The SEC has issued a risk alert directed to broker-dealers that explains how it selects firms to examine and determined the scope of risk areas to review in each examination.

The agency emphasized that it leverages technology to collect and analyze large sets of industry- and firm-level data to help determine which firms to examine. It also helps it to identify risks to investors and the financial markets.

Selecting firms

The Examination Division considers the following in selecting firms to examine:

• prior examination history;
• supervisory concerns, such as disciplinary history of associated individuals or associates;
• tips, complaints or referrals involving the firm;
• the length of time since the firm’s last exam;
• the firm’s customer base;
• the products and services the firm offers;
• the financial notifications or alerts that indicate the broker-dealer is experiencing financial stress;
• reporting by news and media that could have an impact on the firm;
• information filed by the firm with the SEC or with a self-regulatory organization; and
• whether the firm holds customer cash and securities.

The SEC notes that it might decide to conduct an exam based on risk factors identified with a certain geographic location (customer complaints or outside business activities of personnel working from that location, etc) And it reminds firms that every year it offers an annual priorities letter that details the key risks, trends, and examination areas the Exams Division plans to focus on in the upcoming year.

Selecting focus areas

The exams staff looks at a firm’s business model, associated risks, and the reason behind conducting the exam in the first place to determine the scope of the examination. The staff also looks at whether the firm was subject to an examination in a similar area by a self-regulatory organization, such as the Financial Industry Regulatory Authority, and it can be adjusted during the exam at any time based on staff observations and other newly learned information.

The list of requested documents the division typically submits in advance of the examination will ask for such things as:

• general information, so the staff can get acquainted with the firm’s business and securities activities; and
• the written policies of the firm governing the firm’s securities activities and enforcement of same.

Why the risk alert?

The SEC notes that the alert is intended to get firms to assess their supervisory, compliance, and other risk management systems related to the risks noted in the alert – and make any changes as may be appropriate to address or strengthen such systems. At all times, the review of such supervisory and compliance policies and processes are analyzed with reference to the profile of each firm and its unique risk profile, plus other facts and circumstances.

Last March, the SEC updated its examination brochure, which details steps firms should take in preparing for an examination or inspection by the agency; this document would also be helpful to businesses regulated by the US securities watchdog.