Sweep Exams: What, When, Why and How to Prepare and Respond

On December 18, 2012, a panel composed of regulators and industry experts spoke at the SIFMA Compliance and Legal Society monthly luncheon regarding various aspects of sweep exams.  The panel was moderated by C&L Executive Director R. Gerald Baker and was comprised of:

  • William Wollman, Senior Vice President, FINRA;
  • Suzanne McGovern, Assistant Director, U.S. Securities and Exchange Commission, Office of Compliance, Inspections and Examinations (“OCIE”);
  • Debra Roth, Executive Director, Morgan Stanley;
  • Michael Ludwig, Director and Head of Americas Regulatory Exams, Credit Suisse; and
  • Ben Indek, Partner, Morgan, Lewis & Bockius LLP.

Ms. McGovern began the discussion by describing the SEC’s risk targeted exam sweeps — “RITES” — initiative, which she described as both a horizontal and vertical approach to sweep exams.  Ms. McGovern explained that subject matter ideas for sweeps come from a wide assortment of potential sources including regional offices, the identification of new risk areas in the marketplace, which can be gleaned from industry announcements and articles in the press, new legislation, new products, and new systems and platforms introduced by the industry.  The SEC wants to ensure that it understands new initiatives introduced into the marketplace by the industry and to obtain a handle early regarding what does and does not work.  Prior to the launch of any sweep, the SEC has an executive committee that vets and is responsible for approving sweep ideas.

Following a sweep, OCIE will prepare a written report summarizing its findings.  The report is then turned into a public report that includes both the good practices and violative conduct identified during the sweep.  The public reports are published in two formats: risk alerts for routine issues and whitepapers for high-profile issues.  In an attempt to expedite the process, OCIE has dedicated one staff member to preparing summary reports for public consumption, but these still go through the vetting and approval process prior to publication.  See OCIE’s studies and reports at http://www.sec.gov/about/offices/ocie/ocie_studies.shtml.

OCIE’s exams initiatives are currently focused on the following areas:

  • governance of technology and controls;
  • the Facebook IPO;
  • seniors;
  • non-exchange traded REITs;
  • alternative trading systems;
  • high-yield securities and how they are marketed; and
  • due diligence.

Exam alerts that are forthcoming from OCIE relate to:

  • investment adviser due diligence;
  • options;
  • reasonable inquiry (know your customer);
  • structured products to retail clients; and
  • broker-dealer services to investment advisers.

Ms. McGovern added that the SEC attempts to coordinate with FINRA to avoid sweep duplication and it has discussions with FINRA to determine which entity would be best suited to examine what firm.  She described such considerations as “granular.”

For more information about the SEC’s National Exam Program, see http://rnlawfirm.com/2012/05/16/hot-topics-in-the-secs-national-exam-program.  For additional information about the SEC’s examination program of IAs and dually registered firms, see http://rnlawfirm.com/2012/07/30/the-secs-examinations-program-of-ias-and-dually-registered-firms.

As for FINRA, Mr. Wollman explained that FINRA takes a horizontal approach to sweep exams by targeting multiple firms that are representative of the particular subject matter of interest in the sweep.  Sweeps can originate from various areas within FINRA, as well as from self-reporting.  Mr. Wollman added that some sweeps are conducted for the purpose of gathering information.  See FINRA’s sweep requests at http://www.finra.org/Industry/Regulation/Guidance/TargetedExaminationLetters/.

Before a sweep is authorized, a “sweep committee,” comprised of senior members from various FINRA departments, vets the proposed sweep.  FINRA attempts to ensure that sweeps are not duplicative of those conducted by the SEC or the CFTC, as examples.  FINRA also tries to limit the wasting of the examinee’s resources and uses sweeps as a method to improve investor protection.

While FINRA tries to avoid duplicative sweeps, Mr. Wollman acknowledged that there is some overlap between FINRA and OCIE, but that FINRA is working on a governance process to limit/avoid potential duplication.  Because there are over 4,000 member firms, Mr. Wollman explained that there needed to be a consistency in the requests to the firms.  By way of example, Mr. Wollman noted the recent business continuity plan (BCP) sweep that was issued in the wake of Hurricane Sandy.  He explained that prior to issuing the sweep, multiple regulators collaborated on the resultant sweep request, which included 31 individual requests. The requests resulted from a balancing of the various regulatory bodies’ interests involved following the storm. See the BCP sweep at http://www.finra.org/Industry/Regulation/Guidance/TargetedExaminationLetters/P197274.

Mr. Wollman acknowledged that certain sweeps could be reactionary in response to an event in the industry.  He noted, however, that sweeps are outcome focused and not enforcement driven.

Similar to the SEC’s initiatives, Mr. Wollman noted that FINRA also is focused on examining firms that trade and sell non-exchange traded REITs, and especially communications related thereto.  FINRA also is focused on other products that have no transparency in the open marketplace.  Lastly, Mr. Wollman addressed the issue of interpreting another exchange’s rules, and stated that FINRA does not attempt to address non-FINRA rules and the possible violation of those rules.

For more information on FINRA’s exams, see http://rnlawfirm.com/2012/04/26/finra-exam-initiatives-2012.

The industry panelists focused on best practices on behalf of member firms and certain guidance regarding issues confronted during the course of a sweep.

In general, the panelists commented that it was best to be proactive.  For example, if a firm is not targeted during the course of a sweep, it still makes sense for the firm to conduct its own internal exam of the subject matter to determine if it has any issues that require remediation and possible self-reporting.  The panelists also noted that it is a best practice to engage counsel, whether in-house or external, when conducting such internal examinations to maintain privilege.

Another best practice identified by the panelists is to offer more information to the regulators than requested when such information helps to shed light on the situation and supports the firm’s position.  Moreover, when a request seeks information that the firm does not maintain in the ordinary course or in a readily accessible format, the firm should engage in dialogue with the regulator to see if the request can be altered to alleviate undue burden to the firm.

Finally, the panelists noted that all sweeps and exams should be taken seriously.  Even when a sweep letter may appear to be minor or innocuous, it can negatively impact a firm if not responded to properly.

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Reyhani Nemirovsky LLP represents financial services clients in regulatory matters, enforcement proceedings, arbitrations and litigations.  The firm also provides advice and counsel on wide-ranging compliance matters.

For more information about the firm, please visit www.rnlawfirm.com, or contact us by email at info@rnlawfirm.com or by telephone at (212) 897-4030.

Reyhani Nemirovsky LLP, 200 Park Avenue, 17th Floor, New York, NY 10166.

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