a

GAO

United States Government Accountability Office

Report to Congressional Requesters

August 2005 MUTUAL FUND 

INDUSTRY

SEC’s Revised 

Examination 

Approach Offers 

Potential Benefits, but 

Significant Oversight 

Challenges Remain

GAO-05-415
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-05-415.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Richard Hillman 

at (202) 512-8678 or hillmanr@gao.gov. 

Highlights of GAO-05-415, a report to 

congressional requesters 

August 2005

MUTUAL FUND INDUSTRY 

SEC’s Revised Examination Approach 

Offers Potential Benefits, but Significant 

Oversight Challenges Remain 

SEC is initiating several changes intended to strengthen its mutual fund 

exam program but faces challenges overseeing the fund industry. In the 

wake of the fund abuses, SEC has revised its past approach of primarily 

conducting routine exams of all funds on a regular schedule. It concluded 

these exams were not the best tool for identifying emerging problems, since 

funds were not selected for examination based on risk. To quickly identify 

problems, SEC is shifting resources away from routine exams to targeted 

exams that focus on specific risks. It will conduct routine exams on a regular 

schedule but only of funds deemed high risk. SEC also is forming teams to 

monitor some of the largest groups of advisers and funds. Although SEC is 

seeking to focus its resources on higher risk funds and activities, the 

resource tradeoffs it made in revising its oversight approach raise significant 

challenges. The tradeoffs may limit SEC’s capacity not only to examine 

funds considered lower risk within a 10-year period but also to accurately 

identify which funds pose higher risk and effectively target them for routine 

examination. Potentially taxing its resources further, SEC recently adopted a 

rule to require advisers to hedge funds (investment vehicles generally not 

widely available to the public) to register with it. This rule is expected to 

increase SEC’s exam workload, but the precise extent is not yet known. 

 

SEC has integrated some quality controls into its routine exams, but certain 

aspects of its framework could be improved. It relies on experienced staff to 

oversee all exam stages but does not expressly require supervisors to review 

work papers or document their review. GAO found deficiencies in key SEC 

exam work papers, raising questions about the quality of supervisory review. 

SEC also does not require examiners to prepare written exam plans, though 

they use considerable judgment in customizing each exam. Written plans 

could serve as a guide for conducting exams and reviewing whether exams 

were completed as planned. As done by other regulators, SEC also could 

review a sample of work papers to test compliance with its standards. 

A primary tool that SEC uses to assess the adequacy of SRO oversight of 

broker-dealers offering mutual funds provides limited information for 

achieving its objective and imposes duplicative costs on firms. To assess 

SRO oversight, SEC reviews SRO exam programs and conducts oversight 

exams of broker-dealers, including their mutual fund sales practices. SEC’s 

oversight exams take place 6 to 12 months after SROs conduct their exams 

and serve to assess the quality of SRO exams. However, GAO reported in 

1991 that SEC’s oversight exams provided limited information in helping 

SROs to improve their exam quality, because SEC and the SROs used 

different exam guidelines and their exams often covered different periods. 

GAO found that these problems remain, raising questions about the 

considerable resources SEC devotes to oversight exams. GAO also found 

that SEC has not developed an automated system to track the full scope of 

work done during its oversight exams. Thus, SEC cannot readily determine 

the extent to which these exams assess mutual fund sales practices. 

As the frontline regulator of mutual 

funds, the Securities and Exchange 

Commission (SEC) plays a key role 

in protecting the nearly half of all 

U.S. households owning mutual 

funds, valued around $8 trillion in 

2005. Mutual fund abuses raised 

questions about the integrity of the 

industry and quality of oversight 

provided by SEC and selfregulatory organizations (SRO) that 

regulate broker-dealers selling 

funds. This report assesses (1) 

changes SEC has made to, or is 

planning for, its mutual fund exam 

program; (2) key aspects of SEC’s 

quality control framework for 

routine fund exams; and (3) the 

adequacy of SEC’s oversight of 

NASD and the New York Stock 

Exchange in protecting 

shareholders from mutual fund 

sales abuses. 

What GAO Recommends

This report makes four 

recommendations to SEC designed 

to help ensure that it is using its 

resources effectively to oversee 

mutual funds and broker-dealers 

selling mutual funds, to improve 

aspects of its quality control 

framework for routine fund exams, 

and to enhance its oversight of SRO 

exams of broker-dealers selling 

mutual funds. In its written 

comments, SEC provided 

additional information on the 

benefits of its revised exam 

strategy for overseeing funds and 

advisers and on the benefits of its 

broker-dealer oversight exams. 
Page i GAO-05-415 Mutual Fund Oversight

Contents

Letter 1

Results in Brief 4

Background 7

SEC’s Revised Mutual Fund Examination Program Offers Potential 

Benefits but also Poses Significant Oversight Challenges 9

SEC Can Improve Certain Mutual Fund Examination Quality Control 

Measures 19

SEC’s Oversight Examinations of Broker-Dealers Provide Limited 

Information on the Adequacy of SRO Oversight 28

Conclusions 35

Recommendations for Executive Action 36

Agency Comments and Our Evaluation 37

Appendixes

Appendix I: Scope and Methodology 41

Appendix II: Securities and Exchange Commission’s (SEC) Broker-Dealer 

Examination Guidance and Training 43

Appendix III: Comments from the Securities and Exchange Commission 48

Appendix IV: GAO Contact and Staff Acknowledgments 52

Table Table 1: Strategic Areas Covered by SEC’s Risk Scorecards as of 

April 2005 20

Figures Figure 1: Number of Examiners and Entities Subject to 

Examination by SEC and Federal Bank Regulators in 

2004 16

Figure 2: Violations Found by SEC during Oversight Examinations 

of NASD but Not Found by NASD, and SEC Oversight 

Examinations Conducted of NASD, Fiscal Years 

2002-2004 32
Contents

Page ii GAO-05-415 Mutual Fund Oversight

Abbreviations

FDIC Federal Deposit Insurance Corporation

MRO Midwest Regional Office

NERO Northeast Regional Office

NFA National Futures Association

NYSE New York Stock Exchange

OCC Office of the Comptroller of the Currency

OCIE Office of Compliance Inspections and Examinations

ORA Office of Risk Assessment

PDO Philadelphia District Office

SEC Securities and Exchange Commission

SRO self-regulatory organization

STARS super tracking and reporting system

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Page 1 GAO-05-415 Mutual Fund Oversight

