SEC Examinations vs. Enforcement: Key Differences and Strategies

SEC Examinations vs. Enforcement: Key Differences and Strategies

When it comes to the SEC, two key functions are examinations and enforcement. While related, these serve different purposes. It’s important for firms to understand the differences between SEC examinations and enforcement actions. This article will break down the key distinctions and provide strategies for effectively handling both.

SEC Examinations

The SEC conducts examinations of registered firms like investment advisers, broker-dealers, and transfer agents. The purpose is to assess compliance with securities laws and regulations and identify any weaknesses in policies and procedures.^[1] Exams may be routine, cause-based, or sweep exams targeting specific issues across multiple firms.^[2]

During an exam, SEC staff will review documents, interview personnel, analyze records, and assess internal controls. Common areas scrutinized include portfolio management, fees and expenses, custody, conflicts of interest, and disclosures.^[3] Recently, ESG investing and cybersecurity have also been examination priorities.^[4]

If deficiencies are identified, the firm will receive a deficiency letter. The firm must then take prompt action to remediate issues and strengthen compliance programs. Failure to adequately address deficiencies may lead to enforcement action down the road.

Examination Strategies

• Maintain detailed compliance policies and procedures and ensure they are followed
• Conduct ongoing compliance training for staff
• Perform periodic compliance reviews and testing
• Maintain organized records and documentation
• Cooperate fully during exams; be transparent with SEC staff
• Promptly remediate any deficiencies identified

SEC Enforcement Actions

The SEC Division of Enforcement investigates potential securities law violations and brings civil enforcement actions seeking sanctions. Enforcement tools include fines, disgorgement, industry bars, and injunctions.^[5]

Typical violations that lead to enforcement actions include:^[6]

• Fraud
• Misrepresentations or omissions
• Accounting violations
• Compliance deficiencies
• Unregistered offerings
• Insider trading
• Misappropriation of funds

Enforcement actions can arise from tips, complaints, referrals from other agencies, and even SEC examinations. Firms may become subject to formal investigations where SEC staff issue subpoenas to obtain evidence.

Enforcement Strategies

• Implement robust compliance programs to prevent violations
• Conduct thorough internal investigations when potential issues arise
• Self-report violations and cooperate with SEC investigations
• Hire experienced SEC enforcement defense counsel
• Explore settlement options when appropriate

Key Differences

While examinations and enforcement both involve the SEC reviewing firms for compliance issues, there are some notable differences:

• Purpose: Exams assess compliance; enforcement investigates violations
• Scope: Exams are limited reviews; enforcement investigations are expansive
• Approach: Exams foster cooperation; enforcement can be adversarial
• Outcome: Exams identify deficiencies; enforcement brings sanctions
• Impact: Exam deficiencies can be remediated; enforcement actions have lasting consequences

In essence, examinations are focused reviews aimed at strengthening compliance, while enforcement seeks to punish specific violations. But the line between the two is blurring as exams increasingly refer significant issues to enforcement. Firms should strive to avoid ever reaching the enforcement stage by self-identifying and promptly correcting any compliance weaknesses.

Takeaways

• Understand the distinct purposes of SEC exams versus enforcement actions
• Implement robust compliance programs and controls
• Promptly respond to exam deficiencies
• Self-report violations to get ahead of enforcement
• Hire experienced counsel to handle SEC investigations

By making compliance a top priority and partnering with knowledgeable counsel, firms can hope to limit their SEC exposure. While exams and enforcement both aim to improve compliance, enforcement actions can carry severe consequences. Avoiding violations in the first place is the best strategy.