SEC Inspections To Focus On Risk

(Dow Jones) Carlo di Florio is changing the SEC's examination game.

The new director of the Securities and Exchange Commission's Office of Compliance Inspections and Examinations says the agency has ushered in a "new day and a new regulatory approach" following the Bernard Madoff Ponzi scheme debacle. The changes, he says, are focused more on risk.

Random spot checks are among the changes that advisers can expect in the revamped compliance inspections and examinations program, di Florio said in an interview with Dow Jones Newswires on Tuesday.

The remarks were among di Florio's first to reporters since being named OCIE's director in January, when he replaced Lori Richards, who had headed the office from its creation in 1995 until 2009.

A risk-based focus marks a "fundamental change" at OCIE, which could examine more advisers as a result, he says. The office now examines just 9% of the nation's 11,000 investment advisers a year--a limited reach that worries many investor advocates.

For now, OCIE is continuing its program of cyclical exams. It initially examined advisers about every five years, but 10-year intervals are now more common. The cyclical program could ultimately be phased out, di Florio acknowledges.

Risk-based exams would apply to both investment advisers as well as broker-dealers examined by the agency. R. Gerald Baker, executive director of the Securities Industry and Financial Markets Association Compliance and Legal Society, says the approach could mean less exhaustive cyclical exams at firms that don't threaten investors or market integrity.

Baker applauds the change. Many cyclical examinations last for weeks, at a big cost to both the firm and the SEC. Often, they only uncover minor technical violations.

Management and governance practices will be an initial focus of OCIE's risk-based exams, di Florio says. Investment firms that have an internal audit function, board committees and adequate resources, for example, are less likely a concern than those whose compliance officer is also the business manager.

An investment adviser that has governance committees, but which can't demonstrate their activities, such as by producing minutes, would raise suspicions, he said. "We're going to be much more concerned and probe deeper," he says.

Risk-based exams could be shorter than traditional cyclical exams for investment firms that demonstrate good practices. "As we see there are issues and concerns, let's try to go deeper," he says. "But if we don't, let's not necessarily continue--if it means doing it at the cost of another registrant who has never been visited and who might have some risks."

OCIE would complement risk-based exams with random spot checks on varying issues, such as how investment firms use asset-backed securities. Spot checks would also apply to investment firms with low risk profiles, di Florio says. He believes the combination of risk-based exams and random samplings will likely keep advisers on their toes, because they'll be less likely to gauge which issues are of interest to the agency.

"It's never going to be quite clear that you can game the system by just by focusing on three issues that you know are hot topics," he says.