United States Government Accountability Office

Washington, D.C. 20548

A

August 17, 2005 Letr

The Honorable Barney Frank

Ranking Member

Committee on Financial Services

House of Representatives

The Honorable Paul E. Kanjorski

Ranking Member

Subcommittee on Capital Markets, Insurance and 

Government Sponsored Enterprises

Committee on Financial Services

House of Representatives

Nearly half of all U.S. households own mutual funds, with total assets of 

about $8 trillion as of February 2005, and roughly one-third of the total 

assets are held in retirement accounts.1

 Recent trading abuses implicating 

well-known mutual funds have called into question the integrity of the 

mutual fund industry and quality of oversight provided by the Securities 

and Exchange Commission (SEC), which is the industry’s frontline 

regulator. State regulators rather than SEC were the first to uncover in the 

summer of 2003 abuses involving market timing, which typically involves 

the frequent buying and selling of mutual fund shares by sophisticated 

investors seeking opportunities to profit from differences in prices 

between overseas and U.S. markets. Although market timing is not itself 

illegal, it can constitute illegal conduct if, for example, investment advisers 

(firms that manage mutual funds) enter into undisclosed agreements with 

favored customers, such as hedge funds, permitting them to trade 

frequently and in contravention of fund prospectuses—as certain advisers 

1

The term “mutual fund” refers to an open-end management company, which is a type of 

investment company and comprises the largest segment of the investment company 

industry.
Page 2 GAO-05-415 Mutual Fund Oversight

did before September 2003.2 Another type of abuse commonly referred to 

as late trading was significant but less widespread than market timing 

abuses. Late trading occurs when investors place orders to buy or sell 

mutual fund shares after the mutual fund has calculated the price of its 

shares, usually once daily at the 4:00 p.m. Eastern Time (ET) market close, 

but receive that day’s fund share price.3

 Investors who are permitted to late 

trade can profit from their knowledge of events in the financial markets 

that take place after 4:00 p.m., an opportunity that other fund shareholders 

do not have. Although late trading can involve fund personnel, late trading 

violations typically have occurred at intermediaries, such as broker-dealers 

that offer mutual funds to their customers, before these institutions submit 

their daily aggregate orders to mutual funds for final settlement.

SEC’s initial inability to detect the market timing abuses before late 2003 

raised questions about the agency’s mutual fund examination program, 

which is the agency’s primary means of detecting deficiencies and 

violations and thereby protecting investors.4

 However, following the 

detection of the mutual fund trading abuses, SEC initiated a series of 

examinations to determine the extent of the abuses, vigorously pursued 

enforcement actions against violators of securities laws, and issued new 

rules to overhaul the regulatory framework in which funds operate. The 

agency also initiated changes to its examination program that are intended 

to make it more focused on detecting abuses and emerging problems more 

quickly. 

2

The term “hedge fund” generally identifies an entity that holds a pool of securities and 

perhaps other assets that is not required to register its securities offerings under the 

Securities Act and is excluded from the definition of an investment company under the 

Investment Company Act of 1940. Hedge funds are also characterized by their fee structure, 

which compensates an adviser based upon a percentage of the hedge fund’s capital gains 

and capital appreciation. Pursuant to a new rule recently adopted by SEC, advisers of 

certain hedge funds are required to register with SEC under the Investment Advisers Act of 

1940. See Registration Under the Advisers Act of Certain Hedge Fund Advisers, 69 Fed. 

Reg. 72054 (2004) (to be codified in various sections of 17 C.F.R. Parts 275 and 279).

3

Unlike market timing, late trading is illegal. Under SEC rules, mutual funds accept orders to 

sell and redeem fund shares at a price based on the current net asset value, which most 

funds calculate once a day at the 4:00 p.m. ET close of the U.S. securities markets.

4

We discuss the reasons that SEC did not detect the market timing and late trading abuses in 

a recently issued report. See GAO, Mutual Fund Trading Abuses: Lessons Can Be Learned 

from SEC Not Having Detected Violations at an Earlier Stage, GAO-05-313 (Washington, 

D.C.: Apr. 20, 2005). 
Page 3 GAO-05-415 Mutual Fund Oversight

In addition, the involvement of some broker-dealers in the recent mutual 

fund trading abuses has raised concerns about regulatory oversight of that 

industry. NASD and the New York Stock Exchange (NYSE) are selfregulatory organizations (SRO) and have primary responsibility for 

regulating and examining their member broker-dealers, including their 

mutual fund sales practices. Although NASD is primarily responsible for 

assessing broker-dealer mutual fund sales practices, it did not detect the 

trading abuses through examinations or other means.5

 SEC is responsible 

for overseeing the quality of SRO regulation of broker-dealers and does so 

through on-site inspections of SRO regulatory programs. SEC also 

conducts oversight examinations of broker-dealers recently examined by 

SROs to assess the quality of their examination programs.

This report responds to your request that we review various issues 

concerning SEC’s oversight of the mutual fund industry. Specifically, you 

asked us to (1) identify and assess changes SEC has made to, or is planning 

for, its mutual fund examination program; (2) assess key aspects of the 

quality control framework of SEC’s routine mutual fund examinations; and 

(3) determine the adequacy of SEC’s oversight of NASD and NYSE, 

particularly in regard to the SROs’ oversight of mutual fund sales practices.

