The SEC, however, has admitted to its current inability to examine investment advisors as frequently as it deems necessary.  Thus, while your firm may be on the SEC’s “radar,” the OCIE may take some time to finally conduct the audit.

Checklist of Audit Topics

Investment advisors should expect the OCIE to be interested in the following:

  • Filings and reports to the SEC and other regulators;
  • Form ADV and brochure disclosure and delivery;
  • Custody of client assets;
  • Books and records;
  • Contracts;
  • Financial statements and condition;
  • Internal controls;
  • Necessity to register as a broker-dealer;
  • Portfolio management;
  • Conflict of interests concerning compensation arrangements and allocation of investment opportunities;
  • Prohibited transactions;
  • Brokerage and execution;
  • Wrap fee programs;
  • Marketing materials;
  • AML testing;
  • Performance calculations;
  • Compensation and fees;
  • Referrals; and
  • Complaints and litigation.

The OCIE likely will focus on (a) asset verification and custody, (b) disclosures regarding performance, risk, conflict of interests, fees and expenses, (c) risk management, (d) new and complex products, (e) portfolio management and investor goals, (f) best execution, (g) trade allocation and cross trades, (h) inside information compliance, (i) personal trading, and (j) compliance and supervisory procedures.

Examination Priorities for 2013

On February 21, 2013, the National Exam Program (NEP) of the OCIE published its 2013 examination priorities for investment advisors and broker-dealers.  (http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2013.pdf)  The NAP identified the following initiatives applicable to both investment advisors and broker-dealers: 

  • Fraud detection and prevention;
  • Corporate governance and enterprise risk management (management should be prepared to discuss with examiners their firm’s approach to enterprise risk management, the compliance “tone at the top,” and key risks and regulatory requirements);
  • Conflicts of interest; and
  • Adequacy of technology and technology systems.

With respect to specifically investment advisors, the NEP identified the following new and emerging issues:

  • Presence examinations for new registrants;
  • Coordination and joint examinations of firms registered as investment advisors and broker-dealers (focusing upon the firm’s compliance with the regulations applicable to the separate models and conflict of interests);
  • “Alternative” investment companies;
  • Payments made by advisors and funds to distributors and intermediaries; and
  • Compliance with pay-to-play rules. 

Audit Preparation 

Investment advisory firms should consider taking the following steps prior to an examination: 

  • Be certain the deficiencies identified in previous audits/examinations are remedied;
  • Develop an audit/compliance checklist to insure that likely areas of examination are in proper order;
  • Review email access and policies (the SEC may request access to email files);
  • Educate personnel on the audit process and proper cooperation with the examiners, including substantive discussions;
  • Develop a system for keeping track of documents the OCIE reviews; and
  • Designate an individual to be responsible for audit preparation and facilitating the audit.


Should you have questions regarding the audit/examination process, SEC investigations or regulatory compliance, please feel free to contact Raymond W. Henney or John P. Kanan

About Honigman's Broker-Dealer and Investment Adviser Team
Honigman's Broker-Dealer and Investment Adviser industry team has extensive experience in advising and representing broker-dealers and investment advisors in many aspects of business and legal matters, including registration and formation of investment advisers; investment adviser compliance issues; and regulatory and enforcement matters, arbitrations, and class action litigation involving both broker-dealers and investment advisers. Members of the Broker-Dealer and Investment Adviser team have been recognized as leaders in the legal profession by client and peer review publications Chambers USA, Best Lawyers in America and Michigan Super Lawyers.

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