Securities and Exchange Commission: Steps Being Taken to Make	 
Examination Program More Risk-Based and Transparent (14-AUG-07,  
GAO-07-1053).							 
                                                                 
After widespread unlawful trading practices surfaced in the	 
mutual fund industry in late 2003, the Securities and Exchange	 
Commission (SEC), through its Office of Compliance Inspections	 
and Examinations (OCIE), took steps intended to revise its	 
examination process to better identify and focus its resources on
those activities representing the highest risk to investors. More
recently, some registrants raised concerns about the lack of	 
communication from SEC examiners about the status of and results 
of examinations. This report (1) describes OCIE's revisions after
2003 to the examination approach for investment companies and	 
investment advisers; (2) discusses OCIE's compliance with its	 
examination exit procedures; and (3) describes reforms OCIE	 
implemented since January 2006 to enhance, among other things,	 
communication with registrants. To address these objectives, GAO 
analyzed OCIE examination data; planning documents and guidance; 
interviewed OCIE officials; and gathered views of registrants.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-1053					        
    ACCNO:   A74488						        
  TITLE:     Securities and Exchange Commission: Steps Being Taken to 
Make Examination Program More Risk-Based and Transparent	 
     DATE:   08/14/2007 
  SUBJECT:   Communication					 
	     Federal regulations				 
	     Internal controls					 
	     Investigations by federal agencies 		 
	     Investment companies				 
	     Noncompliance					 
	     Policy evaluation					 
	     Risk assessment					 
	     Securities 					 
	     Securities fraud					 
	     Securities regulation				 
	     Policies and procedures				 
	     Program goals or objectives			 

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GAO-07-1053

   

     * [1]Results in Brief
     * [2]Background
     * [3]OCIE Revised Its Examination Approach to Target Higher-Risk

          * [4]Goal of Revised Examination Approach for Investment Companie
          * [5]OCIE Is Taking Steps to Refine Its Method for Assessing the

     * [6]With Some Exceptions, OCIE Generally Applied Exit Procedures

          * [7]OCIE Guidance on Exit Procedures Gives Flexibility to Examin
          * [8]OCIE Deviated from Exit Procedures for Certain Market-Timing
          * [9]Examiners Generally Applied Exit Procedures during Review Pe

     * [10]OCIE Implemented New Initiatives Intended to Improve Communi

          * [11]OCIE Has Recently Implemented Initiatives to Increase Commun
          * [12]Examiners Generally Followed OCIE's New Procedure to Notify
          * [13]Comments from Industry Participants on OCIE's New Initiative

     * [14]Conclusions
     * [15]Recommendations for Executive Action
     * [16]Agency Comments and Our Evaluation
     * [17]GAO Contact
     * [18]Staff Acknowledgments

          * [19]Order by Mail or Phone

Report to Congressional Requesters

United States Government Accountability Office

GAO

August 2007

SECURITIES AND EXCHANGE COMMISSION

Steps Being Taken to Make Examination Program More Risk-Based and
Transparent

GAO-07-1053

Contents

Letter 1

Results in Brief 3
Background 6
OCIE Revised Its Examination Approach to Target Higher-Risk Registrants
and Compliance Issues 8
With Some Exceptions, OCIE Generally Applied Exit Procedures for the
Period We Reviewed 16
OCIE Implemented New Initiatives Intended to Improve Communication and
Coordination 24
Conclusions 29
Recommendations for Executive Action 31
Agency Comments and Our Evaluation 31
Appendix I Scope and Methodology 34
Appendix II Comments from the Securities and Exchange Commission 36
Appendix III GAO Contact and Staff Acknowledgments 38

Figures

Figure 1: Estimated Percentage of Investment Company and Investment
Adviser Examinations Where Examiners Conducted Exit Interviews and Sent
Closure Notifications, Fiscal Years 2003 to 2006 21
Figure 2: Estimated Percentage of Broker-Dealer Examinations Where
Examiners Conducted Exit Interviews and Sent Closure Notifications, Fiscal
Years 2003 to 2006 23

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Abbreviations

CCO Chief Compliance Officer
NASD National Association of Securities Dealers
NYSE New York Stock Exchange
OCIE Office of Compliance Inspections and Examinations
ORA Office of Risk Assessment
OIT Office of Information Technology
RADAR Risk Assessment Database for Analysis and Reporting
SEC Securities and Exchange Commission
SRO self-regulatory organizations

United States Government Accountability Office
Washington, DC 20548

August 14, 2007

Congressional Requesters:

The authority of the Securities and Exchange Commission (SEC) to conduct
inspections and examinations of certain participants in the securities
industry is one of its most important tools in detecting fraud and
violations of securities laws. SEC exercises this authority through its
Office of Compliance Inspections and Examinations (OCIE). In fiscal year
2006, OCIE conducted over 2,600 examinations of investment companies,
investment advisers, broker-dealers, and other securities-related firms
registered with SEC (registrants).^11The authority of the Securities and
Exchange Commission (SEC) to conduct inspections and examinations of
certain participants in the securities industry is one of its most
important tools in detecting fraud and violations of securities laws. SEC
exercises this authority through its Office of Compliance Inspections and
Examinations (OCIE). In fiscal year 2006, OCIE conducted over 2,600
examinations of investment companies, investment advisers, broker-dealers,
and other securities-related firms registered with SEC (registrants).

After widespread unlawful trading practices in the mutual fund industry
surfaced in late 2003, OCIE attempted to address concerns about the
effectiveness of its ability to detect such practices in its examinations
of registrants by revising its examination approach to try to better
identify and focus its limited resources on those activities representing
the highest risk to investors.^2 To ensure registrants understand and
address weaknesses in compliance and violations found during examinations,
OCIE has formal exit procedures for examiners to follow when communicating
the findings of examinations to registrants. However, some
registrants--including investment companies, investment advisers, and
broker-dealers--have raised concerns about OCIE staff's not communicating
the status and results of examinations. In May 2006, the SEC Chairman
testified before the House Financial Services Committee on recent changes
to the examination program, which were designed to After widespread
unlawful trading practices in the mutual fund industry surfaced in late
2003, OCIE attempted to address concerns about the effectiveness of its
ability to detect such practices in its examinations of registrants by
revising its examination approach to try to better identify and focus its
limited resources on those activities representing the highest risk to
investors.^23 To ensure registrants understand and address weaknesses in
compliance and violations found during examinations, OCIE has formal exit
procedures for examiners to follow when communicating the findings of
examinations to registrants. However, some registrants--including
investment companies, investment advisers, and broker-dealers--have raised
concerns about OCIE staff's not communicating the status and results of
examinations. In May 2006, the SEC Chairman testified before the House
Financial Services Committee on recent changes to the examination program,
which were designed to further increase communication with registrants as
well as enhance pre-examination planning. These reforms include a new
procedure that, among others, requires examiners to contact registrants
when an examination extends 120 days beyond the on-site visit and alert
them to the status of the examination.

^1SEC regulates investment companies and investment advisers under the
Investment Company Act of 1940, the Investment Advisers Act of 1940, the
Securities Act of 1933, and the Securities Exchange Act of 1934. The
Investment Company Act and the Investment Advisers Act requires certain
investment companies and investment advisers, respectively, to register
with SEC and thus subject their activities to SEC regulation.
Broker-dealers are required to register with SEC and are subject to SEC
regulation under the Securities Exchange Act of 1934.

^2We discussed SEC's response to the surfacing of these widespread abuses
previously. See, for example, GAO, Mutual Fund Industry: SEC's Revised
Examination Approach Offers Potential Benefits, but Significant Oversight
Challenges Remain, [20]GAO-05-415 (Washington, D.C.: Aug. 17, 2005) and
GAO, Mutual Fund Trading Abuses: Lessons Can Be Learned from SEC Not
Having Detected Violations at an Earlier Stage, [21]GAO-05-313 ,
(Washington, D.C., Apr. 20, 2005).

This report addresses your interest in OCIE's progress toward more
risk-based examinations for registered investment companies and investment
advisers, implementation of recent initiatives in the examination program,
and efforts to communicate key examination information to registrants and
minimize disruption. Specifically, we (1) describe how OCIE revised the
examination approach after 2003 for investment companies and investment
advisers registered with SEC; (2) discuss OCIE's exit procedures and the
frequency with which examiners have followed these procedures when
conducting examinations; and (3) describe reforms OCIE implemented since
January 2006 to increase communication with registrants and improve the
examination program, including how examiners complied with the new 120-day
notification requirement.

To address the first objective, we analyzed information obtained through
OCIE documents and interviews with OCIE and other SEC officials on OCIE's
revised examination approach for investment companies and investment
advisers and a new process for identifying risks in the marketplace. We
also observed a demonstration of the information-technology application
that OCIE uses to conduct its annual risk-assessment process. To address
the second objective, we reviewed OCIE's guidance to examiners,
interviewed OCIE officials on exit procedures, and reviewed examination
data. We selected two random samples of 129 examinations, one from the
population of investment company and investment adviser examinations and
one from the population of broker-dealer examinations completed during
fiscal year 2003 through fiscal year 2006. This process allowed us to
project our results to the two respective populations at the 95 percent
level of confidence. All estimates in this report have margins of error of
plus or minus 8 percent or less. To address the third objective, we
reviewed memorandums from OCIE to the Commission and the revised
examination brochure, analyzed examination data related to the
notification procedure, interviewed officials from OCIE, and obtained the
views of various industry participants representing investment companies,
investment advisers, and broker-dealers. In determining the frequency with
which examiners complied with the new notification procedure, we
identified all closed examinations that lasted 120 days or more conducted
between July 31, 2006, the day the guidance was implemented, and February
2, 2007, the day OCIE gave us the records. We reviewed all 13 examinations
that met these criteria. In conducting our analyses of examination data,
we conducted a data reliability assessment of the data OCIE provided us
and determined it was reliable for our purposes.