To accomplish our reporting objectives, we reviewed policies, procedures, 

and other guidance applicable to SEC’s mutual fund examination program 

as well as laws and regulations related to mutual funds. We also reviewed 

policies, procedures, and other guidance applicable to SEC’s oversight of 

NASD’s and NYSE’s broker-dealer examination programs. At three SEC 

field offices that accounted for the largest number of completed routine 

fund examinations in fiscal year 2004, we reviewed all routine 

examinations of funds completed that year. In addition, we interviewed 

officials at SEC headquarters and four field offices, NASD, NYSE, the 

Investment Company Institute, and other industry participants about SEC’s 

oversight of mutual funds or broker-dealers. Finally, we interviewed 

officials from the Federal Deposit Insurance Corporation (FDIC), the 

Board of Governors of the Federal Reserve System, the Office of the 

Comptroller of the Currency (OCC), NASD, NYSE, and the National 

Futures Association (NFA) about their examination programs. We also 

5

Although NYSE is also responsible for regulating its member broker-dealers, NASD 

typically conducts the sales practice portions of examinations for firms that are dually 

registered with it and NYSE. As a result, NYSE generally plays a lesser role in examining 

broker-dealers for matters involving mutual fund sales. 
Page 4 GAO-05-415 Mutual Fund Oversight

reviewed guidance related to those programs. We performed our work in 

Boston, Massachusetts; Chicago, Illinois; New York, New York; 

Philadelphia, Pennsylvania; and Washington, D.C. We conducted our work 

between February 2004 and July 2005 in accordance with generally 

accepted government auditing standards. Appendix I provides a detailed 

description of our scope and methodology.

Results in Brief Although SEC is initiating several significant changes intended to 

strengthen its mutual fund examination program, it faces challenges in 

effectively overseeing the mutual fund industry. In the wake of the recent 

mutual fund trading abuses, SEC has revised its traditional approach of 

primarily conducting routine examinations of all funds generally within a 5-

year period to oversee the industry. Agency staff concluded that these 

examinations were not the best tool for identifying emerging compliance 

problems, because funds were selected for examination based on the 

passage of time and not based on risk. To more proactively identify and 

address compliance risks, SEC is shifting resources away from routine 

examinations to targeted examinations that narrowly focus on specific 

risks (e.g., market timing) at individual or groups of funds based on tips or 

other information. SEC is continuing to conduct routine examinations on a 

regular schedule but only of funds it perceives to pose higher risk. It will 

randomly select a sample of lower risk advisers and funds for routine 

examination each year. In addition, SEC plans to implement a pilot 

program to assign examination teams to continuously monitor some of the 

largest mutual funds, an approach modeled after the use of similar teams 

by federal bank regulators to supervise large banks. Although SEC is 

seeking to focus its resources on higher risk advisers and funds as well as 

higher risk activities, the resource tradeoffs it made in revising its oversight 

approach raise significant challenges. Specifically, the tradeoffs may limit 

SEC’s capacity to examine funds considered lower risk within a 10-year 

period. In turn, this outcome could limit SEC’s capacity to accurately 

identify which mutual funds pose relatively higher or lower risk and 

effectively target higher risk funds for routine examination. Potentially 

taxing its examination resources further, SEC recently adopted a rule to 

require hedge fund advisers—some of which were involved in the recent 

mutual fund abuses—to register with the agency. This rule is expected to 

increase SEC’s examination workload, but the precise extent is not yet 

known.
Page 5 GAO-05-415 Mutual Fund Oversight

SEC has integrated some quality controls into its routine mutual fund 

examinations, but quality control improvements could further ensure that 

examinations are conducted in a thorough and consistent manner 

throughout SEC field offices. Under its revised examination priorities, 

SEC’s routine examinations are continuing to serve as the primary 

regulatory tool for testing whether higher risk mutual funds are complying 

with the federal securities laws. As part of its quality controls, SEC relies 

extensively on experienced supervisory examiners to oversee all stages of 

the routine examination process, but three controls could be enhanced to 

facilitate and ensure the adequacy of supervisory review. First, although 

SEC has standards for preparing examination work papers, it does not 

expressly require supervisors to review work papers or document their 

review. Requiring documented supervisory review could further ensure 

that work is reviewed and meets SEC standards. Deficiencies we found 

raise questions about the adequacy or completeness of supervisory review 

of completed risk scorecards—work papers that play a key role in 

determining the scope of a fund’s routine examination and the timing of the 

fund’s next routine examination. Second, SEC standards do not require 

examiners to prepare written examination plans for supervisory review, 

even though examiners use considerable judgment in customizing the 

examination scope to the particular risks of a mutual fund. Written plans 

could serve as a guide for conducting examinations, coordinating 

examination work, and reviewing whether examinations were completed 

as planned. Third, while SEC uses several methods to ensure examination 

quality and consistency, federal bank and other regulators take the 

additional step of reviewing some completed examinations and work 

papers to test compliance with and evaluate the effectiveness of applicable 

policies and procedures. SEC officials cited staff resource constraints for 

not reviewing completed examinations and work papers. While reviews of 

a sample of completed examinations and work papers involve resource 

tradeoffs, they can yield important benefits and are an integral part of an 

effective quality control system. 

A primary tool that SEC uses to assess the adequacy of SRO oversight of 

broker-dealers offering mutual funds to customers provides limited 

information for achieving its objective and imposes duplicative regulatory 

costs on the securities industry. To assess SRO oversight, SEC reviews SRO 

examination programs and conducts oversight examinations of brokerdealers, including their mutual fund sales practices. SEC’s oversight 

examinations take place 6 to 12 months after SROs conduct their 

examinations of broker-dealers and are intended to assess the quality of 

SRO examinations. However, we reported in 1991 that SEC’s broker-dealer 
Page 6 GAO-05-415 Mutual Fund Oversight

examination program had significant problems.6 For example, we reported 

that the way in which SEC conducted these broker-dealer oversight 

examinations provided limited information in helping SROs to improve the 

quality of their examination programs. This was because SEC and the SROs 

used different broker-dealer examination guidelines, and their 

examinations often covered different periods of time. Our recent work 

found that these problems still remain, which raises questions about SEC’s 

goal of conducting about 40 percent of its broker-dealer examinations as 

oversight examinations. Another deficiency we found during our review is 

that SEC has not developed an automated system to track the full scope of 

work performed during broker-dealer examinations. Absent such an 

automated system, SEC managers cannot readily determine the extent to 

which the agency’s broker-dealer examinations assess mutual fund sales 

practices or other issues. Given the resource challenges that SEC faces in 

its role as the frontline regulator of mutual funds, SEC’s current 

commitment of staff to broker-dealer oversight examinations may need to 

be reexamined.

