Client funds, net capital among hot topics for SEC 2012 exam program

May 18, 2012

By Nick Paraskeva, Thomson Reuters Accelus contributing author

NEW YORK, May 18 (Thomson Reuters Accelus) –  The SEC has new priorities in its 2012 exam program, including verifying firms’ holding of client funds and their net capital calculations.

The changes follow the collapse of MF Global, which revealed that client funds were missing despite regulations requiring that they be segregated. The revisions also reflect top findings found during the 2011 exam program, and follow major reforms to the SEC’s exam office.“Events at MF Global led to greater concerns on how firms are calculating their reserve formula, their net capital computations, and custody of customer assets,” said Carlo di Florio, director of the SEC Office of Compliance Inspections and Examinations (OCIE). Di Florio was speaking at a meeting of the Securities Industry and Financial Markets Association (SIFMA) Compliance and Legal Society in New York.

Exam program developments

The compliance inspections office has moved from a confederation of 12 autonomous regional programs to building a national exam program. This includes consistent policies and procedures and recruitment of a Chief Compliance Officer.

New management in the last year includes Julius Leiman-Carbia to lead the national broker-dealer exam program and Drew Bowden to lead the national investment adviser/Investment company exam program. The exam office has also recruited specialists with PhDs in math, quantitative analytics and models.

The office moved from a manual process to an automated exam system on an Oracle platform, which is flexible and better analyzes exam results, di Florio said. A new Office of Risk Analytics and Surveillance identifies those firms with higher-risk attributes for the SEC to review. An Office of Data Analytics can further investigate the firms so identified, where there is a lot of data to analyze.

A new Office of Large Firm Monitoring looks at complex firms for their unique business profiles, and picks the critical business units and products to target in exams. The SEC now shares with firms what it finds in exams, via issuance of a new series of Risk Alerts to identity best practices seen and areas of concern.

“We look to separate the forest from the trees”, said di Florio ”by looking at firms’ corporate governance, models, and how they take and manage risk”. This includes how the chief compliance officer, chief risk officer and general counsel work together and with the business. Internal Audit is the third line of defense.

“We have really enhanced our interaction with the board to oversee how they govern, and will continue to do so for larger and medium sized firms” said di Florio. This helps set firm leadership and tone at the top, and allows candid dialog on major risks. The SEC will ask for evidence of concrete decisions that the firm has taken as a result of board discussions involving compliance and other control areas.

2012 SEC Exam Issues

  • 2011 main exam findings (will continue to review in 2012)
    1. Reserve formula and net capital computation;
    2. Safekeeping and custody of customer assets;
    3. Risk and control functions, compliance, internal audit;
    4. Supervision, including for distributed business models such as where contractors used;
    5. Sale practice unit;
    6. Order handling; and
    7. Underwriting.
  • Due diligence in municipal securities underwriting and private placements, where a Risk Alert was issued on the need to assess the financial and operational condition of issuers before selling.
  • Supervision of broker dealer employees. The SEC have seen issues with dually-registered broker dealer and advisor firms, especially representatives recommending complex products and private placements, and the need for training to ensure their understanding of the products.
  • Supervision of employees in remote locations.
  • Supervision of trading activity. The SEC issued two Risk Alerts on unauthorized trading and broker dealer inspections of their branch offices.
  • Fraud. The SEC continues to find Ponzi schemes, pump and dump, and manipulation schemes. OCIE partners with the Enforcement division to act quickly and to protect client funds. They are looking at sales manipulation in affinity frauds, e.g. for seniors, the military and religious groups.
  • Unregistered entities, including via use of master/sub accounts, where a Risk alert was issued with effective practices and controls. The focus is on harmful activities such as excessive margin, insider trading and market manipulation.
  • Sale of private placement securities.
  • Trading risks, including high frequency trading, algorithms and alternative trading system (ATS) that the SEC still have not examined, they have now completed seven of the 10 largest ATS.
  • New regulatory risks. Examine compliance with new rules on market access, municipal adviser registration, and incentive compensation. The SEC is also getting ready for five new categories of swap registrants, and the forthcoming Volcker Rule.
  • Large firm risks. OCIE works with SEC Trading and Markets division, FINRA, Fed, OCC, and CFTC on coordination, looking at financial and operational issues such as customer protection. New regulatory colleges pull together data from various sources on large firms for exam planning.

SEC OCIE Risk Alerts are available from:


(Nick Paraskeva is principal of Reg-Room LLC (, which provides regulatory information and consultancy. He covers various facets of the banking and securities industry and delivers exclusive analysis through Thomson Reuters. He can be contacted at (212) 217-0403 and Follow Nick on Twitter@regroom.)

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see