SEC Recommends Change to its Examination Program

The Dodd-Frank Act financial reform bill that was enacted on July 21, 2010, required the SEC to conduct a study on enhancing the examinations of SEC-registered investment advisers. Congress wanted to know what concerns the SEC has about conducting a good examination program and what legislative and regulatory steps it would recommend to meet these concerns.


The SEC recently released its study report. In the report, the SEC describes significant obstacles to the SEC conducting a good examination program. Specifically, the SEC describes what it calls “capacity” problems, funding problems, and additional requirements imposed under the Dodd-Frank Act.

Regarding its concerns, the SEC stated in the report that “the examination program requires a source of funding that is adequate to permit the Commission to meet the new challenges it faces and sufficiently stable to prevent examination resources from periodically being outstripped by growth in the number of registered investment advisers (i.e., it requires resources that are scalable to any future increase ― or, for that matter, decrease ― in the number of registered investment advisers).”

Regarding legislative and regulatory steps, the SEC gave Congress three approaches to consider when addressing these obstacles. These approaches include (1) imposing user fees on SEC-registered investment advisers that could be retained by the SEC to fund the investment adviser examination program; (2) authorizing one or more SROs to examine, subject to SEC supervision, all SEC-registered investment advisers; and (3) authorizing FINRA to examine dual registrants for compliance with the Investment Advisers Act of 1940.

It appears from the SEC’s study that additional costs may be imposed on investment advisers in the form of user fees or SRO registration fees. As the examination program and its obstacles are addressed by Congress and the SEC, advisers may also incur additional time and other resources understanding and complying with additional regulations regarding examinations.

Although the SEC’s study does not address state-registered advisers, it is clear that many states, which already have budget problems, may not be in a position to allocate existing resources to fund a good examination program. Resources will be further stretched after July 21, 2011, when advisers with AUM between $30,000,000 and $100,000,000 register with the states. State securities regulators must have an examination program that subjects these newly registered advisers to an examination. Therefore, expect states to impose additional costs on state-registered advisers. For example, South Carolina, which has one auditor to examine all of its registered advisers, has a securities law that allows the state to “assess a reasonable charge for conducting an audit or inspection” of an adviser. S.C. Code Ann. § 35-1-411(d). In the past, South Carolina has assessed a nominal charge. The South Carolina Securities Division could significantly increase this charge and thereby fund the salary, benefits, and overhead of the existing auditor and additional auditors.

South Carolina Guidance on the New Form ADV 2

Form ADV, Part 2, is used as an investment adviser’s disclosure document (or brochure), which must be provided to investment advisory clients. As you know, the SEC has changed the old form, which was in a check-the-box format with some narrative explanation, to a new form, which is entirely narrative. The SEC also now requires that an adviser electronically file its Form ADV, Part 2, with the SEC, making it available for viewing by the public.

However, many investment advisers do not register with the SEC. Generally, if an investment adviser has less than $25,000,000 of assets under management (or less than $100,000,000 of assets under management after July 20, 2011), then the adviser must register with one or more state securities regulators.

When registering with the South Carolina Securities Division, an adviser also must submit Form ADV, Part 2. The Securities Division has issued guidance on its requirements regarding Form ADV, Part 2. First, as of January 1, 2011, the Securities Division requires the new Form ADV, Part 2, to be submitted as part of any initial application for registration as an investment adviser in South Carolina. Second, as of January 1, 2011, all investment advisers who are already registered in South Carolina must include the new Form ADV, Part 2, as part of the adviser’s next annual updating amendment (or as part of any amendment to Form ADV). Therefore, advisers with a December 31 year-end must file the new Form ADV, Part 2, at least by March 31, 2011. Finally, the Securities Division encourages advisers to follow the distribution and delivery schedule of the new Form ADV, Part 2, as provided in the instructions to that new form.

If filing electronically through the IARD, an adviser must also file the new Form ADV, Part 2, electronically. It will then become available for viewing by the public. Since South Carolina allows filing an application for registration as an adviser by paper (i.e., not electronically, but by filing the documents directly with the Securities Division), a paper-filer presumably would file the new Form ADV, Part 2, directly to the Securities Division.