This report makes four recommendations to the SEC Chairman for 

improving oversight of mutual funds and SRO oversight of broker-dealers 

that sell mutual funds. First, we recommend that SEC periodically assess 

the level of resources allocated to the various types of examinations in light 

of their regulatory benefits to help ensure that the agency is using its 

resources efficiently and effectively to oversee the mutual fund industry, 

including broker-dealers that offer mutual funds. As part of this 

assessment, SEC should seek to ensure that it allocates sufficient 

resources to mitigate any regulatory gaps that may currently exist 

concerning the timely examination of mutual funds perceived to represent 

lower risk; complete fund risk assessments within a more reasonable 

period; and fulfill its new oversight responsibilities of the hedge fund 

industry. Second, in so doing, we recommend that SEC assess its 

methodology for conducting broker-dealer oversight examinations and 

whether some portion of the resources currently devoted to these 

examinations could be better utilized to perform mutual fund 

examinations. Third, to strengthen SEC’s approach to mutual fund 

examinations, we recommend that SEC establish additional policies or 

procedures for improving its controls to ensure examination quality and 

consistency throughout SEC field offices. Fourth, we recommend that SEC 

6

GAO, Securities Industry: Strengthening Sales Practice Oversight, GAO/GGD-91-52

(Washington, D.C.: Apr. 25, 1991). 
Page 7 GAO-05-415 Mutual Fund Oversight

electronically track information about the full scope of work performed 

during broker-dealer oversight examinations.

We received comments on a draft of this report from SEC, which are 

included in appendix III. SEC also provided technical comments on a draft 

of the report, which were incorporated into the final report, as appropriate. 

SEC focused most of its comments on providing further elaboration on the 

potential benefits of its examination strategy for overseeing mutual funds 

and investment advisers and on the benefits obtained from its brokerdealer oversight examinations. In addition, SEC briefly commented that it 

will consider our recommendation directed at improving its quality 

controls for routine fund examinations and that it has formed a working 

group to explore ways to enhance the value of its broker-dealer oversight 

examinations.

Background SEC oversees mutual funds primarily through its Office of Compliance 

Inspections and Examinations (OCIE), Division of Investment 

Management, and Division of Enforcement. OCIE examines mutual funds 

to evaluate their compliance with the federal securities laws, to determine 

if they are operating in accordance with disclosures made to investors, and 

to assess the effectiveness of their compliance control systems. The 

Division of Investment Management administers the securities laws 

affecting funds and advisers. It reviews disclosure documents that mutual 

funds are required to file with SEC and engages in other regulatory 

activities, such as rulemaking, responding to requests for exemptions from 

federal securities laws, and providing interpretation of those laws. Finally, 

SEC’s Division of Enforcement investigates and prosecutes violations of 

securities laws related to mutual funds. 

SEC regulates mutual funds 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 was passed 

specifically to regulate mutual funds and other types of investment 

companies. Under the act, mutual funds are required to register with SEC, 

subjecting their activities to SEC regulation. The act also imposes 

requirements on the operation and structure of mutual funds. Its core 

objectives are to

• ensure that investors receive adequate and accurate information about 

mutual funds, 
Page 8 GAO-05-415 Mutual Fund Oversight

• protect the integrity of fund assets, 

• prohibit abusive forms of self-dealing, 

• prevent the issuance of securities that have inequitable or 

discriminatory provisions, and 

• ensure the fair valuation of investor purchases and redemptions. 

The Investment Advisers Act requires mutual fund advisers to register with 

SEC, imposes reporting requirements on them, and prohibits them from 

engaging in fraudulent, deceptive, or manipulative practices. The Securities 

Act requires fund shares offered to the public to be registered with SEC and 

regulates mutual fund advertising. Under the Securities Act and Investment 

Company Act, SEC has adopted rules to require mutual funds to make 

extensive disclosures in their prospectuses. The Securities Exchange Act, 

among other things, regulates how funds are sold and requires persons 

distributing funds or executing fund transactions to be registered with SEC 

as broker-dealers.

SEC, NASD, and NYSE regulate broker-dealers, including their mutual fund 

sales practices, by examining their operations and reviewing customer 

complaints. Broker-dealers that are members of NYSE and do business 

with the public are typically also required to be members of NASD. 

Historically, NASD has conducted the mutual fund sales practice portions 

of examinations for firms that are dually registered with it and NYSE. As a 

result, NYSE generally plays a lesser role in examining broker-dealers for 

mutual fund sales practices. NASD has established specific rules of 

conduct for its members that provide, among other things, standards for 

advertising and sales literature, including filing requirements, review 

procedures, approval and recordkeeping obligations, and general 

standards. NASD also tests members to certify their qualifications as 

registered representatives. 

SEC evaluates the quality of NASD and NYSE oversight in enforcing their 

member compliance with federal securities laws through SRO oversight 

inspections and broker-dealer oversight examinations. SROs are private 

organizations with statutory responsibility to regulate their own members 

through the adoption and enforcement of rules of conduct for fair, ethical, 

and efficient practices. As part of this responsibility, they conduct 

examinations of the sales practices of their broker-dealer members. SEC’s 

SRO oversight inspections cover all aspects of an SRO’s compliance, 
Page 9 GAO-05-415 Mutual Fund Oversight

examination, and enforcement programs. The inspections determine 

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. Under its broker-dealer 

oversight examinations, SEC examines some of the broker-dealers that 

SROs recently examined. SEC conducts these examinations to assess the 

adequacy of the SRO examination programs. In addition to its oversight 

examinations, SEC conducts cause, special, and surveillance examinations 

of broker-dealers, but these examinations do not serve to assess the quality 

of SRO examinations.