^3Protecting Investors and Fostering Efficient Markets: A Review of the
S.E.C. Agenda Before the H. Comm. on Financial Services, Statement of
Christopher Cox, Chairman, Securities and Exchange Commission, 109th Cong.
45-46 (2006).

We performed our work in Washington, D.C., between October 2006 and July
2007 in accordance with generally accepted government auditing standards.
Appendix I provides a more detailed description of our scope and
methodology.

Results in Brief

Since 2003, when SEC and state securities regulators discovered widespread
unlawful conduct in mutual fund trading by investment advisers and other
service providers, OCIE has revised its approach to examining registered
investment companies and investment advisers to try to better identify
firms with greater compliance risks as well as emerging industry practices
that may have potential compliance issues and to target examination
resources accordingly.^4 More specifically, in fiscal year 2005 OCIE
shifted its focus from the routine examination of all registered
investment companies and advisers, regardless of compliance risks, to the
examination of "higher-risk" firms--about 10 percent of the
population--once every 3 years. From the remaining 90 percent of the
population designated as "lower risk," OCIE examines a small random sample
annually. Under OCIE's revised approach, "sweep" examinations, which
target specific activities across firms, and "cause" examinations, which
target known problems at an individual firm, are also a higher priority.
The effectiveness of OCIE's revised approach depends on its ability to
accurately assess the level of risk at individual investment advisers;
inaccurately categorizing firms as lower-risk could result in harmful
practices' going undetected.^5 Since 2002, OCIE has assigned risk ratings
to investment advisers after evaluating their compliance controls through
routine examination. However, most firms have not yet received this
evaluation. To assign risk ratings to unexamined firms, OCIE assesses
publicly available information to identify risks inherent in a firm's
businesses, such as conflicts of interest. While these variables may
indicate areas of high risk, they do not provide any information on the
firm's policies or procedures for mitigating these risks. OCIE's analysis
of fiscal year 2006 data showed that the accuracy of this methodology for
predicting whether firms are higher- or lower- risk has some limitations.
OCIE officials said that they are evaluating other potential indicators of
compliance risks, such as investment adviser performance, to improve their
risk-rating methodology and otherwise aid them in identifying higher-risk
firms. Implementation of our prior recommendation to obtain and review
documentation associated with the compliance reviews that firms must
conduct under SEC rules--a source of information on the effectiveness of
their compliance controls--could potentially help OCIE better identify
higher-risk firms as part of its risk-assessment methodology.^6

^4Compliance risks refers to the propensity of an SEC registrant to be in
violation of federal securities laws and regulations or, where applicable,
the rules of a governing self-regulatory organization.

Our review of investment company, investment adviser, and broker-dealer
examinations completed during fiscal year 2003 through fiscal year 2006
found that examiners generally applied OCIE's exit procedures, with the
major exceptions occurring during sweep examinations relating to mutual
fund trading abuses, instances where OCIE directed examiners to forgo exit
procedures. To communicate deficiencies to registrants, OCIE has
instituted specific exit procedures that include an exit interview, which
examiners use to inform registrants of deficiencies prior to the close of
an examination, and a "closure notification" letter, which communicates
the outcome of the examination. OCIE guidance allows examiners to refrain
from applying these procedures when they refer their findings to the
Division of Enforcement (Enforcement) and are asked to forgo the exit
interview, the deficiency letter, or both; or when an examination results
in no findings, in which case an exit interview is not necessary. OCIE
management also has directed examiners to deviate from exit procedures
under exigent circumstances, such as during the extensive sweep
examinations initiated to address the widespread unlawful trading in
mutual funds that surfaced in 2003 and that included inappropriate market
timing, among other practices.^7 Our analysis of a sample of investment
company and investment adviser examinations completed during fiscal year
2003 through fiscal year 2006 estimated that examiners conducted exit
interviews for 79 percent of the examinations completed during this
period. They did not conduct interviews in an estimated 12 percent for
reasons consistent with their guidance. In the other estimated 9 percent,
OCIE directed examiners not to conduct exit interviews because the
examinations were part of ongoing sweep examinations related to market
timing. We also estimated that examiners sent either a deficiency letter
or a "no further action" letter in 87 percent of the examinations.
Examiners did not send closure notifications in an estimated 11 percent
because the examination was part of the ongoing sweep examinations related
to market timing and in 2 percent for other guidance-related reasons. We
did not find evidence that examiners sent closure notification letters in
the remaining estimated 1 percent, when OCIE guidance indicated they
should have been sent.^8 We also analyzed a sample of broker-dealer
examinations and estimated that examiners conducted exit interviews and
sent closure notifications in 82 percent and 88 percent, respectively, of
the total number of examinations completed during the review period and
did not conduct these procedures in 11 percent and 9 percent,
respectively, of examinations for reasons consistent with OCIE's guidance.
However, in an estimated 7 percent of examinations, we did not find
evidence of an exit interview when OCIE guidance indicated one was
warranted. This estimate includes an estimated 3 percent of cases where
OCIE officials told us examiners conducted the interviews but did not
document the discussion.

^5OCIE assigns risk ratings to investment advisers, but not investment
companies. Many investment companies have few employees and rely on
investment advisers to perform key functions such as providing management
and administrative services. When OCIE examines an investment adviser, it
generally examines related investment companies concurrently. OCIE
officials estimated that about one-third of registered investment advisers
have received applicable risk ratings from an examination as of September
2006.

^6Currently, the use of these reports is limited to the routine
examinations of investment companies and investment advisers, where OCIE
examiners review the reports as part of the examination planning process
to learn about compliance issues identified by these firms. See
[22]GAO-05-313 , p. 35, for previous discussion of these reports and our
related recommendation.

OCIE generally followed its new procedure requiring examiners to inform
registrants of the status of examinations extending past 120 days, one of
a variety of new initiatives OCIE implemented to improve coordination and
communication among examiners, and with other SEC divisions and
registrants. Other examples include protocols and tools to help examiners
across SEC headquarters and regional offices coordinate their examinations
and avoid duplication as well as a hotline for registrants to call with
complaints or concerns about the examination program. In reviewing OCIE
examination data to determine the extent to which examiners followed the
120-day requirement, we identified 13 closed examinations to which this
procedure was applicable. In 12 of the 13, examiners either provided the
notification or had a guidance-related reason for not contacting the firm,
such as a request by Enforcement. To obtain the views of registrants on
OCIE's new initiatives, we contacted various industry participants
representing investment companies, investment advisers, and
broker-dealers. A number of registrants questioned the effectiveness of
the new hotline, as it is located within OCIE's Office of the Chief
Counsel and not in another SEC office or division that is independent of
OCIE. These registrants said they would hesitate to use the new hotline,
thereby limiting its effectiveness as a communication tool.

^7Other compliance issues that surfaced during this time included the late
trading of fund shares and the misuse of material, nonpublic information.

^8Percentages do not add exactly to 100 percent due to rounding.

This report contains one recommendation designed to facilitate greater use
of OCIE's new examination hotline by relocating it to a division or office
that is independent of OCIE. We received comments on a draft of this
report from SEC, which are included in appendix II. In its written
comments, SEC agreed with our conclusions and noted that in response to
our recommendation, OCIE is developing a revised hotline where callers can
choose to speak with the Commission's Office of the Inspector General, in
addition to staff from OCIE's Office of the Chief Counsel. SEC also
provided technical comments on a draft of the report, which were
incorporated into the final report, as appropriate.

Background

SEC oversees investment companies and investment advisers primarily
through OCIE; the Division of Investment Management (Investment
Management); and Enforcement. OCIE examines investment companies and
investment advisers to evaluate their compliance with federal securities
laws, determine if these firms are operating in accordance with
disclosures made to investors, and assess the effectiveness of their
compliance control systems. Investment Management administers the
securities laws affecting investment companies and investment advisers. It
reviews the disclosure documents that investment companies registered with
SEC are required to file with the agency and engages in other regulatory
activities, such as rule making, responding to requests for exemptions
from federal securities laws, and providing interpretation of those laws.
Enforcement is responsible for investigating and prosecuting violations of
securities laws or regulations that are identified through OCIE
examinations, referrals from other regulatory organizations, and tips from
firm insiders, the public, and other sources.

OCIE conducts routine, sweep, and cause examinations to oversee registered
investment companies and investment advisers. Routine examinations are
conducted according to a cycle that is based on the registrant's perceived
risk. During a routine examination, OCIE assesses a firm's process for
assessing and controlling compliance risks. In 2002, OCIE started to use a
systematic approach for documenting and assessing the effectiveness of
investment advisers' compliance controls.^9 Based on that assessment,
examiners assign investment advisers risk-ratings indicating whether they
are at higher- or lower- risk for experiencing compliance problems. In a
sweep examination, OCIE probes specific activities of a sample of
investment companies and investment advisers to identify emerging
compliance problems in order that they may be remedied before becoming too
severe or systemic. OCIE conducts cause examinations when it has reason to
believe something is wrong at a particular registrant. Investment
companies and investment advisers can be candidates for cause examinations
if they are the subject of investor complaints, tips, or critical news
media reports.

