April 13, 2023CORDIUM POWERPOINT MASTER 1

WHAT TO EXPECT WHEN EXPECTING THE SEC

BILL MULLIGAN – CEO, CORDIUM US

Agenda

o Regulatory landscape o OCIE National Exam Program (“NEP”)o Types of SEC Examso Presence Exams

oKey Areas of Focuso Recent SEC Enforcement/Common Deficiency

Themes

oWhat to Expect from a SEC Examo Timeline:

o Document Productiono Timing/Durationo Onsite Visito After the Onsite

o How Best to Prepareo Identification of SEC Examination Priorities for

2014

Agenda continued

Regulatory Landscape

o As of February 2014:o There were over 4,000 private fund advisers registered with

the SEC.o Close to 40% of all RIAs manage one or more private funds.o Of these 4,000 private fund advisers:

oOver 2,000 registered with the SEC since July 21, 2010, when the President signed the Dodd-Frank Act into law.

oOf these private fund advisers, 352 (8%) are domiciled in a foreign country

oMost of these are domiciled in the United Kingdom.

Polling Question #1

o How many members of the audience work at a firm that is registered with the SEC as an investment adviser? o DO NOT ANSWER YES IF YOUR FIRM SOLELY REPORTS AS

AN “EXEMPT REPORTING ADVISER” WITH THE SEC.o ANSWERS:

o Yes ___oNo ___

OCIE National Exam Program (“NEP”)

o Andrew J. Bowden - Director of the agency's Office of Compliance Inspections and Examinations (“OCIE”)

o Missiono Improve Industry Compliance

o Local and national outreach seminars, risk alerts, recruitment of industry experts, etc.

o Identify and Prevent Fraudo Focused, risk-based examinations of registered advisers, specialized

working groups, coordination across SEC offices and Divisions of Risk, Strategy and Financial Innovation and Enforcement

o Monitor Risko Specialized units (Office of Risk Analysis and Surveillance, Office of

Large Firm Monitoring and Quantitative Analytics Unit, etc.)o Inform Policy

o Utilize results/findings to inform future rulemaking and provide guidance to the industry

Different Types of Exams

o Routine Exams o May be based on the passage of time since last exam

o Presence Exams

o Risk-based, focused examinations of newly registered adviserso Usually average 90 days, ½ as long as typical exam

o Industry Sweeps

o Focus on a narrow issue and seek to determine how the industry is handling that issue

o Recent examples include firm use of social media and disaster recovery preparedness

o For Cause Examso May be based on a tip or investor complainto Typically unannounced

Examinations by the Numbers

o RIA Examso FY 2012: The SEC was able to examine only about 8% of

registered investment advisers. o As of April, 2013, over 40 percent of advisers (including

relatively recently registered advisers) have never been examined.

o As of April, 2013, an estimated 20% of all advisers that have been registered for more than three years have never been examined.

o Focus throughout 2013 was on conducting Presence Exams.

Polling Question #2

o If your firm is registered as an investment adviser with the SEC, has your firm ever been subject to an examination by the SEC?o ANSWERS:

o Yes ___oNo ___

Presence Exam Initiative

o As of January 2014o Over 250 presence exams completedo On pace to meet goal of 15-25% of new registrants by

March 2014o Participation from EVERY regional officeo Many issues in the five target areas being notedo Contributed to developments in:

o Guidance from Division of IM on Custody Ruleo Guidance/caution on broker-dealer registration requirements

Examination Focus Areas

o 5 “High Risk” Target Areas Identified for Presence Exams Initiative

o Conflicts of Interesto How does the firm address conflicts such as: fees and

compensation, personal trading, allocation of expenses?

o Marketing/Performance Advertisingo Are disclaimers adequate/accurate? o Is appropriate back-up in place to substantiate

performance/claims made?o Are there inconsistences between documents?o Cherry-Picking?

Examination Focus Areas continued

o Portfolio Managemento Style drift?o How are portfolio decision-making/objectives being reviewed?

o Custodyo Does the adviser recognize when it has custody?o Are proper procedures in place to safeguard client assets and

abide by the Custody Rule (e.g., surprise exams where required)?

o Valuationo Are procedures adequate/consistently followed? o What documentation is in place to evidence difficult to value

securities?o How are numbers being presented to investors?

Polling Question #3

o Which of the 5 targeted risks areas expected to be focused upon by the SEC in Presence Exams give you the greatest concern? o PLEASE ANSWER THE QUESTION REGARDLESS OF WHETHER YOUR

FIRM IS ACTUALLY REGISTERED AS AN INVESTMENT ADVISER WITH THE SEC.

o ANSWERS:o Conflicts of Interest ___o Marketing/Performance Advertising ___o Portfolio Management ___o Custody ___o Valuation ___o None ___

Recent SEC Enforcement

o During 2013 - SEC brought 686 enforcement actionso Recent Conviction:

o Former SAC Capital portfolio manager Matthew Martoma was found guilty of insider trading on February 6, 2014

o The verdict was the eighth insider trading conviction of a current or former employee at SAC Capital

o SEC intends to continue to direct its focus on insider trading cases o 44 such cases were initiated in 2013

o New Enforcement Strategies:o “Broken Windows” – pursuing “smaller” violations as a deterrent (Minor

violations can feed bigger ones..)o Aberrational Performance Risk Analytics – using advanced technologies to

identify issueso Increased Expertise

Common Deficiency Themes

o Cases where CCOs were charged – four main themes:o Deficient/nonexistent compliance programs (or “off the

shelf” and not tailored to firm)o No annual review, no Code of Ethics adoptedo Recidivism – Firm/CCO was warned by the SEC staff or an

outside consultant and did not fix the issueo Consultiva case – 5 years of failure to address deficiencies

o Egregious behavior – alteration of documents o Omni case – CCO backdated signature