SEC’s Revised Mutual 

Fund Examination 

Program Offers 

Potential Benefits but 

also Poses Significant 

Oversight Challenges

Since the detection of the mutual fund trading abuses in the summer of 

2003, SEC has made significant changes to its traditional examination 

approach, which generally focused on conducting routine examinations of 

all funds on an established schedule. To better detect potential violations, 

SEC has reallocated or plans to reallocate its staff to conducting targeted 

examinations focusing on specific risks and monitoring larger funds on a 

continuous basis. SEC’s revised examination approach offers the potential 

for the agency to more quickly identify emerging risks and better 

understand the operations of large and complex funds, although it is too 

soon to reach definitive judgments. However, due to the limited number of 

SEC’s examination staff relative to the number of mutual funds and 

advisers for which the agency has oversight responsibility, the decision to 

focus examination resources on particular areas involved tradeoffs that 

raise regulatory challenges. In particular, SEC’s capacity to examine lower 

risk advisers and funds within a reasonable time period and develop 

industry risk ratings has been limited. 

SEC Has Revised Its 

Traditional Mutual Fund 

Examination Approach in 

the Wake of the Mutual 

Fund Trading Abuses

Historically, routine examinations of mutual fund complexes—groups or 

families of funds sharing the same adviser or underwriter—have served as 

the cornerstone of SEC’s mutual fund oversight, accounting for 85 percent 

of the total fund examinations done from 1998 through 2003. During that 

period, SEC generally tried to examine each complex at least once every 5 
Page 10 GAO-05-415 Mutual Fund Oversight

years.7 Due to resource constraints, SEC examinations typically focused on 

discrete areas that staff viewed as representing the highest risks of 

presenting compliance problems that could harm investors. Major areas of 

review have included portfolio management, order execution, allocation of 

trades, and advertising returns. In late 2002, SEC implemented a revised 

approach to conducting routine examinations that included a systematic 

process for documenting and assessing risks and controls for managing 

those risks in a range of areas related to the asset management function.8

Besides routine examinations, SEC conducts sweep examinations to probe 

specific activities of a sample of funds identified through tips, complaints, 

the media, or other information. The agency also conducts cause 

examinations when it has reason to believe something is wrong at a 

particular fund. Sweep and cause examinations accounted for about 5 and 

10 percent, respectively, of the total examinations done during 1998 

through 2003.

After the detection of the market timing and late trading abuses in the 

summer of 2003, SEC officials concluded that the agency’s traditional focus 

on routine examinations had limitations. In particular, SEC staff said that 

routine examinations were not the best tool for broadly identifying 

emerging compliance problems, since funds were selected for examination 

based largely on the passage of time, not based on their particular risk 

characteristics.9

 In addition, SEC officials stated that they concluded the 

growth in the number of mutual fund companies and the breadth of their 

operations, combined with the need to perform more in-depth 

examinations of discrete areas, did not allow SEC to maintain its existing 

routine examination cycle. 

7

In late 2003, SEC established a 2 or 4-year examination cycle based on the size or risk level 

of the fund complex. However, this cycle was not fully implemented before SEC made 

significant changes to its mutual fund examination program as described in this section.

8

Under this process, examiners use a set of standardized work papers called control or risk 

scorecards to guide and document their assessment of the effectiveness of a fund’s 

compliance controls designed to prevent or detect violations of the federal securities laws. 

Based on that assessment, examiners assign the fund an overall compliance risk rating of 

low, medium, or high. 

9

In an earlier report, we found that SEC’s focus on areas traditionally considered to be high 

risk hindered its capacity to detect violations not traditionally considered to be high risk, 

such as market timing abuses. We concluded that SEC needed to test controls in a variety of 

areas at least at a sample of companies to validate its assumptions about risks and verify the 

adequacy of controls in place to mitigate them. 
Page 11 GAO-05-415 Mutual Fund Oversight

To focus its resources on issues and funds presenting the greatest risk of 

having compliance problems that may harm investors, SEC has made 

significant revisions to its examination priorities and oversight processes 

as described below:

• First, SEC is placing a higher priority on sweep and cause examinations 

and a lower priority on routine examinations. SEC has directed its 10 

field offices that conduct fund examinations to give priority to initiating, 

as warranted, sweep examinations of funds or advisers, focusing 

particularly on operational or compliance issues.10 To address the 

market timing and late trading abuses surfacing in late 2003, SEC shifted 

resources away from routine examinations to support sweep and cause 

examinations, according to SEC officials. As a result, sweep and cause 

examinations accounted for 87 percent of the 690 fund examinations 

completed in fiscal year 2004. SEC officials said that about 17 percent of 

these examinations resulted in referrals to the agency’s Division of 

Enforcement for potential violations of securities laws and regulations. 

(We note that the large increase in the number of sweep and cause 

examinations in fiscal year 2004 as well as the number of referrals was 

likely due to SEC’s focusing a substantial amount of resources on 

detecting market timing and late trading abuses.) 

• Second, SEC no longer will routinely examine all funds and advisers on 

a regular basis, but it will conduct routine examinations of funds and 

advisers perceived to be high risk, once every 2 to 3 years. In addition, 

SEC will randomly select a sample of advisers and their affiliated funds 

perceived to be low risk for routine examination each year. Because 

these firms will be selected randomly, each firm will have an equal 

chance of being examined each year. According to SEC officials, the 

random selection process will enable agency staff to project the 

examination findings to the population of firms deemed low risk and 

assess the possible existence of problems within the population. 