SEC regulates broker-dealers in conjunction with National Association of
Securities Dealers (NASD) and the New York Stock Exchange (NYSE), among
others. ^10 NASD and NYSE are self-regulatory organizations (SRO) with
statutory responsibilities to regulate their own members. As part of their
responsibilities, they conduct examinations of their members to ensure
compliance with SRO rules and federal securities laws. OCIE evaluates the
quality of NASD and NYSE oversight in enforcing their members' compliance
through oversight inspections of the SROs and broker-dealers. SRO
oversight inspections review all aspects of an SRO's compliance,
examination, and enforcement programs.^11 Through broker-dealer oversight
examinations, OCIE re-examines a sample of firms within 6 to 12 months
after the SRO completed its examination.^12 In addition to broker-dealer
oversight examinations, OCIE also directly assesses broker-dealer
compliance with federal securities laws through special and cause
examinations. Special examinations include sweep examinations and internal
controls risk management examinations of the 20 largest broker-dealer
firms. The Division of Market Regulation (Market Regulation) administers
the securities laws affecting broker-dealers and engages in related
oversight activities such as rule making. Both SEC's Enforcement and the
SROs' enforcement divisions are responsible for investigating and
disciplining violations of securities laws or regulations by
broker-dealers.

^9Prior to 2002, routine examinations typically focused on discrete areas
that staff viewed as representing the highest risks of compliance problems
that could harm investors.

^10In July 2007, after the completion of our fieldwork, NASD and the
member regulation, enforcement and arbitration functions of NYSE
consolidated to become the Financial Industry Regulatory Authority.

OCIE Revised Its Examination Approach to Target Higher-Risk Registrants and
Compliance Issues

Since 2003, OCIE changed its examination program for certain registrants
including investment companies and investment advisers to try to focus its
examination resources on those firms and industry practices with the
greatest risk of having compliance problems. In particular, OCIE went from
routinely examining registered firms on an established schedule to
emphasizing the examination of higher-risk firms. Accurate risk ratings of
investment advisers are critical to making this revised approach
effective. However, to assign risk ratings to firms that have not had
their compliance controls evaluated through routine examinations, OCIE
uses proxy indicators for compliance risk that do not incorporate
information on the strength of the firm's compliance controls, a
limitation that OCIE has recognized. One potential source of information
that could be used to improve the accuracy of risk ratings is the
compliance reports that firms must prepare and maintain on-site under
rules that became effective in 2004 (Compliance Program Rules), but do not
have to file with SEC.^13 These reports include information on the quality
of the firms' compliance controls and any material weaknesses identified,
which could be useful to OCIE for risk-rating purposes if OCIE were able
to review these records regularly outside of routine examinations.
Implementation of a prior recommendation to periodically obtain and review
these compliance reports could potentially help OCIE better identify
higher-risk firms.

^11OCIE undertakes SRO inspections in order to evaluate whether an SRO is
(1) adequately assessing risks and targeting its examinations to address
those risks, (2) following its examination procedures and documenting its
work, and (3) referring cases to enforcement authorities when appropriate.

^12OCIE also conducts surveillance examinations, which are generally
broker-dealer oversight examinations that occur slightly more than 12
months after the examination.

^13Rule 38a-1 applies to registered investment companies, including
business development companies. See 17 C.F.R. SS 270.38a-1 (2006). Rule
206(4)-7 applies to registered investment advisers. See 17 C.F.R
S275.206(4)-7. Prior to the adoption of these rules, investment advisers
were already subject to requirements to maintain written compliance
polices and procedures in certain areas. See Compliance Programs for
Investment Companies and Investment Advisers, 68 Federal Register 74714,
74715 n. 14 (Dec. 24, 2003) (adopting release), for a list of such
requirements.

Goal of Revised Examination Approach for Investment Companies and Investment
Advisers Is to Identify and Shift Resources to Higher-Risk Firms and Compliance
Issues

Following the detection of mutual fund trading abuses in the summer of
2003, OCIE revised its examination approach for investment companies and
investment advisers. Specifically, OCIE shifted its examination approach
from one that focused largely on the routine examination of all registered
firms on an established schedule, regardless of risk, to one that targets
resources on firms and issues that present the greatest risk of having
compliance problems. Between 1998 and 2003, routine examinations accounted
for about 90 percent of the approximately 10,400 investment company and
investment adviser examinations OCIE conducted. During this period, OCIE
generally tried to examine each firm at least once every 5 years.^14
However, the growth in the number of investment advisers, from 5,700 to
about 7,700, and in the breadth of their operations did not allow OCIE to
maintain this routine examination cycle. Also, OCIE concluded that routine
examinations were not the best tool for broadly identifying emerging
compliance problems, because firms were selected for examination based
largely on the passage of time and not their particular risk
characteristics.

To address these limitations, OCIE implemented a new risk-based
examination approach in fiscal year 2005 that provides for more frequent
routine examination of investment advisers determined to be higher-risk
for compliance issues. Under this revised approach, OCIE's goal is to
conduct at least one on-site, comprehensive, risk-based examination of all
firms that have a higher-risk profile every 3 years. From those firms
designated as lower-risk, OCIE randomly selects a sample each year to
routinely examine. According to the 2007 "goals" memorandum--OCIE's key
planning document for communicating examination priorities and guidance to
examiners nationwide--OCIE targets more than three times the amount of
examination resources to the routine examinations of higher-risk
investment advisers (and their associated investment companies) than to
the routine examination of lower-risk firms. Higher-risk firms represent
about 10 percent of registered firms and 51 percent of assets under
management. OCIE also now targets greater resources to sweep and cause
examinations.

^14During 2003, OCIE began to address these concerns by establishing a 2-,
4-, or 5-year examination cycle based on the size or risk level of the
investment adviser. However, this cycle was not fully implemented before
OCIE made significant changes to its examination program for investment
companies and investment advisers as described in this section.

As part of its revised approach, OCIE began a pilot program in fiscal year
2006 that uses dedicated teams of two to four examiners to provide more
continuous and in-depth oversight of the largest and most complex groups
of affiliated investment companies and investment advisers. As of June
2006, OCIE officials said that a few select firms, representing
approximately $1.5 trillion, or 4 percent, of assets under management in
the United States, are currently participating in this voluntary program.
Because these firms have been in the program for less than 12 months, we
were unable to evaluate the effectiveness of OCIE's monitoring teams or
this pilot. OCIE officials told us they plan on adding a limited number of
additional firms and corresponding monitoring teams to the program by the
end of 2007. Depending on the results of the pilot, the officials
tentatively plan to have at least one and, perhaps, two monitoring teams
in each field office.

To enhance OCIE's ability to identify and address emerging risks across
the securities industry, in 2004 OCIE implemented a process intended to
identify and map high-risk industry practices and compliance issues across
the securities markets, including investment companies, investment
advisers, and broker-dealers. SEC's Office of Risk Assessment (ORA)
initially developed this process for agencywide use. In 2005, this process
was automated, using a database application called Risk Assessment
Database for Analysis and Reporting (RADAR).^15 As used by OCIE, examiners
in headquarters and regional offices identified and prioritized various
risks to investors and registrants. OCIE staff then used RADAR to identify
the highest-risk areas designated by examiners and then develop and
recommend regulatory responses to address these higher-risk areas. ^16 For
example, OCIE officials said that they are addressing some risks by
conducting examinations on the related issues and other risks by
recommending that Market Regulation and Investment Management provide new
rules or interpret existing ones. In addition, as part of OCIE's fiscal
year 2007 goals memorandum, OCIE included information on the key risks
identified through RADAR for each registrant type. OCIE examiners were
directed to consider these risk areas as they plan examinations. OCIE
officials said that they have not yet formally evaluated the effectiveness
of RADAR for identifying new or resurgent compliance risks, as they have
been largely focused on developing RADAR and the risk-assessment process
itself. However, they said that the implementation of their recommended
regulatory responses, through their own examination program and by other
divisions and offices, would allow them to validate the risks identified
through RADAR. OCIE officials said that they are considering developing a
task force whose role, in part, would be to track the outcome of what OCIE
recommends for risks entered in RADAR.

^15OCIE developed the RADAR application in conjunction with staff from the
Office of Risk Assessment (ORA) and OIT. In 2005 and 2006, RADAR was a
database application; in 2007, OCIE and OIT staff enhanced RADAR to make
it a Web-based application.

^16OCIE officials said that the risks entered into RADAR by SEC
examination staff and managers are based on information learned during
examinations and constitute non-public information.

OCIE Is Taking Steps to Refine Its Method for Assessing the Compliance Risk
Level of Investment Advisers but Faces Challenges

Accurately identifying compliance risk among registered investment
advisers is critical to OCIE's revised approach to examinations,
particularly for routine examinations. Because only a small number of
low-risk firms are selected for routine examinations in a year, improperly
categorizing investment advisers as lower-risk could lead to harmful
practices' not being detected on a timely basis. To determine which firms
are higher-risk and thus a priority for routine examination, every year
OCIE queries its examination database and identifies those investment
advisers that have been examined during the past 3 years and assigned a
compliance risk rating of "high," indicating that their compliance
controls have been assessed as "weak." These firms are automatically
placed on the high-risk list and scheduled for routine examination within
a 3-year period. However, because OCIE had only begun assigning risk
ratings to firms in 2002 when it started using its risk-scorecard approach
to evaluate compliance risks at individual firms, it was unable to assign
risk ratings to all firms prior to revising the approach to routine
examinations in 2004. Approximately 70 percent of registered investment
advisers had not yet received a compliance risk-rating through a routine
examination before OCIE implemented its new approach. Further, according
to OCIE, its staff have not yet examined most of the more than 4,500 new
investment advisers that have registered with SEC since fiscal year 2004.

