Mutual Fund Industry: SEC's Revised Examination Approach Offers Potential Benefits, but Significant Oversight Challenges Remain

SEC's Office of Compliance Inspections and Examinations (OCIE) has taken various steps. In conjunction with NASD (now called the Financial Industry Regulatory Authority), it evaluated and modified its program of oversight examinations of broker-dealers. Based on its evaluation, OCIE reallocated selected examiner positions among SEC's regional offices to better implement the examination program and address resource disparities and significant risks. In 2007, OCIE created a surveillance branch for advisers and funds to address and mitigate potential regulatory gaps in its mutual fund examinations and added new positions. Each year, the surveillance branch uses an algorithm to analyze information provided electronically by each adviser through Web Central Registration Depository/Investment Adviser Public Disclosure. Also, OCIE examiners annually input risks into the agency's risk assessment database (RADAR). OCIE uses RADAR information to determine the issues and firms on which it should focus in setting examination schedules and allocating staff to those identified focus areas and examinations. OCIE staff document these decisions in an annual memorandum submitted to the Commission.

SEC created an internal task force to assess the agency's methodology, or approach, for conducting broker-dealer oversight exams. The task force identified areas for improvement, including the need to analyze the program on a national level to ensure consistent oversight and to identify better the underlying causes of deficiencies found by SEC examiners but missed by self-regulatory organization (SRO) examiners. SEC staff said that they disagree that resources should be shifted away from the broker-dealer oversight exams to mutual fund exams. They said that the broker-dealer oversight exams serve the dual purpose of evaluating the effectiveness of SRO exams and detecting violations and compliance risk at broker-dealers. SEC examiners find deficiencies not found by SROs in over 90 percent of their exams. Based on its overall risk-based approach, SEC staff do not support shifting resources away from broker-dealer oversight exams.

Following the recommendation, SEC's OCIE conducted a review of and revised its policies and procedures regarding its examination work papers. In November 2006, OCIE issued Oversight Examination Guidelines. With input from the regional offices, OCIE issued updated policies and procedures regarding the organization and supervisory review of examination work papers in July 2008. In addition, in November 2008, OCIE issued guidance on preparing a scope memorandum when planning an examination. In addition, OCIE electronically gathers and tracks a variety of information about firms and their examinations in a database, called Super Tracking and Reporting System (STARS). The information collected in STARS helps provide consistency among examinations. OCIE has been upgrading its ability to track examination information through the development of a new program, but progress has slowed due to funding limitations.

OCIE has been upgrading its ability to track examination information through the development of a new program, called Risk Assessment Documentation and Inspection Umbrella System (RADIUS). However, the development of RADIUS has slowed due to funding limitations. Once fully functional, RADIUS will permit OCIE to store examination documentation electronically. In the interim, OCIE has taken other steps. First, in 2006, OCIE issued guidance to standardize, strengthen, and document the process of assessing firm risk and identifying preliminary review areas before field work. Second, OCIE is in the process of migrating to an electronic examination workbook, which enables examiners to enter examine information into a central location. The workbook also permits managers to approve examination scope and review examiner work. OCIE is piloting the workbook in several regional offices and plans to implement it nationally in early 2011. Third, OCIE has implemented a quarterly management review process to determine the appropriateness of the scope and areas reviewed. Through the process, managers can identify and address difficulties encountered or new issues identified that may require modification of an examination's scope or plan. Finally, OCIE's regional office policies include a review of all examination reports with significant findings. Such findings are stored in an electronic database, which can be used to generate reports to assess common or emerging trends.