SEC

Notice 1 week
Advisers will generally receive about a one week advance notice of an examination. And don’t think not being registered will let you off the hook – if the SEC suspects fraudulent activity they will make a visit regardless of whether you’re on its books or not.   

Approach
Stickler for technical detail
Usually a Regular Review will take place, but larger firms can be subjected to a Targeted Review, which focuses a specific area of the business – valuation, for example. 
In general, managers should be prepared to turn over, at short notice, almost all written documents, ranging from fund offering documents, to the compliance manual, minutes of meetings of the board of directors, marketing materials, trading records, bank statements, brokerage statements, copies of emails and more. Before the exam begins, the adviser will receive a questionnaire (typically customised) and/or a request for a lengthy list of documents. Most must be provided before the exam begins.
Compliance issues are of particular interest to the SEC, says one hedge fund professional. “They want to know how fit and suitable a compliance officer is. If you say your chief compliance officer has had education, they will want to know the form this education has taken. ‘What kind of pre-clear has taken place? Can I see? Have there been exceptions? What do you do?’ There are a lot of questions.” 

Duration 2 wks to 4 mths
“The length of the examination will depend on the number of examiners assigned and the size and complexity of the manager’s business,” says Mazin. “They can take as little as two weeks and as much as two months.” The CCO of one multi-billion dollar US hedge fund business, meanwhile, suggests that the most complex firms of all can receive visits that last three to four months. Examiners may also leave an inspection midway through and return a few weeks later, they add.
  
Frequency
Every 2-3 yrs to 6-7 yrs
The SEC employs a risk-based system to select the advisers being examined. Higher risk advisers will be examined every two to three years. Low risk advisers could go five or six years without being examined.  “We’re on a three-to-four-year cycle,” says the CCO of the same multi-billion dollar US hedge fund business. “But I know of some firms locally that have one only every six to seven years.”

Other factors
Geography
The SEC has offices of varying sizes across the US. Teams such as those in New York or Chicago will be larger and contain more examination officials than the team in Montana for example. Your firm’s location therefore, suggests one hedge fund professional, is likely to influence the length, breadth and focus of an inspection. 

Recent events
If several members of senior management leave, regardless of the reason, the SEC is likely to come knocking. If an increasing number of stories have appeared in the media about a particular firm, containing quotes or otherwise, and could be deemed beneficial in terms of marketing, the SEC will want to know why. Change is a red flag.

Expecting the unexpected
“The best preparation is to go through a mock examination,” says Mazin. “If the manager does not wish to do so, the CCO should do a thorough review on an annual basis of all compliance policies and procedures in order to identify deficiencies or areas of weakness, and to update the policies where necessary to stay on top of regulatory changes, as well as improving the policies to better detect and prevent non-compliance.”

FSA

Notice 1 month
Managers are normally given about a month’s notice of an FSA visit, unless, of course, said inspection has been prompted by the suspicion of criminal activity. In which case, the first you’ll hear is the knock at the door. For an ARROW visit, the FSA require certain people to be available and, in some cases, will allow the date of a visit to be pushed back to ensure all can attend.   

Approach
Principles-based and flexible
There are three types of FSA inspection: ARROW Firm, ARROW Theme and general. The ARROW approach was originally developed in 2000, with a re-drafting, ARROW II, established in 2006.
ARROW Firm visits affect all hedge funds of a certain size and complexity. Here, those funds deemed of systemic importance are monitored on a regular basis. The cut-off point is believed to be around $2.5bn in AuM, but firms under this threshold that, for example, trade heavily in CDS or operate a black box strategy will also be subject to inspections.
ARROW Theme visits concentrate on a single area and can affect any firm deemed useful. According to one London-based in-house counsel, recent thematic visits have focused on market abuse, conflicts of interest and bribery.
Either, or a mixture of, ARROW visits can take place. Smaller firms can be subjected to a general inspection outside the ARROW banner but using almost identical documentation, one source reveals. 
The process for both ARROW Firm and Theme is similar. “The call comes in, followed by a detailed, pre-visit request via email outlining who the FSA wants to see and the issues it wants to discuss,” says the in-house counsel. You are assigned an ‘ARROW contact’ and become part of the ARROW team itself.
For ARROW Firm, you start by discussing the firm itself: size, marketing, investors, assets etc. Compliance is then the main focus, as it is with the SEC, including: the manual, procedure and representative; board documents, who reports to the board and the extent to which the board is involved; and the extent to which employees are trained and the type of training.
If during the course of visit, the FSA gets the sense an aspect may not be compliant they tend to require a third party to produce a report. “Most of the time the FSA doesn’t have the resources to get into every nook and cranny,” says one source.

Duration
ARROW Firm: 2-3 days to 1 wk
ARROW Theme: single morning or afternoon
Not as time-consuming as the SEC equivalents, ARROW Firm visits rarely last more than a week, even for the most complex of firms, with thematic visits typically only taking a matter of hours. The FSA are however, more likely to visit more frequently. 

Frequency
ARROW Firm: Every 18-24 mths
ARROW Theme: Varied
Although taking place roughly every two years, the frequency of visits are not set in stone and take place to the extent the FSA deems it appropriate. Thematic visits are similarly flexible but, due to the focus being a theme rather than a particular firm, some businesses may be visited more frequently simply because they have employees that are deemed experts in their field.   

Expecting the unexpected
“If you are a firm that is large enough to have a supervisory contact then you need to take steps to remain close to that person, and if there are problems, bring them swiftly to the attention of the FSA so that there’s little chance an ARROW visit turns up a surprise,” says one source at a legal and compliance consultancy firm. What about mock examinations? “You hear of it much more in an SEC context than you do FSA. Indeed we’ve had colleagues that have come over to do mock SEC examinations with UK firms. I’ve not heard of a consulting firm doing a mock ARROW visit.”