To assign a risk rating for investment advisers that have never been
examined by OCIE, OCIE uses an algorithm to calculate a numeric "score"
for each firm based on certain affiliations, business activities,
compensation arrangements, and other disclosure items that pose conflicts
of interest.^17 Examples include participation or interest in client
transactions, managing portfolios for individuals, and receiving
performance fees. OCIE determines the risk profile of all registered
investment advisers every year using the risk algorithm. Those that are
designated as higher-risk through this method are added to the high-risk
list and scheduled for routine examination within the next 3 years. At the
start of fiscal year 2006, OCIE officials said they had identified about
10 percent of registered investment advisers as higher-risk. Slightly more
than half of these were firms that had been routinely examined by OCIE
within the last 3 years and given a risk-rating of "high" and slightly
less than half were rated as higher-risk through the risk algorithm. A
small percentage were firms OCIE had classified as higher-risk because of
their large size. OCIE automatically designates the top 20 investment
advisers according to assets under management as higher-risk.^18 According
to OCIE officials, these larger firms are a priority because of the number
of investors who could suffer adverse consequences as a result of any
compliance problems at these firms.

Although the risk algorithm allows OCIE to determine an investment
adviser's relative risk profile in the absence of a compliance risk
rating, it is potentially limited because it does not measure the
effectiveness of the investment adviser's compliance controls that are
designed to mitigate conflicts of interest or other risks that could harm
mutual fund shareholders. Rather, it relies on information that serves
largely as proxy measures of the firm's compliance-related controls. OCIE
has recognized these limitations and has taken some steps to evaluate the
effectiveness of this methodology. OCIE officials told us they evaluate
the accuracy of the risk ratings generated by the risk algorithm by
comparing the results of completed routine examinations of firms initially
presumed to be low-risk against the examination's outcome. According to
data generated by OCIE, 91 percent of investment advisers that were
initially rated lower-risk and examined in fiscal year 2006 retained the
lower-risk designation after examination. OCIE officials said that they
are reviewing the remaining 9 percent of examinations where the risk
rating changed from lower to higher to determine the reasons for the
change and whether they can use that information to improve the accuracy
of the risk algorithm.

^17The risk algorithm, developed by OCIE and the Office of Economic
Analysis, is a formula using values of various factors to derive a
relative ranking for the firm's compliance risk.

^18Combined, these 20 investment advisers have $8.9 trillion in assets
under management, about 28 percent of all registered investment advisers'
assets under management.

OCIE data also showed that 25 percent of all investment advisers that were
initially rated higher-risk and examined during fiscal year 2006 retained
their higher-risk rating, while the remaining 75 percent were reclassified
as lower-risk. According to OCIE officials, one reason that the accuracy
rate for predicting higher-risk firms appears low is that many of the
firms on the higher-risk list, as previously discussed, were classified as
higher-risk as a result of a prior examination. These firms likely took
steps in the interim to improve their compliance controls, so OCIE
officials expected that these firms would be rated as lower-risk after
re-examination. However, the officials said that there are also many firms
that had ratings assigned through the risk algorithm, and the fact that
their ratings were changed from higher- to lower-risk after the
examination demonstrates the limitations of the algorithm--it can
determine which firms are at higher risk for compliance problems, but does
not indicate the effectiveness of the firms' policies or procedures for
mitigating these risks.^19

To improve the accuracy of the risk-algorithm, OCIE initiated a sweep
examination during 2007 of a sample of recently registered investment
advisers that were identified as lower-risk and that had not yet been
subject to a routine examination by OCIE. These reviews are typically
targeted, 1-day reviews that allow examiners to obtain an initial
assessment of these recently registered investment advisers' conflicts of
interest, the related compliance policies and procedures these advisors
use to manage these risks, and the capabilities of the firms' compliance
and other personnel. OCIE anticipates that these limited-scope visits will
assist examiners in determining whether a recently registered investment
adviser's risk rating is accurate, and if it is not, will allow them to
assign a more accurate risk rating and potentially identify additional
information to refine the risk algorithm. According to OCIE officials,
thus far, examiners have concluded over 225 of these reviews, with 85
percent of these resulting in firms' remaining classified as lower-risk
and 15 percent being reclassified as higher risk and placed on a 3-year
examination cycle. The officials said that they plan to make these sweep
examinations a regular component of the examination program.

^19OCIE officials said that the composition of the higher-risk risk firms
examined reflected the composition of the total firms rated higher-risk at
the start of fiscal year 2006, in that slightly more than half were firms
that had received a higher-risk rating through routine examination and
slightly less than half had received higher-risk rating through the risk
algorithm.

In addition, OCIE officials said that they are exploring ways to obtain
and use additional sources of information that will allow them to further
identify higher-risk firms.^20 OCIE officials told us they have purchased
access to several commercial databases containing information on various
data points, such as the performance of investment advisers, that OCIE
does not otherwise have. OCIE officials said that they are currently
assessing the usability of these databases for surveillance purposes,
primarily to identify higher-risk firms. For example, if a firm's reported
performance is significantly higher or lower than its peers, the officials
said that performance could indicate that the firm's business processes
deviate from the norm and require follow-up. Further, OCIE officials said
that several OCIE and Office of Information Technology (OIT) staff are
working on a project to identify other possible information sources that
OCIE could use to better monitor investment companies and investment
advisers. OCIE officials said that they are formalizing this effort by
creating a Branch of Surveillance and Reporting, which will have staff
permanently dedicated to the review and analysis of internal and external
data sources to identify compliance risks at registered investment
companies and investment advisers.^21

The accurate prediction of each investment adviser's risk-level is
critical to the protection of investors under the revised approach, as
some firms rated lower-risk may never be routinely examined within a
reasonable period of time, if at all, because of the sampling approach
being used.^22 According to OCIE's review of 2006 examination data, 9
percent of investment advisers currently classified as lower-risk firms
are actually higher-risk firms that should be scheduled to be examined
within the next 3 years. Among newly registered advisers, the results of
OCIE's targeted 1-day reviews show that the percentage of firms
inappropriately characterized as lower-risk appears to be higher. OCIE's
efforts to improve the capacity of the algorithm and obtain alternative
sources of surveillance information could increase the likelihood that
higher-risk firms will be identified and examined. However, neither the
risk algorithm nor the alternative information sources OCIE is currently
considering give OCIE any insights into the effectiveness of a firm's
internal controls for mitigating identified compliance risks.

^20In 2005, SEC considered the development of a surveillance program for
OCIE to gather and analyze additional information from investment
companies and investment advisers outside of the data collected in OCIE's
usual examination and reporting process. However, OCIE officials told us
that SEC decided to postpone this effort, which would have imposed
potentially significant costs for SEC and firms and required formal rule
making to implement, in favor of obtaining access to third-party
databases.

^21OCIE officials told us they are planning to staff the new Branch of
Surveillance and Reporting with a branch chief and four analysts.

^22OCIE officials said that when preparing to generate the random sample
of investment advisers rated as lower-risk, they first remove from the
universe those firms that were selected and routinely examined the
previous year.

One potential source of information that might allow OCIE to assess the
effectiveness of firms' internal controls is the reports registered
investment companies and investment advisers are required to prepare at
least annually under the Compliance Program Rules.^23 These rules require
firms subject to the rule to adopt written compliance policies and
procedures and review, at least annually, the adequacy of such compliance
controls, policies, and procedures and the effectiveness of their
implementation. Registered investment companies must designate a chief
compliance officer responsible for giving the firm's board of directors a
written report that, among other requirements, addresses the operation of
the compliance controls of the investment companies and the controls of
each of its service providers, including its investment adviser, and each
material compliance matter that has occurred during the reporting period.
Under the Compliance Program Rules, each investment company and investment
adviser is required to maintain as part of its books and records any
records documenting the firm's annual review of its compliance controls.
OCIE staff currently review these compliance reports as part of the
examination-planning process to learn about compliance issues identified
by the firms and determine whether the firms have implemented corrective
action. Currently, the rule does not require firms to submit the annual
reports to the agency for its ongoing review. We previously recommended
that SEC obtain and review these reports or the material weaknesses
identified in them periodically rather than solely in connection with a
planned examination.^24 OCIE officials noted that obtaining these reports
on a regular basis would require rule making by SEC. We continue to
believe, however, that using these reports outside of the examination
process could potentially allow OCIE to improve its ability to identify
higher-risk firms.

^2317 C.F.R. SS 270.38a-1 and 275.206(4)-7 (2006).

^24 [23]GAO-05-313 , 35.

With Some Exceptions, OCIE Generally Applied Exit Procedures for the Period We
Reviewed

Our review of investment company, investment adviser, and broker-dealer
examinations completed during fiscal year 2003 through fiscal year 2006
found that examiners generally applied OCIE's exit procedures. OCIE's
guidance on exit procedures gives examiners flexibility for communicating
deficiencies and outcomes of examinations to registrants. These procedures
include an exit interview, in which examiners inform registrants of
deficiencies before closing an examination, and a closure notification
letter, which communicates the outcome of the examination. Under certain
circumstances, these procedures may not apply, such as when examiners
refer their findings to Enforcement and are asked to forgo any or all of
the procedures. OCIE management also has directed examiners to deviate
from exit procedures under exigent circumstances, most recently for
certain sweep examinations conducted during fiscal years 2003 through 2004
that addressed market timing and other newly emergent, high-risk
compliance issues. OCIE officials told us that they did not inform the
industry of their decision to forgo exit procedures for many of these
sweep examinations, a situation that various industry participants told us
confused the firms because they did not receive information on the status
or outcome of the examination. We reviewed a sample of investment adviser
and investment company examinations and a sample of broker-dealer
examinations completed during fiscal year 2003 through fiscal year 2006.
Based on this review, we estimated that examiners generally applied exit
procedures. The exceptions were an estimated 9 percent of investment
company and investment adviser examinations that were part of the
market-timing and other related sweep examinations, as well as an
estimated 7 percent of broker-dealer examinations where examiners either
did not conduct these exit procedures or they did not provide evidence
that they conducted them.