• Third, SEC plans to provide more continuous and in-depth oversight of 

the largest mutual funds. Specifically, SEC is creating teams of 

examiners dedicated to regularly interacting with and closely 

monitoring and examining the activities of firms in the largest and most 

complex groups of affiliated advisers and mutual funds. SEC initially 

plans to form teams under a pilot program to monitor 10 large advisory 

10SEC has 11 field offices, but 1 office does not have fund examination staff.
Page 12 GAO-05-415 Mutual Fund Oversight

groups. Any decision to form additional monitoring teams will depend 

on how the pilot program develops, according to an SEC official. SEC 

officials said that the monitoring teams are loosely modeled on the 

federal bank regulators’ use of on-site teams to continuously monitor 

operations of large banks. However, unlike the bank regulator approach, 

SEC staff said the monitoring teams would not be located on-site at 

large mutual fund companies. 

• Fourth, an SEC task force is considering the development of a 

surveillance program to support the agency’s oversight of all funds and 

advisers. The purpose of this program is to obtain from firms 

information that would enable examiners to identify aberrant patterns 

in fund and adviser activities and the possible existence of fraud or 

abusive schemes that require follow-up through examinations. In its 

fiscal 2006 budget request, SEC reported that the agency expects the 

surveillance system to begin operations during the second half of 2006.11

• Fifth, SEC has promulgated rules that require investment advisers and 

investment companies to appoint independent chief compliance officers 

(CCO) who are responsible for ensuring that their companies adopt 

policies and procedures designed to prevent violations of federal 

securities laws and regulations.12 Fund CCOs are also responsible for 

preparing annual reports that must, among other things, identify any 

material compliance matter at the company since the date of the last 

report. SEC staff said that they plan to review such annual compliance 

reports while conducting examinations to assist in identifying problems 

at mutual funds and determine whether the funds have taken corrective 

actions. (As described later in this report, SEC is missing opportunities 

to take full advantage of CCO compliance reports to detect potential 

violations in the mutual fund industry.)

• Finally, SEC has established the Office of Risk Assessment (ORA) to 

assist the agency in carrying out its overall oversight responsibilities, 

including mutual fund oversight. ORA’s director reports directly to the 

SEC Chairman. According to SEC staff, ORA will enable the agency to 

analyze risk across divisional boundaries, focusing on new or resurgent 

11SEC, In Brief: Fiscal 2006 Congressional Budget Request (Feb. 2005).

12SEC, Final Rule: Compliance Programs of Investment Companies and Investment 

Advisers, 68 Fed. Reg. 74714 (Dec. 24, 2003). 
Page 13 GAO-05-415 Mutual Fund Oversight

forms of fraudulent, illegal, or questionable behavior or products. ORA’s 

duties include (1) gathering and maintaining data on new trends and 

risks from external experts, domestic and foreign agencies, surveys, 

focus groups, and other market data; (2) analyzing data to identify and 

assess new areas of concern across professions, industries, and 

markets; and (3) preparing assessments of the agency’s risk 

environment. ORA is to work in coordination with internal risk teams 

established in each of the agency’s major program areas—including 

OCIE—and a Risk Management Committee responsible for reviewing 

implications of identified risks and recommending appropriate courses 

of action. 

SEC’s Revised Oversight 

Approach Reflects Some of 

the Lessons Learned from 

the Recent Mutual Fund 

Scandals 

As we recently reported, the market timing and late trading abuses that 

surfaced in 2003 revealed weaknesses in SEC’s mutual fund oversight 

approach.13 We noted in the report that lessons can be learned from SEC 

not having detected market timing arrangements at an earlier stage. The 

key initiatives that SEC is taking to strengthen its mutual fund oversight 

program are largely intended to focus the agency’s resources on the largest 

and highest risk funds and activities. Although it is too soon to assess the 

effectiveness of the initiatives in light of their recent or planned 

implementation, the initiatives are consistent with some of the lessons 

learned concerning the importance of (1) conducting independent 

assessments of the adequacy of controls over areas such as market timing, 

(2) developing the institutional capability to identify and analyze evidence 

of potential risks, and (3) ensuring the independence and effectiveness of 

company compliance staff and potentially using their work to benefit the 

agency’s oversight program.

By placing greater priority on sweep examinations, SEC may be better 

positioned to independently assess, as needed, the adequacy of fund 

controls designed to prevent and detect abusive practices. As we reported, 

SEC staff did not examine mutual funds for market timing abuses before 

late 2003, because they viewed market timing as a relatively lower risk area 

since agency staff believed that funds had adequate financial incentives to 

establish effective controls for it. In that regard, we noted the importance 

for SEC to conduct independent assessments of controls at a sample of 

funds, at a minimum, to verify that areas viewed as low risk, such as market 

13GAO-05-313.
Page 14 GAO-05-415 Mutual Fund Oversight

timing, are in fact low risk and effective controls are in place. SEC’s revised 

examination priorities, particularly their emphasis on initiating sweep 

examinations that focus on operational or compliance issues, may provide 

the agency with greater opportunity to conduct independent assessments 

of controls for emerging risks, in part to validate critical assumptions about 

such risks and confirm the adequacy of controls in place to address those 

risks. 

By forming examiner teams dedicated to monitoring the largest and most 

complex groups of affiliated advisers and funds, SEC may have the 

opportunity to more efficiently or effectively use its resources and help 

ensure the independence and effectiveness of the monitored firms’ 

compliance staff. SEC estimates that the 100 largest advisory groups of 

affiliate advisers and funds accounted for about $7.1 trillion, or 85 percent, 

of the fund assets under management as of the end of September 2004. 

