An SEC mock audit is an important tool that your registered investment advisor can utilize to help ensure that your firm is in compliance and your employees are prepared the next time the SEC appears at your door.
When Does a Mock Audit Make Sense?
A mock audit is particularly beneficial if your advisor has never been examined as there may be significant gaps and deficiencies that have not been discovered yet. Even if your firm has already been examined, a mock audit is worth considering as there may have been significant changes at your business, such as a new investment strategy or product, since your last exam. Similarly, new rules and regulations may have come into effect that your firm hasn’t yet addressed. The same is true if it has been at least a couple of years since your last mock audit.
The Benefits
Perhaps one of the most significant benefits of a SEC mock exam is that your consultant can identify deficiencies and inadequate internal controls before they appear in an SEC deficiency letter, or worse, an enforcement referral. You can also receive guidance on how to address these issues. Another benefit is that you can gain important insights from your consultant, who brings with them their own unique experience and expertise. This advice can range from employee coaching to tips on what your firm should and shouldn’t do during an actual examination. An SEC mock audit also sends a signal to regulators (and clients) that you are working hard to be in compliance.
Selecting the Consultant
If you have decided to move forward and schedule a mock audit, you will need to consider a compliance consultant that is right for the job. What should you look for? At least some SEC experience is preferable as your consultant will be better able to advise you on technical details, such as which request items are negotiable. You also will want a fit in terms of the characteristics of your firm. If your advisor manages private funds, you will want a consultant with private fund experience.
If your firm already has a compliance consultant and they have provided other compliance services, like drafting policies and procedures or conducting forensic testing, it may be a good idea to bring in a different consultant to conduct the mock exam. A new firm will have a fresh perspective and won’t be auditing their own work.
The Mock Exam Process
Once you have decided on a consultant, it is a good idea to have counsel involved in the engagement of the firm so that the mock exam report and any correspondence can be subject to attorney-client privilege.
After the contract has been executed and the mock exam has commenced, you can expect from your consultant a request list of documents your firm will need to produce. This request list is generally drafted based on recent actual request lists from the SEC. My firm, NCA Compliance, also makes a point of ensuring that the request list is tailored to the advisor’s business, taking into account, among other things, the types of clients and the different investment strategies and securities utilized by the firm. In addition, the request list should reflect the latest focus areas, speeches, and guidance from the SEC.
After the consultant has received and reviewed the documents requested, an on-site visit and interviews with various key employees are then typically scheduled. The on-site portion of the mock audit can last anywhere from one to five days. In addition to interviewing employees, the consultant may request additional documents during this time. Although generally recommended, an on-site visit may not be feasible or necessary depending for some firms, depending on their objectives and compliance budget.
Report of Findings
After the off-site and on-site reviews have concluded, the consultant will provide a report of any findings from the mock examination and offer suggestions on how these issues can be addressed. This report can be provided in different forms. A detailed written report is generally preferable, even though the SEC may be able to review this document during an examination, as it can be included in your annual review and may be used to create action items for your employees. Alternatively, a firm can opt to receive a written summary of areas that need improvement without detailing any specific deficiencies found. Yet another option is a verbal report, which prevents the SEC from obtaining a road-map to potential deficiencies at your firm.
Summary
Overall, a mock SEC exam can provide a number of benefits to a registered investment advisor and may be a good idea for your firm. At the end of the day, it may mean the difference between not receiving a deficiency letter and being referred to the Division of Enforcement.
Hayley Nelson is the President and Principal Consultant of NCA Compliance, Inc., a compliance consulting firm specializing in SEC mock audits and forensic testing. Previously, she worked for the Securities and Exchange Commission and a large investment manager in New York.