OCIE Guidance on Exit Procedures Gives Flexibility to Examiners for
Communicating Examination Findings

OCIE has instituted specific exit procedures that give flexibility to
examiners for communicating deficiencies and notifying registrants of the
outcome of examinations. Prior to closing an examination, the guidance
generally requires examiners to offer registrants an exit interview to
inform them of any deficiencies that examiners found. According to a
December 2001 memorandum, which formalizes OCIE's guidance for conducting
exit interviews, these interviews are to ensure that registrants are
informed of examiners' concerns at the earliest possible time, give
registrants an opportunity to provide additional relevant information, and
elicit early remedial action.^25 According to the guidance, OCIE's goal is
to ensure that examiners inform registrants of all deficiencies prior to
sending written notification of the examination findings, while at the
same time giving examiners flexibility as to when to communicate their
concerns. If examiners find deficiencies, they can communicate them either
informally during the course of the fieldwork while on-site at the
registrant, during a formal exit interview at the end of the on-site
visit, or in an exit conference call after they complete additional
analysis off-site.

The guidance directs examiners to document these discussions in the
examination's work papers and in the final examination report. OCIE's
guidance for exit interviews also permits examiners to take into
consideration the extent and severity of matters found during examinations
when determining whether to conduct an exit interview. For example, when
examiners refer a firm to Enforcement for securities law violations, in
some cases Enforcement staff will ask the examiners to refrain from
further discussions with the firm to protect the integrity of the
impending investigation.

OCIE officials also told us that if the examiners did not identify any
deficiencies to bring to the firm's attention once the on-site visit and
subsequent fieldwork were complete, they were not expected to conduct
formal exit interviews. Instead, examiners would let the firm know at the
end of the on-site visit that they had not found any problems to date. If
after completion of the off-site analysis, the examiners still did not
identify any deficiencies, the guidance directs examiners to inform the
firm of that fact prior to closing the examination.

Examiners formally close an examination by sending a "closure
notification" letter to the firm. A closure notification letter can be a
no further action letter, which indicates the examination concluded
without any findings, or a deficiency letter, which cites any problems
found. While the examiners may issue a deficiency letter and also refer
some or all of the examination findings to Enforcement, in some cases, as
with exit interviews, Enforcement staff may ask the examiners to refrain
from sending a deficiency letter or exclude certain findings from a
deficiency letter.

^25Prior to the December 2001 memorandum, examiners were not required to
offer an exit interview.

OCIE Deviated from Exit Procedures for Certain Market-Timing and Other Related
Sweep Examinations, but Did Not Inform the Industry

OCIE officials said that they only direct examiners to deviate from
established exit procedures when they believe it is in the best interest
of the examination program and under exigent circumstances, such as during
the period OCIE conducted sweep examinations of hundreds of firms to
gather information on market timing and other newly emergent, high-risk
compliance issues. OCIE officials said that in consultation with
Enforcement staff, they decided for several of the market-timing and
certain other concurrent sweep examinations to direct examiners not to
conduct exit interviews or send closure notification letters. OCIE
officials told us that they conducted these sweep examinations largely
over fiscal years 2003 and 2004. As discussed later in this section,
examination data we reviewed showed that some of these examinations were
not completed until fiscal year 2005 or fiscal year 2006.

OCIE officials discussed the factors that contributed to their decision.
First, they said that OCIE staff and examiners in the regional offices had
little prior experience planning, conducting, and reporting on sweep
examinations of such large scale and on such complex issues as market
timing. At that time, OCIE did not have formal protocols in place to guide
examiners when conducting sweep examinations. Second, the officials said
that these sweep examinations involved a prolonged production of
documents, data, and e-mails by firms and analysis of this information by
OCIE and other SEC divisions and offices over periods as long as a year or
more. For example, OCIE staff said that the review of initial documents
provided by many firms often did not reveal any deficiencies, but the
review of more detailed data a few months later did reveal deficiencies.
OCIE officials said that if they had conducted an exit interview or sent a
no further action letter based on the initial review of data, registrants
would have stopped sending documents to the examination staff. As a
result, the examiners would not have been able to detect the deficiencies
that such information would have revealed. Third, OCIE officials said that
to expedite the process for some groups of firms, they directed examiners
not to write individual examination reports, which would have formed the
basis for exit interviews and deficiency or no further action letters.
Rather, they asked examiners to write a global report summarizing their
findings.

Further, OCIE officials said that they did not inform the individual firms
targeted during these sweep examinations or the industry generally of
their decision to direct examiners to forgo exit procedures. We obtained
the views of various industry participants representing investment
companies, investment advisers, and broker-dealers on OCIE's decision.
Several registrants said that the lack of communication during these sweep
examinations was problematic and unsettling, as often they were unsure of
the status of the examination, if they should be concerned about what OCIE
was finding, or when they could assume the examination was over. Other
industry representatives echoed these concerns and said that for any OCIE
examination, early and ongoing communication with the examiners regarding
any deficiencies identified, in addition to holding prompt exit
interviews, is essential for the examination process to be effective and
efficient. First, the representatives said that firms want to know
immediately whether the examiners have identified any deficiencies so they
can begin to address them as soon as possible. Second, if examiners
identify deficiencies early, it allows the firm the opportunity to clarify
any potential misinterpretations by examiners of the firm's policies,
procedures, and practices before a deficiency letter is sent.

In the wake of the market-timing and other related sweep examinations,
OCIE officials said they expect examiners to follow standard exit
procedures for all sweep examinations, i.e., to conduct exit interviews to
discuss any deficiencies, send deficiency or no further action letters,
and make referrals to Enforcement as appropriate. In March 2006, OCIE
issued formal guidelines for initiating, conducting, and concluding these
examinations. As part of the guidelines, OCIE clarified that it expected
sweep examinations to follow the same procedures as for other types of
examinations. OCIE officials said that these expectations were reinforced
with the issuance of an updated examination brochure (described in more
detail below) in July 2006, which examiners are to provide registrants
when beginning any examination and which details the exit procedures.

Examiners Generally Applied Exit Procedures during Review Period, with Some
Exceptions Noted

Based on our review of a sample of investment company and investment
adviser examinations and a sample of broker-dealer examinations completed
during fiscal year 2003 through fiscal year 2006, we estimated that
examiners generally applied exit procedures, with some exceptions. The
exceptions were an estimated 9 percent of investment company and
investment adviser examinations that were part of the market-timing and
other related sweep examinations, as well as an estimated 7 percent of
broker-dealer examinations where examiners either did not conduct these
exit procedures or they did not provide evidence that they conducted them.
In conducting this analysis, we analyzed examination data from two random
samples of 129 examinations each, drawn from (1) the population of 8,107
investment company and investment adviser examinations and (2) the
population of 3,044 broker-dealer examinations completed during fiscal
year 2003 through fiscal year 2006. These samples allowed us to project
the results of our review to the population of all investment company and
investment adviser examinations and to the population of all broker-dealer
examinations completed during this period at a 95 percent level of
confidence.

We estimated that examiners held exit interviews to discuss deficiencies
found in 79 percent of the investment company and investment adviser
examinations completed during the review period (see fig. 1). In addition,
examiners did not conduct these interviews for reasons allowed under
OCIE's exit interview guidance in an estimated 12 percent of the
examinations. For example, in some cases examiners did not find any
deficiencies during the examination and so were not required to conduct an
exit interview. Instead, they were only required to inform the firm that
they did not find any deficiencies and later send a no further action
letter closing the examination.^26 Other reasons for not conducting exit
interviews included referrals to Enforcement, where Enforcement staff
directed the examiners to forgo the interviews, and other circumstantial
reasons.

We estimated that for the remaining 9 percent of examinations, examiners
did not conduct exit interviews because these examinations were part of
the market-timing and other related sweep examinations where OCIE directed
examiners to forgo these interviews, even though deficiencies were found.

^26Several of the examinations in our sample which resulted in no
deficiencies were market-timing and other related sweep examinations where
OCIE officials told us that in many cases examiners did not provide any
indication of the outcome of the examination regardless of whether any
deficiencies were found.

Figure 1: Estimated Percentage of Investment Company and Investment
Adviser Examinations Where Examiners Conducted Exit Interviews and Sent
Closure Notifications, Fiscal Years 2003 to 2006

Note: Percentages may not add exactly because of rounding. All estimated
percentages in this table have margins of error of plus or minus 8 percent
or less.

^aExaminers were not required to conduct a formal exit interview because
they did not find any deficiencies during the examination.

^bExaminers referred deficiencies found to Enforcement, whose staff
requested that examiners forgo conducting the exit interview, sending a
deficiency letter, or both.

^cOther reasons include more circumstantial reasons OCIE examiners did not
conduct exit interviews or send closure notifications. For example, in one
case, the firm did not produce requested documents in a timely manner
during a sweep examination conducted by headquarters staff, and the
examination team closed the exam and referred the firm to a regional
office, which began a new examination. We did not request additional
information on the new examination.

We also analyzed the frequency with which examiners sent closure
notifications to investment companies and investment advisers and
estimated that examiners sent either a deficiency or a no further action
letter in 87 percent of the examinations completed during the review
period. The predominant reason for the higher rate of closure
notifications sent compared with exit interviews conducted was that
examiners sent no further action letter to firms when no deficiencies were
found.

Examiners did not send closure notification letters in an estimated 11
percent of examinations (14 of the 129 examinations we reviewed) because
the examinations were part of the market-timing and other related sweep
examinations and OCIE had directed examiners not to send any letters. We
found that of these 14 examinations, 11 concluded in fiscal year 2004, 2
concluded in fiscal year 2005, and 1 concluded in fiscal year 2006.
Examiners did not send closure notifications for allowable reasons in an
estimated 2 percent of examinations, and in an estimated 1 percent, we
found no evidence that closure notifications were sent and no legitimate
reason why they should not have been sent.