Thus, focusing on the largest advisory groups may enable SEC to attain the 

greatest dollar coverage with its limited examination resources. Focusing 

on the largest advisory groups may also be appropriate due to the control 

deficiencies that have been found at such companies. For example, SEC 

determined that nearly 50 percent of the 80 largest mutual funds had 

entered into undisclosed arrangements permitting certain shareholders to 

engage in market timing that appeared to be inconsistent with the funds’ 

policies, prospectus disclosures, or fiduciary obligations. In our earlier 

mutual fund work, we also found that compliance staff at some funds 

identified market timing but lacked the independence or authority 

necessary to control it. This finding suggested that routine communications 

with fund compliance staff could enhance SEC’s capacity to detect 

potential violations at an earlier stage, if compliance staff are effective and 

forthcoming about the problems they detect. SEC’s monitoring teams will 

provide agency staff with the opportunity to be in routine communication 

with fund compliance staff, including CCOs. Furthermore, such 

communications, combined with examinations, could help SEC ensure that 

fund CCOs, as required under SEC’s compliance rules, are in a position of 

authority to compel others to adhere to applicable compliance policies and 

procedures. 

By creating ORA, SEC is laying an important part of the foundation for 

developing the institutional capability to identify and analyze evidence of 

potential risks. SEC staff said that ORA will seek to ensure that SEC will 

have the information necessary to make better, more informed decisions 

on regulation. Working with other SEC offices, ORA staff expect to identify 

new technologies, such as data mining systems, that can help agency staff 
Page 15 GAO-05-415 Mutual Fund Oversight

detect and track risks. SEC’s compliance rules create opportunities for 

ORA to leverage the knowledge of fund CCOs, including their annual 

compliance reports. Although ORA may help SEC be more proactive and 

better identify emerging risks, it is too soon to assess its effectiveness. In 

this regard, we note that as of February 2005, ORA had established an 

executive team of 5 individuals but still planned to hire an additional 10 

staff to assist in carrying out its responsibilities.

Finally, SEC’s fund and adviser surveillance system is in the exploratory 

stage but, if properly designed and implemented, may help the agency to 

leverage its limited resources to augment its examinations and oversee 

funds and advisers. Federal bank and other regulators use off-site 

surveillance programs to complement their on-site examinations. Each 

federal bank regulator has an off-site surveillance program to monitor the 

financial condition of banks between examinations. Information from offsite monitoring is used in setting bank examination schedules and 

determining the allocation of examiner resources for higher risk banks. 

Similarly, a recently deployed NASD surveillance program is used to 

analyze trends in broker-dealer activities and identify unusual patterns that 

indicate potential problems.14 NASD uses surveillance analyses to initiate 

cause examinations and to help its examiners focus on high-risk areas 

during their routine broker-dealers examinations. 

SEC’s Revised Examination 

Approach Raises Oversight 

Challenges

SEC’s planned changes to its mutual fund examination program offer 

potential advantages, but they also involve significant tradeoffs that raise 

important regulatory challenges for the agency. In comparison to federal 

bank regulators, SEC has significantly less examiners relative to the 

number of entities it regulates (see fig. 1), although bank and mutual fund 

regulatory regimes, including their examinations, differ from each other.15

As reflected in SEC’s revised oversight approach, any decision by SEC to 

focus additional examination resources on one or more fund areas involves 

tradeoffs that could result in less oversight of, or create a regulatory gap in, 

other areas. We are particularly concerned about SEC’s capacity going 

14NASD’s surveillance program is called Integrated National Surveillance and Information 

Technology Enhancements.

15SEC recently reported that mutual funds and other investment companies managed 

roughly $8 trillion in assets at the start of fiscal year 2005, nearly double the $4.5 trillion in 

insured deposits at commercial banks and about equal to the $8 trillion of financial assets at 

commercial banks.
Page 16 GAO-05-415 Mutual Fund Oversight

forward to review the operations of firms considered to be lower risk, 

conduct risk assessments of the industry, and potentially oversee the hedge 

fund industry.

Figure 1: Number of Examiners and Entities Subject to Examination by SEC and Federal Bank Regulators in 2004 

By shifting examination resources to targeted sweep and cause 

examinations as well as monitoring teams for larger funds, SEC may be 

limiting its capacity to examine the operations of funds perceived to pose 

lower risk (generally smaller funds) within a reasonable period. As stated 

previously, between 1998 and 2003, SEC generally sought to conduct 

routine examinations of all funds once every 5 years and shortened the 

cycle to 2 or 4 years in fiscal year 2004 following an increase in resources.16

However, under SEC’s revised examination program, some mutual funds 

may not be examined within a 10-year period. This is because SEC plans to 

annually review the operations of 10 percent of the funds deemed lower 

risk on a random basis. While reviewing funds on a random basis means 

each firm will have an equal chance of being reviewed annually, it is not 

clear that this approach will have more of an effect in deterring abuses than 

if each fund was assured of being examined every 5 years or less. Moreover, 

if SEC lacks sufficient resources to annually examine 10 percent of the 

funds deemed lower risk, its approach would have less of a deterrent 

effect. We recognize that through sweep examinations, SEC may review 

particular facets of funds deemed lower risk much more frequently than 

OCC

FDIC

Federal

Reserve

SEC

495

9,517

1,223

6,970

2,076

1,819

5,272

1,824

Sources: SEC, the Federal Reserve, FDIC, and OCC.

Examiners

Examiners

Examiners

Examiners—Includes only staff devoted to fund and adviser examinations

Entities—national banks (2,024) and federal branches of foreign banks (52)

Entities—FDIC-insured, state-chartered institutions (nonmembers of the Federal Reserve System)

Entities—bank holding companies (5,863), state member banks (919), and foreign banking organizations (188)

Entities—Includes investment advisers (8,535) and fund complexes (982) but not broker-dealers and transfer agents

16In fiscal year 2004, SEC sought to conduct routine examinations of (1) the 20 largest funds 

as well as funds and advisers posing high risk every 2 years and (2) all other funds, including 

their advisers, every 4 years.
Page 17 GAO-05-415 Mutual Fund Oversight

every 10 years or more. At the same time, sweep examinations are much 

more narrowly scoped than routine examinations and may exclude other 

potential areas of noncompliance at individual firms.

