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Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Monday, November 23, 2009

SEC's Inspector General Makes Recommendations on Inspection of Investment Advisers

The SEC's Office of Inspector General released its final report on its investigation into why the SEC did not discover Madoff's Ponzi scheme, even after his investment advisory business registered with the SEC. The Review of the Commission’s Processes for Selecting Investment Advisers and Investment Companies for Examination (Nov. 19, 2009) contains 11 recommendations designed to improve OCIE’s process for selecting investment advisers and investment companies for examination:

We recommend that OCIE implement a procedure requiring, as part its process for creating a risk rating for an investment adviser, that OCIE staff perform a search of Commission databases containing information about past examinations, investigations, and filings related to the investment adviser.

We recommend that OCIE change the risk rating of an investment adviser based on pertinent information garnered from all Divisions and Offices of the Commission, including information from OCIE examinations and Enforcement nvestigations, regardless of whether the information was learned during an examination conducted to look specifically at a firm’s investment advisory business.

Further, Enforcement and OCIE should establish and adhere to a joint protocol providing for the sharing of all pertinent information (e.g., securities laws violations, disciplinary history, tips, complaints and referrals) identified during the course of an investigation or examination or otherwise.

We recommend that OCIE establish a procedure to thoroughly evaluate negative information that it receives about an investment adviser and use this information to determine when it is appropriate to conduct a cause examination of an investment adviser, and when it becomes aware of negative information pertaining to an investment adviser, it examine the investment adviser’s Form ADV filings and document and investigate discrepancies existing between the adviser’s Form ADV and information that OCIE previously learned about the registrant.

We further recommend that OCIE establish a procedure to thoroughly evaluate an investment adviser’s Form ADV when OCIE becomes aware of issues or problems with an investment adviser.

We also recommend that OCIE re-evaluate the point scores that it assigns to advisers based on their reported assets under management and their reported number of clients to which they provide investment advisory services and assign progressively higher risk weightings to firms accordingly.

Further, we recommend that a Commission rulemaking be instituted that would require additional information to be reported as part of Form ADV and that the proposed rule providing for Amendments to Form ADV be finalized. We also recommend that OCIE develop and adhere to policies and procedures for conducting third party verifications, such that OCIE verifies the existence of assets, custodian statements, and other relevant criteria.

We believe that implementation of the recommendations contained in this report will significantly improve OCIE’s operations and its process for selecting investment advisers and investment companies for examination.

The OIG also asks the SEC to provide a written corrective action plan within 45 days.

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