For the population of broker-dealer examinations, we estimated that
examiners conducted exit interviews and sent closure notifications in an
estimated 82 percent and 88 percent, respectively, of examinations
conducted during the review period (see fig. 2). Examiners did not conduct
exit interviews or send closure notifications for reasons allowable under
OCIE guidance, such as related to referrals to Enforcement, in an
estimated 11 percent and 9 percent, respectively, of the examinations.

Figure 2: Estimated Percentage of Broker-Dealer Examinations Where
Examiners Conducted Exit Interviews and Sent Closure Notifications, Fiscal
Years 2003 to 2006

Note: Percentages may not add exactly because of rounding. All estimated
percentages in this table have margins of error of plus or minus 8 percent
or less.

^aExaminers were not required to conduct a formal exit interview because
they did not find any deficiencies during the examination.

^bExaminers referred deficiencies found to Enforcement, whose staff
requested that examiners forgo conducting the exit interview, sending a
deficiency letter, or both.

^c"OCIE officials believed interviews conducted, but not documented,"
refers to those cases where OCIE officials believed that examiners
conducted exit interviews, but were not able to provide documentation of
them.

In an estimated 7 percent of examinations, we did not find evidence of an
exit interview when OCIE guidance indicated one was warranted. However,
this estimate includes the 3 percent of cases where OCIE officials told us
they believed examiners conducted the interviews but did not document the
discussion. For the other estimated 4 percent, we found no evidence that
exit interviews were held and no legitimate reason why they should not
have been held. In addition, we found no evidence that closure
notifications were sent in an estimated 3 percent of examinations and no
legitimate reason why they should not have been sent.

OCIE Implemented New Initiatives Intended to Improve Communication and
Coordination

OCIE has implemented several initiatives since January 2006 designed to
improve internal and interagency coordination and communication with
registrants. For instance, OCIE has undertaken efforts that include
developing tools and protocols to avoid duplication of examinations and
forming interdivisional committees intended to improve referrals to
Enforcement. Other initiatives include establishing a "hotline" for
registrants and formalizing a new requirement to notify registrants when
an examination extends past 120 days. Our review indicated that examiners
generally complied with this new notification requirement. Some industry
participants who provided their views on OCIE's initiatives expressed
hesitations about using the new hotline. Specifically, several
participants questioned the independence of the new hotline, because it is
located within OCIE's Office of the Chief Counsel and not in another SEC
office or division.

OCIE Has Recently Implemented Initiatives to Increase Communication with
Registrants and Improve Interagency Coordination

In May 2006, the SEC Chairman testified before the House Financial
Services Committee on several reforms designed to improve pre-examination
planning and increase the transparency of SEC's examination program. We
found that OCIE has generally implemented the following reforms and
additional protocols and tools that are intended to improve coordination
across SEC headquarters and regional offices and with other key SEC
divisions.

           o To minimize the number of firms selected for multiple sweep
           examinations and to provide advance notice to the commission
           regarding planned sweep examinations, OCIE developed a formal
           review and approval process for sweep examinations that is
           detailed in the March 2006 sweep examination guidance previously
           discussed. As part of this guidance, OCIE field examiners and OCIE
           staff are directed to submit a list of firms to OCIE management
           that they propose to include as part of the sweep examinations.
           OCIE management is responsible for comparing the list of proposed
           firms against a master list of firms subject to ongoing or
           recently completed sweep examinations to ensure that that the
           firms are not bearing an undue share of examination focus, given
           the nature of their business and OCIE's risk assessment. Once OCIE
           has approved the proposed sweep examination and the targeted firm,
           the new guidance directs OCIE to provide the proposal to Market
           Regulation, Investment Management, or Enforcement for notification
           and to obtain comments. Finally, OCIE is to provide the Commission
           an information memorandum summarizing the proposed sweep
           examination and its objectives. The memorandum directs staff to
           allow the Chairman and Commissioners time to review the memorandum
           and ask questions before commencing the sweep examination. We
           reviewed four of these memorandums, which discussed the time
           frames for the sweep, the issues OCIE planned to investigate and
           the methodology it would use, and the firms it planned to include.

           o SEC, NASD, and NYSE have developed a database, maintained by
           NASD, which collects data on examinations conducted by SEC, NYSE,
           and NASD on 170,000 broker-dealer branch offices. OCIE officials
           said that examiners are now using this database when planning
           examinations to avoid dual examinations of the same branch office
           (with the exception of the broker-dealers selected for review as
           part of SEC's oversight program of the SROs). Further, as part of
           the pilot program for assigning permanent monitoring teams to the
           largest investment company and investment adviser complexes, each
           firm's monitoring team is responsible for conducting all
           examinations related to the firm, including examinations at branch
           offices in different areas of the country. OCIE officials said
           that prior to the implementation of this program, examiners from
           different regional offices would conduct separate examinations of
           the firm's branch offices, which resulted in duplication and
           imposed a burden on the firm.

           o To improve coordination with other key SEC divisions, OCIE
           officials said they have designed a new training program for
           fiscal year 2007 that is designed to educate examiners about rules
           affecting investment companies, investment advisers, and
           broker-dealers. The four scheduled courses are taught by
           Investment Management and Market Regulation staff and focus on
           rules that are new or about which examiners have frequent
           questions in the course of conducting examinations for compliance
           with these rules. Second, OCIE and Enforcement have established
           interdivisional committees in headquarters and the regional
           offices in late 2006 and 2007 to bring more transparency and
           consistency to the decisions made to pursue OCIE referrals to
           Enforcement about investment companies, investment advisers, and
           broker-dealers. According to joint guidance issued by OCIE and
           Enforcement in November 2006, the responsibilities of these
           committees include discussing new referrals to understand their
           strengths and weaknesses and reviewing those examinations referred
           to Enforcement that have not resulted in an investigation or
           enforcement action. In headquarters, these committees also include
           staff from Investment Regulation and Market Regulation, whose role
           is to provide insight with respect to referrals that involve novel
           fact patterns or applications of the law.

           OCIE has also taken the following measures that are intended to
           improve communication with registrants.

           o In January 2006, OCIE established an examination hotline where
           registrants can call or e-mail anonymously to ask questions about
           their specific examinations or other issues, lodge complaints, or
           make comments. To preserve anonymity of the registrants, OCIE does
           not keep a formal log of calls and e-mails to share with OCIE
           management although staff take notes on the calls. OCIE officials
           told us that examples of complaints and concerns to date have
           included duplicative requests, complaints about examiners, and
           questions about public statements made by OCIE officials about the
           examination program. We discuss registrants' views of the
           effectiveness of the new hotline later in this section.

           o In July 2006, OCIE began requiring examiners to contact
           registrants when examinations extend beyond 120 days to discuss
           the status of the examination, the likely schedule for completion,
           and the date of the final exit interview. Previously, OCIE
           officials told us that examiners had no notification requirement
           but as a best practice, tried to contact the registrant if the
           examination extended beyond the usual 90 days it took to complete
           most examinations. However, because of the increasing complexity
           of firms and the increased emphasis on sweep examinations, both of
           which require additional analysis on the part of examiners and can
           increase the time needed to complete an examination, OCIE decided
           to formalize this practice so that firms would be fully aware of
           the status of the examination. We discuss the extent to which
           examiners complied with the new notification requirement later in
           this section.

           o OCIE officials said that they have made more information
           publicly available on the examination program and current
           compliance issues. In July 2006, OCIE issued a revised examination
           brochure, which provides more detailed information to registrants
           about the examination process, including the 120-day notification
           procedure and exit procedures. Later, in January 2007, SEC issued
           a guide, prepared by OCIE, to assist broker-dealers in their
           efforts to comply with anti-money-laundering laws and rules.
           Finally, in June 2007, OCIE issued its first Compliance Alert
           letter to chief compliance officers (CCO) of investment companies
           and investment advisers as part of its CCO outreach program.^27
           These letters, which OCIE officials said they plan to issue twice
           a year, are intended to describe areas of recent examination focus
           and certain issues found during investment company, investment
           adviser, and broker-dealer examinations.

^27SEC implemented the CCO Outreach program in 2005. The program is
jointly sponsored by OCIE and Investment Management and is designed to
enable the Commission and its staff to better communicate and coordinate
with the CCOs of investment companies and investment advisers.

           Examiners Generally Followed OCIE's New Procedure to Notify in 120
			  Days Where Applicable

           We reviewed OCIE examination data to determine the extent to which
           examiners followed the new 120-day notification procedure for
           investment company, investment adviser, and broker-dealer
           examinations and determined that examiners generally followed this
           procedure where applicable since its implementation on July 31,
           2006. As previously discussed, OCIE implemented the new 120-day
           notification procedure to better inform registrants of the status
           of examinations that would not be completed within 120 days. OCIE
           has directed examiners to contact the firm on or about the 120th
           day after the completion of the on-site visit to discuss the
           status of the examination and the likely schedule for completing
           the examination and conducting an exit interview. OCIE officials
           said that this procedure largely was intended to address those
           instances when an examiner left the firm after the on-site portion
           of the examination and did not have further contact with the firm
           while conducting subsequent analysis. OCIE examiners are
           instructed to call the firm in these cases to update the firm on
           the examination and should document the discussion in a note to
           the examination file. However, OCIE officials said that sometimes
           an examination will extend beyond 120 days because OCIE is waiting
           for the firm to produce documents or data. In those cases, the
           firm knows that the examination is still ongoing and examiners are
           not expected to call on or about the 120th day.

