Views on improving the integrity of global capital markets
25 September 2012

2012 GIPS Standards Annual Conference: SEC Inspections and Examinations Update

Last week more than 300 investment performance and measurement professionals gathered in Boston for the 2012 GIPS Standards Annual Conference. Along with addressing the current state of the GIPS standards, the conference included a diverse collection of sessions designed to assist the attendees with both their daily responsibilities and understanding of broader trends and events facing the industry.

The presentation by Carlo di Florio, director of the Office of Compliance Inspections and Examinations (OCIE) at the SEC, provided useful information for industry professionals beyond the performance and measurement specialists in attendance. After providing the obligatory SEC speech disclaimer, he provided a short update on the activities of his division. OCIE anticipates conducting 1,400 company exams annually based on its current staffing and funding levels.

Di Florio also discussed the changes he has observed within the SEC over the last two years, including several department and process reorganizations and the addition of specialized staff members (e.g., those with direct industry knowledge and quantitative analytical experience). He is confident that these changes are having a positive impact on the organization’s examination and enforcement actions.

The real substance of the presentation came when di Florio outlined some of the touch points of the examination process for the year ahead. As private equity funds are starting to register with the SEC, many new corporate management teams will be introduced to a SEC examiner in the near future. To help these private equity management teams better understand the SEC’s process, OCIE will provide guidance statements and seek appropriate outreach opportunities to this new covered sector.

An area of focus for the examinations is risk governance. Discussions with a myriad of groups within the firm will determine how risk management needs are addressed. New firms should be aware that examiners are likely to hold discussions with members of your portfolio management team, compliance department, internal audit team, senior firm management, and board of directors. Each group plays a different role in the oversight of risk management practices across a firm.

The examinations will also be conducted based on a combination of risk metrics for identified firms. Preventing fraud is a primary goal of the examinations, and the risk assessment is proving useful in uncovering numerous infractions around fraudulent and misleading practices. Relevant factors include:

  • asset verification practices
  • how firms address conflicts of interest around compensation plans and fee structures
  • the number and nature of related party events
  • abnormal returns
  • policies regarding trade allocation, advertising, and general corporate governance practices.

The risk assessment and examination process will continue to evolve. Di Florio described several observed trends, which are impacting aspects of the examination;

  • For individuals dually registered as advisers and brokers, how are they addressing the differences between the suitability requirements as a broker and the stricter fiduciary responsibilities as an adviser?
  • As a firm adds alternative investment, do employees have the appropriate knowledge and skills to understand these new investment vehicles?
  • Do firms have appropriate policies related to the payments made to business distributors?
  • How are firms adhering to new requirements on money market fund stress testing and political contribution restrictions to individuals with oversight or influence on public pension plans?

During the GIPS conference, di Florio spent some time discussing observations related to how the SEC views the GIPS standards. Its examinations have found that smaller firms have greater instances of failing to meet all the requirements of the GIPS standards. Additionally, the SEC has some concerns that there is no clear oversight of the verification firms. This may lead to some confusion among investors as to the actual definition of a GIPS-verified firm.

When discussing performance portability, di Florio noted that the SEC rules are more strict than the GIPS standards. Along with appropriate record keeping, allowing the use of past performance anticipates a close level of comparability in the investment portfolio of the composite and alignment of interest between the old and new investors.

Finally, the SEC will potentially include unfounded claims of GIPS compliance in a list of violations when undertaking broader enforcement actions against a firm. The SEC understands errors will occur, especially in the multitude of consultant databases in use today, but egregious errors would be considered a misrepresentation that requires remediation and corrections. In the Locke Capital Management, Inc. finding of fact, the SEC cited GIPS compliance as one of the company’s errors.

The insights offered by di Florio provide CFA Institute and its members with useful takeaways. For CFA Institute, there is a better understanding of areas around the GIPS standards that may benefit from additional updates. Our members are provided with a clearer picture of how the SEC examination process is performed.

CFA Institute will continue to engage with the SEC and other capital market regulators as all industry participants strive to prevent the further erosion of investor trust that is critical to a well-functioning capital market.

About the Author(s)
Glenn Doggett, CFA

Glenn Doggett, CFA, was a director of professional standards for CFA Institute. His responsibilities included providing member guidance in applying the ethics and standards of practice policies, supporting related educational and public awareness activities, and working with the Standards of Practice Council of CFA Institute on its initiatives. He was a co-host of the free, live, interactive webinars used by CFA Institute to promote ethical decision making and global best practices. Previously, Mr. Doggett, as a member of the CFA Institute Financial Reporting Policy Group, represented membership interests regarding reporting and disclosures initiatives, including XBRL. Prior to joining CFA Institute, he worked in the financial information sector with SNL Financial, where he focused on the real estate and energy industries, directing the development and maintenance of a financial data storage system. Mr. Doggett holds a BA in economics from the University of Virginia. He was awarded the CFA charter in 2006 and is a member of CFA Society Virginia.

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