What to Expect from a SEC Exam

o How Does it Start?o Notification – usually by phone/emailo Request Letter

o What Does Life of Presence Exam Look Like?o Document Production – often on a rolling basiso Timing/Durationo Onsite Visito After the Onsite

What to Expect from a SEC Exam

o Document Productiono Usually 15 to 25 requests in the initial request (normal

exam could be from 40 to 50 requests in initial request)o Example of Information Requested:o Org charts – including ownership % and list of affiliateso List clients, type, AUM, name of custodian, type of strategy, types of fees (in EXCEL)o List of private funds, number of investors, domicile, master/feeder, nature of lock-up, amount of

leverage, etc. (in EXCEL)o QTRs and all other personal trading records (in EXCEL if you use software to track)o Trade blotter/ ten most and least profitable tradeso List of JVs (this should include outside business activities of key employees)o Written policies and procedureso Violations of Policieso Investor complaintso Committee minutes (if any)o ADV Part 2Bs, marketing materials, Pitchbooks, etc.

What to Expect from a SEC Exam

o Document Productiono Could be 5 to 10 additional requests (could be another 20 to 30

in a normal exam)o If you don’t understand something on a request list - call and

ask o Should Consider;

o Attorney Client Privilegeo Freedom of Information Acto Bates Stamping and other Logistics

o Timing/Noticeo SEC can request information that pre-dates registrationo Notice Periods could be as short as 4-7 days

What to Expect from a SEC Exam

o Onsite Visito Typical Presence Exam onsite time ranges from 2-3 dayso Helpful Tips:

o Do not try to delay the visito Present your “story” to the SEC on day 1o Prepare your partners and key people – the SEC will want to talk with

certain people (CCO, CFO, IR, Head Trader, etc.)o Keep the office clean, file cabinets locked, no papers outo Set up a room for the examinerso Make yourself availableo Discuss potential issues with counsel/compliance consultants in advance!o It’s ok to say “let me get back to you on that”o Ask for it in writing if they have follow-up document requests

What to Expect from a SEC Exam

o After the Onsiteo Exit Interview

o Clarify questions/correct any perceived inaccuracies during the callo Be proactive – if an issue is identified– work to remedy it ASAPo Consider responding with the manner in which you have corrected or are in the

process of correcting any issues identifiedo A proactive written response to the Exit Interview may affect the

content/substance of your firm’s Deficiency Lettero Could be additional requests for information

o Potential for Deficiency/”Findings” Lettero Generally received within 120 days of the exam (although not required)o Generally have 30 days to respondo Next examination will likely address issues raised by examiners – Need to follow-

through on corrections!

What to Expect from a SEC Exam

o How Should You Prepare?o When Preparing for an Actual Audit:

o Prepare a written response to each requested itemo Gather and Organize requested documentso Prep team for possibility of interviews

o Things to Start Doing NOW:o Create a “First Day” presentation o Proactively identify conflicts, gaps and possible problemso Critically review Compliance Manual – are policies in line with practices?o Test P&P throughout the year o Beef up Annual Reviews – SEC is concerned that firms may only be doing cursory annual

reviews of policies and procedureso Consider conducting Audit Prep or Mock Audit exerciseo Conduct periodic trainings

Headline Review of SEC Examination Priorities for 2014

o On January 9, 2014, the NEP published its 2014 examination prioritieso Contains areas that the staff perceives to have heightened risk in part based on (i)

information reported by registrants, (ii) information gathered through examinations and (iii) comments and tips

o NEP-Wide Initiativeso Fraud Detection and Prevention

o Utilize and enhance its quantitative and qualitative tools and techniques o Corporate Governance/Conflicts

o Evaluate firms’ control environment and “tone at the top”o Understand firms’ approach to conflict and risk management

o Technologyo Examine governance and supervision of information technology systems,

operational capability, market access, information security and preparedness to malfunctions/outageso Noted as a big focus area for 2014 during January 30, 2014 SEC Compliance

Outreach Program

Headline Review of SEC Examination Priorities for 2014

o Core Risks Identified for RIAso Safety of Assets and Custody – Failing to realize the firm has custody and/or failing to

comply with Rule 206(4)-2o Noted as the #1 Core Risk by OCIE

o Conflicts of Interest – Putting interests of the firm ahead of client interests or failing to identify and mitigate conflicts (e.g., compensation arrangements, allocation of investment opportunities, etc.)

o Marketing/Performance – Accuracy and completeness of claims/performance information, hypothetical and back-tested performance, use of composite performance figures, record-keeping, compliance oversight, cherry-picking, etc.

o New and Emerging Issues and Initiatives for RIAso Never-Before Examined Advisers – Focused, risk-based exams for advisers that have

been registered for more than three years and have never been examinedo Quantitative Trading Models – Are policies tailored to address compliance issues and

risks of relying on such models?o Presence Exams – continue 2012 initiative