           We identified a total of 13 closed examinations that had lasted
           120 days or more in the period between the date OCIE implemented
           the new procedure (July 31, 2006) and the date OCIE provided us
           its records (February 2, 2007). These 13 cases included 10
           investment company and investment adviser examinations and 3
           broker-dealer examinations. In 7 of the 13 examinations, examiners
           either contacted the firm on or around the 120th day of the
           examination or otherwise already had ongoing communication with
           the firm because they were waiting for documents or other data
           from the firm. In 5 of the 13 examinations, examiners did not
           provide 120-day notification for allowable reasons. For example,
           in two of these five cases, the examiners referred their findings
           to Enforcement staff, who asked the examiners to cease contact
           with the firm. In the other three of these five cases, further
           contact was not warranted, either because the firm decided to
           withdraw its registration or the examiners only reviewed available
           data about the firm in SEC's offices and never contacted the firm
           to open a formal examination. In the last of the 13 examinations,
           examiners did not contact the firm on or about the 120th day.
			  
			  Comments from Industry Participants on OCIE's New Initiatives Revealed
			  Concerns about the Independence of the New Hotline

           We contacted various industry participants representing investment
           companies, investment advisers, and broker-dealers to gather their
           views on OCIE's recent initiatives. They generally expressed
           support for these initiatives, but some expressed hesitations
           about using the new hotline. More specifically, several
           registrants viewed the new hotline as a positive step by OCIE to
           provide an additional channel of communication, and at least one
           registrant reported finding the hotline very useful. However,
           others expressed concern about the independence of the staff that
           operate the hotline, because, as previously discussed, OCIE's
           hotline is staffed by attorneys in OCIE's Office of the Chief
           Counsel. Other industry participants questioned the utility of the
           hotline as a tool for addressing issues that are of concern to
           them. For example, they said that they often have concerns about
           the interpretation of SEC rules by examiners during examinations.
           They said that when these issues arise, they would like OCIE to
           consult with Market Regulation --the SEC division that writes and
           interprets the rules for broker-dealers--to ensure that examiners
           interpret these rules appropriately. However, they said that they
           do not perceive that this consultation currently occurs, and as a
           result, have doubts that calling the hotline would result in an
           effort by OCIE to obtain clarification. Further, they said that it
           is important to resolve concerns about rule interpretations while
           an examination is ongoing and obtain the views of Market
           Regulation early on, before the exit conference occurs or a
           deficiency letter is sent. Similarly, another group of registrants
           thought that OCIE was unresponsive to their past concerns and did
           not see the hotline as a valuable tool for addressing these
           concerns.

           OCIE officials told us they decided to locate the hotline in their
           Office of the Chief Counsel because this office is the ethics
           office for OCIE. OCIE managers thought it was important to keep
           the hotline in a centralized location, as an issue could arise
           that involved any one of OCIE's examination programs (such as the
           programs for investment companies and investment advisers or
           broker dealers). In addition, according to OCIE officials, the
           Associate Director and Chief Counsel reports directly to the OCIE
           director, and therefore the Chief Counsel's Office can exercise a
           great deal of institutional autonomy when determining how to
           handle the calls or e-mails received. As discussed earlier, OCIE
           officials said the Chief Counsel's Office does not keep a formal
           log of contacts, to better preserve the anonymity of registrants.
           Finally, the officials said that the issues that registrants bring
           to them may be legally sensitive, so it made sense that the Chief
           Counsel's office evaluates them first to determine how to best
           address them.

           In contrast to OCIE, NASD has created an Office of the Ombudsman
           to receive and address concerns and complaints, whether anonymous
           or not, from any source concerning the operations, enforcement, or
           other activities of NASD. The Office of the Ombudsman is an
           independent office within NASD that reports directly to the Board
           of Directors. As part of its responsibilities, the Office of the
           Ombudsman also provides summary information on the development of
           trends based on complaints, which may support resulting system
           change. By locating the hotline in an office or division that is
           independent of OCIE, OCIE could lessen registrants' concern about
           the independence of that staff who operate the hotline and thus
           encourage greater use of it. Besides assisting callers with any
           complaints, the independent office could periodically summarize
           information from complaints and concerns for OCIE, while
           preserving the anonymity of the contacts. Such information could
           allow OCIE management to identify and respond to any trends in
           this information and potentially improve the examination program.
			  
			  Conclusions

           In the aftermath of the widespread trading abuses that surfaced in
           the mutual fund industry in late 2003, OCIE has taken steps to
           make its approach to examining investment companies and investment
           advisers more risk-based. While such an approach may provide a
           basis for OCIE to allocate its limited resources to examine firms
           that are designated as higher risk for compliance problems, the
           effectiveness of the program largely depends on OCIE's ability to
           accurately determine the risk level of each investment adviser.
           Since many firms rated lower-risk are unlikely to undergo routine
           examinations within a reasonable period of time, if at all,
           harmful practices could go undetected if firms are inappropriately
           rated as lower-risk. The risk algorithm that OCIE employs to
           predict the level of risk for the majority of investment advisers
           is potentially limited in that it relies on proxy indicators of
           compliance risks without incorporating information about the
           relative strength of a firm's compliance controls, information
           that is critical to assessing a firm's risk level. OCIE has
           recognized this limitation and has started to take steps to
           enhance the effectiveness of the risk algorithm to accurately
           predict risk levels by seeking additional information that could
           improve OCIE's ability to identify higher-risk firms. Based on
           fiscal-year-2006 data, OCIE's internal assessment showed that the
           risk algorithm has a 91 percent accuracy rate for predicting
           lower-risk ratings but appears to have a lower accuracy rate when
           considering newly registered investment advisers. Further, the
           accuracy rate for higher risk firms was 25 percent--in part
           because the risk-rating did not incorporate information on the
           firms' ability to mitigate the compliance risks identified. The
           results of these initial analyses indicate that continued
           assessing and refining the risk algorithm is warranted. As we have
           previously recommended, one potential source OCIE might consider,
           as it continues to enhance its methods that assess risk, is the
           documentation associated with the compliance review that firms
           must conduct under the Compliance Program rules. We recognize that
           SEC would first have to require that firms submit these reports to
           SEC through rule making. However, we continue to believe that
           using them could potentially allow OCIE to improve its ability to
           identify higher-risk firms. As part of the revised examination
           approach, OCIE has also implemented a process intended to
           identify, map, and develop regulatory responses to high-risk
           industry practices and compliance issues across the securities
           markets, although it has not yet developed a formal approach to
           evaluate the effectiveness of this process for identifying new or
           resurgent compliance risks. Implementing the task force that OCIE
           is currently considering could facilitate such an assessment.

           Our review found that OCIE examiners generally followed OCIE
           guidance for conducting exit procedures during the period
           reviewed, with a major exception for market-timing and other
           related sweep examinations conducted largely over fiscal years
           2003 and 2004, with a few concluding in fiscal year 2005 and
           fiscal year 2006. OCIE directed examiners to forgo these exit
           procedures. OCIE guidance provides management and examiners
           flexibility in determining when and how to communicate
           deficiencies to registrants and is responsive to Enforcement's
           directives. However, by not providing the industry any notice or
           explanation of the decision to forgo these procedures for certain
           market-timing and other related sweep examinations, OCIE
           unnecessarily created concern and confusion for some registrants
           during this difficult time. Going forward, OCIE has directed its
           examiners to follow standard exit procedures for all sweep
           examinations.

           Since January 2006, OCIE has generally implemented a number of
           initiatives to improve coordination and communication. Ongoing
           monitoring and reassessing of these initiatives by OCIE is
           important to ensure that they are achieving their intended
           objective. For example, OCIE's procedure to notify firms when
           examinations continue beyond 120 days could help mitigate the
           uncertainty firms told us they experience when examiners leave the
           firm and do not update the firm on the status of examinations for
           long periods of time. While our review of 13 examinations revealed
           general compliance with this notification procedure, OCIE must
           ensure that examiners continue to adhere to the requirement in the
           future. Another new initiative, the examination hotline, could
           give registrants an effective means to communicate concerns or
           complaints about the examination program, but several registrants
           reported reluctance to use it because the hotline was located in
           and staffed by OCIE. Their concerns about OCIE's receiving their
           complaints or concerns included a perceived lack of impartiality.
           Locating the hotline in a division or office that is independent
           of OCIE could encourage greater use and increase effectiveness.
           Further, this new office could analyze the contact information and
           give OCIE management with information summarizing trends generated
           from analysis of complaints or inquiries, information that OCIE
           could use to improve its examination programs.
			  
			  Recommendations for Executive Action

           To encourage registrants to communicate their concerns, questions,
           or complaints to SEC about the examination process, we recommend
           that the SEC Chairman explore relocating the hotline to an
           independent office such as an ombudsman function within the agency
           or within a division or office that is independent of OCIE and, as
           part of the responsibilities of this office, consider requiring it
           to give OCIE management summary information on the development of
           trends resulting from complaints or inquiries.
			  
			  Agency Comments and Our Evaluation

           SEC provided written comments on a draft of this report, which are
           reprinted in appendix II. SEC also provided technical comments,
           which were incorporated into the final draft as appropriate. SEC
           noted in its comment letter that while an important benefit of the
           current establishment of the hotline is that it provides immediate
           access to a member of senior OCIE management, it also wants to
           encourage calls from anyone who has a question or concern about an
           examination. As a result, SEC stated it is taking steps to revise
           the hotline in order that callers can choose to speak with the
           commission's Office of the Inspector General, in addition to staff
           from OCIE's Office of the Chief Counsel. In taking this step, SEC
           believes it is preserving the benefits of the current system while
           responding to our recommendation.

           As agreed with your office, unless you publicly announce the
           report's contents earlier, we plan no further distribution of this
           report until 30 days after the date of this report. At that time,
           we will send copies of this report to the Chairmen of the
           Committee on Financial Services and its Subcommittee on Capital
           Markets, Insurance, and Government Sponsored Enterprises, House of
           Representatives; and other interested committees. We will also
           send a copy of the report to the Chairman, Securities and Exchange
           Commission. We will make copies available to others upon request.
           The report will also be available at no charge on our Web site at
           [24]http://www.gao.gov .

           If you or your staff have any questions regarding this report,
           please contact Orice M. Williams at (202) 512-8678 or
           [25][email protected] . Contact points for our Offices of
           Congressional Relations and Public Affairs may be found on the
           last page of this report. GAO staff who made major contributions
           to this report are listed in appendix III.

           Orice M. Williams
			  Director, Financial Markets and Community Investment

           List of Congressional Requesters

           The Honorable Spencer Bachus
			  Ranking Member
			  Committee on Financial Services
			  House of Representatives

           The Honorable Deborah Pryce
			  Ranking Member
			  Subcommittee on Capital Markets, Insurance, and Government
			    Sponsored Enterprises
			  Committee on Financial Services
			  House of Representatives

           The Honorable Richard H. Baker
			  House of Representatives

           The Honorable Vito Fossella
			  House of Representatives
			  
			  Appendix I: Scope and Methodology	

           To better understand the Office of Compliance Inspections and
           Examination's (OCIE) revisions to the examination approach for
           investment companies and investment advisers after 2003 and the
           process OCIE implemented to better identify compliance risks
           across the securities markets, we obtained and analyzed
           information from OCIE on its revised examination approach for
           investment companies and investment advisers and a new,
           examiner-driven process for identifying emergent or resurgent
           systemic risks to investors and SEC registrants. Specifically, we
           reviewed OCIE's internal planning documents, a memorandum from
           OCIE to the Commission, and data OCIE generated as part of an
           internal evaluation on its methodology for assessing compliance
           risk at investment advisers. We did not verify these data. We also
           observed a demonstration of the information technology application
           OCIE uses to conduct its annual risk-assessment process, reviewed
           prior GAO reports, and interviewed OCIE and other Securities and
           Exchange Commission (SEC) officials.

           To identify OCIE's exit procedures and assess the frequency with
           which examiners have followed these procedures when conducting
           investment company, investment adviser, and broker-dealer
           examinations, we reviewed OCIE's guidance to examiners and
           interviewed officials from OCIE and industry participants
           representing investment companies, investment advisers, and
           broker-dealers, and analyzed examination data. We focused our
           analysis on these registrants because they comprise over 95
           percent of all SEC registrants and OCIE expends most of its
           examination resources on these entities. We analyzed broker-dealer
           examinations separately from investment company and investment
           adviser examinations because the two examinations areas have
           different types of examinations and are managed separately within
           OCIE.

           We obtained data from OCIE on all investment adviser, investment
           company, and broker-dealer examinations completed during fiscal
           year 2003 through fiscal year 2006. We chose to review this period
           because it included a time when OCIE did not require examiners to
           apply their usual exit procedures for certain sweep examinations
           as well as periods when OCIE said that it applied the exit
           procedures to most examinations. We selected random samples of 129
           examinations each from the population of 8,107 investment company
           and investment adviser examinations and the population of 3,044
           broker-dealer examinations. This sample size allowed us to project
           our results from these two samples to the two respective
           populations at the 95 percent level of confidence. All estimates
           have margins of error of plus or minus 8 percent or less. To
           determine the extent to which examiners conducted exit interviews
           and sent closure notifications in our samples, we reviewed the
           electronically available examination reports and, where necessary,
           asked OCIE for additional documentation from the examination
           files. The results of our analysis for each of these two
           registrant types are limited to estimates of this combined 4-year
           time frame. In conducting our analysis, we conducted a data
           reliability assessment of the data OCIE provided us and determined
           they were reliable for our purposes.

           To identify OCIE's recent initiatives to increase communication
           with registrants and improve the examination program, including
           the frequency with which examiners have followed OCIE's new
           notification requirement for examinations that continue longer
           than 120 days, we reviewed documentation obtained from OCIE,
           including memorandums to the Commission, internal OCIE guidance,
           and the revised examination brochure. We also analyzed examination
           data related to the 120-day notification procedure and interviewed
           officials from OCIE and the industry participants previously
           discussed. In determining the frequency that examiners have
           complied with the new 120-day notification procedure, we obtained
           data from OCIE of all of the investment adviser, investment
           company, and broker-dealer examinations conducted between July 31,
           2006, the day the policy was implemented, and February 2, 2007,
           the day OCIE gave us the records. We identified all closed
           examinations that lasted 120 days or more, thus triggering the
           120-day notification requirement. Because there were only 13
           closed examinations where the procedure was applicable, we
           reviewed all of them. We first reviewed the electronically
           available reports for evidence of the notification and, in those
           cases where we did not find evidence, asked OCIE for additional
           documentation from the examination files. In conducting our
           analysis, we conducted a data reliability assessment of the data
           OCIE provided us and determined they were reliable for our
           purposes.

           We conducted our work in Washington, D.C., between September 2006
           and July 2007 in accordance with generally accepted government
           auditing standards.
			  
			  Appendix II: Comments from the Securities and Exchange Commission
			  
			  Appendix III: GAO Contact and Staff Acknowledgments
			  
			  GAO Contact

           Orice M. Williams (202) 512-8678 or [email protected]
			  
			  Staff Acknowledgments

           In addition to the contact named above, Karen Tremba (Assistant
           Director), James Ashley, Rudy Chatlos, Nina Horowitz, Stefanie
           Jonkman, Christine Kuduk, Marc Molino, Omyra Ramsingh, and Barbara
           Roesmann made key contributions to this report.
			  
			  GAO's Mission

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(250338)

[32]www.gao.gov/cgi-bin/getrpt?GAO-07-1053 .

To view the full product, including the scope
and methodology, click on the link above.

For more information, contact Orice M. Williams (202) 512-8678 or
[email protected].

Highlights of [33]GAO-07-1053 , a report to congressional requesters

August 2007

SECURITIES AND EXCHANGE COMMISSION

Steps Being Taken to Make Examination Program More Risk-Based and
Transparent

After widespread unlawful trading practices surfaced in the mutual fund
industry in late 2003, the Securities and Exchange Commission (SEC),
through its Office of Compliance Inspections and Examinations (OCIE), took
steps intended to revise its examination process to better identify and
focus its resources on those activities representing the highest risk to
investors. More recently, some registrants raised concerns about the lack
of communication from SEC examiners about the status of and results of
examinations. This report (1) describes OCIE's revisions after 2003 to the
examination approach for investment companies and investment advisers; (2)
discusses OCIE's compliance with its examination exit procedures; and (3)
describes reforms OCIE implemented since January 2006 to enhance, among
other things, communication with registrants. To address these objectives,
GAO analyzed OCIE examination data; planning documents and guidance;
interviewed OCIE officials; and gathered views of registrants.

[34]What GAO Recommends

GAO recommends that SEC consider relocating its registrant complaint
hotline to an independent office, such as an ombudsman function, within
the agency or within a division or office outside of OCIE. SEC generally
agreed and is taking steps to address the intent of the recommendation.

Since the detection of mutual fund trading abuses in late 2003, OCIE has
shifted its approach to examinations of investment companies and
investment advisers from one that focused on routinely examining all
registered firms, regardless of risk, to one that focuses on more
frequently examining those firms and industry practices at higher-risk for
compliance issues. The effectiveness of OCIE's revised approach largely
depends on OCIE's accurately assessing the risk level of investment
advisers. The method that OCIE employs to predict the level of risk for
the majority of investment advisers has some limitations, particularly in
that this method relies on proxy indicators of compliance risks without
incorporating information about the relative strength of a firm's
compliance controls. OCIE has taken steps to assess the effectiveness of
this method for predicting risk-levels and to seek additional indicators
of compliance risks. GAO continues to believe that implementing GAO's
prior recommendation to obtain and use compliance reports from firms--a
source of information on the effectiveness of their compliance
controls--could potentially help OCIE better identify higher-risk firms.

GAO's review of investment company, investment adviser, and broker-dealer
examinations conducted from fiscal years 2003 through 2006 found that
examiners generally follow OCIE's exit procedures for communicating
deficiencies to registrants and providing written notice of the
examination's outcome, except in an estimated 9 percent of investment
company and investment adviser examinations where OCIE directed examiners
to forgo these procedures. These examinations were part of a series of
OCIE examinations that probed specific activities across a number of firms
and were initiated in response to the widespread unlawful trading
practices which had surfaced at that time. In addition, GAO estimated that
in 7 percent of broker-dealer examinations, either examiners did not
follow exit procedures or OCIE officials were not able to provide evidence
that they did.

OCIE has implemented several initiatives since January 2006 intended to
improve communication with registrants and other aspects of the
examination program. For instance, OCIE established a hotline for
registrants to receive comments or complaints, began requiring examiners
to contact registrants when examinations extend past 120 days, and
implemented tools and protocols designed to reduce duplicating
examinations. GAO's review indicated that examiners generally complied
with the new requirement to notify registrants when an examination extends
past 120 days. Comments from industry representatives on OCIE's
initiatives suggested some concerns about the hotline. Specifically,
several registrants questioned the independence of the hotline, as it is
located within OCIE, and said that as a result they would hesitate to use
it.

References

Visible links
  20. http://www.gao.gov/cgi-bin/getrpt?GAO-05-415
  21. http://www.gao.gov/cgi-bin/getrpt?GAO-05-313
  22. http://www.gao.gov/cgi-bin/getrpt?GAO-05-313
  23. http://www.gao.gov/cgi-bin/getrpt?GAO-05-313
  24. http://www.gao.gov/
  25. mailto:[email protected]
  26. http://www.gao.gov/
  27. http://www.gao.gov/
  28. http://www.gao.gov/fraudnet/fraudnet.htm
  29. mailto:[email protected]
  30. mailto:[email protected]
  31. mailto:[email protected]
  32. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1053
  33. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1053
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