Similarly, SEC’s inability to conduct examinations of all mutual funds 

within a reasonable period may limit its capacity to accurately distinguish 

relatively higher risk funds from lower risk funds and effectively conduct 

routine examinations of higher risk funds. Between late 2002 and October 

2004, SEC routinely examined 297, or 30 percent, of the existing fund 

complexes and used its revised examination guidelines to assess the 

effectiveness of the funds’ compliance controls in deterring and preventing 

abuses and to assign the funds risk ratings of low, medium, or high. Had 

SEC not decided in late 2003 and 2004 to shift examination resources to 

sweep and cause examinations, it might have been able to assign risk 

ratings to all 982 fund complexes within the following 3 years in 

accordance with its routine examination cycle. Completing risk ratings for 

all fund complexes would have provided SEC with an additional basis for 

allocating resources to the highest risk firms.17 Over time, SEC’s risk ratings 

can become outdated, or stale, raising the possibility for funds deemed 

lower risk to become higher risk. For example, changes in a fund’s 

management, such as CCO, could lead to changes that weaken the fund’s 

compliance culture and controls. However, because SEC may not examine 

all fund complexes within a 10-year period under its revised examination 

program, its ability to assign risk ratings to all fund complexes and 

routinely examine all higher risk funds may be limited.18

In a previous report, we found that SEC may be missing opportunities to 

obtain useful information about the compliance controls of mutual funds, 

including those perceived to represent lower risks and may not be 

17Absent a compliance risk rating for a fund complex, SEC officials stated that an alternative 

risk rating assigned to the fund’s adviser will be used to determine when the fund will be 

routinely examined. The alternative rating captures risks inherent in the adviser’s business 

such as conflicts of interests but does not measure the effectiveness of the adviser’s 

compliance controls designed to mitigate conflicts of interest or other risks that could harm 

mutual fund shareholders. 

18We note that, as described later in this report, our work has identified deficiencies in SEC’s 

implementation of its revised mutual fund examination guidelines, which raise questions 

about the quality of risk assessments made between 2002 and 2004. Further, risk ratings 

completed in 2002 and much of 2003 do not reflect the quality of fund controls over market 

timing and late trading as SEC did not view these as high-risk areas. SEC subsequently 

implemented revised procedures to test these areas at each mutual fund that it examined.
Page 18 GAO-05-415 Mutual Fund Oversight

examined within a reasonable period of time.19 While SEC plans to review 

investment company CCO annual compliance reports during examinations, 

the agency has not developed a plan to receive and review the reports on 

an ongoing basis. Obtaining access to such annual reports and reviewing 

them on an annual basis could provide SEC examiners with insights into 

the operations of all mutual funds, including those perceived to represent 

lower risks, and could serve as a basis for initiating examinations to correct 

potential deficiencies or violations. SEC noted that it is considering how 

best to utilize the annual reports but noted any required filing of the reports 

with SEC would require rulemaking by SEC.

A final oversight challenge facing SEC’s mutual fund examination program 

involves a new rule requiring hedge fund advisers to register with the 

agency.20 Issued in December 2004, the new rule requires hedge fund 

advisers to register with SEC as investment advisers by February 2006. The 

rule is designed, in part, to enhance SEC’s ability to deter or detect fraud by 

unregistered hedge fund advisers, some of which were involved in the 

recent mutual fund abuses. Once hedge fund advisers register, SEC will 

have the authority to examine their activities. The rule is expected to 

increase SEC’s examination workload, but because of data limitations the 

precise extent will not be known until hedge fund advisers actually register. 

Currently, comprehensive information on the number of hedge funds and 

advisers is not available, but SEC estimates that from 690 to 1,260 

additional hedge fund advisers may be required to register under the new 

rule, increasing the pool of registered advisers by 8 to 15 percent.21

SEC officials estimate that at least 1,000 hedge fund advisers have 

previously registered as investment advisers with SEC to meet client needs 

or requirements. Under its examination program, SEC has examined these 

hedge fund advisers in the same way it has examined all other registered 

advisers. According to SEC officials, it is anticipated that the additional 

hedge fund advisers that register with SEC will be treated the same as all 

other registered advisers under SEC’s examination program. SEC has 

19GAO-05-313.

20SEC, Final Rule: Registration Under the Advisers Act of Certain Hedge Fund Advisers, 

69 Fed. Reg. 72054 (Dec. 18, 2004).

21For additional detail on how SEC arrived at its estimates, see Proposed Rule: Registration 

Under the Advisers Act of Certain Hedge Fund Advisers, Release No. IA-2266, File No. S7-

30-04 (July 20, 2004).
Page 19 GAO-05-415 Mutual Fund Oversight

recognized that providing oversight of the additional registered hedge fund 

advisers will pose a resource challenge and has identified options for 

addressing the challenge. It could require fewer hedge fund advisers to 

register with SEC by raising the threshold level of assets under 

management required for adviser registration. It also has the option of 

seeking additional resources from Congress for the increased workload 

resulting from an increased number of registered advisers. Whatever 

approach is ultimately taken, SEC will have to consider the potential 

resource implications of the new rule for its oversight of mutual funds.

SEC Can Improve 

Certain Mutual Fund 

Examination Quality 

Control Measures 

SEC has integrated quality controls into its routine examinations but could 

benefit from additional controls to ensure that policies and procedures are 

being implemented effectively and consistently throughout SEC field 

offices. Under its new initiatives, SEC’s routine examinations will continue 

to be the primary regulatory tool for determining whether all funds and 

advisers are complying with the federal securities laws. Examination 

quality controls provide, among other things, assurances that important 

documents are provided supervisory review, and examinations are 

conducted according to agency policies, procedures, and individual 

examination plans.22 SEC could improve its quality control measures in 

three areas: supervisory review of risk scorecards, preparation of written 

examination plans, and review of completed examinations and work 

papers. Bank and other financial regulators have quality control measures 

that provide assurances above and beyond those measures used by SEC. 

SEC Standards for 

Reviewing Mutual Fund 

Risk Scorecards Do Not 

Ensure Accuracy or 

Completeness 

The risk scorecards prepared by SEC during each mutual fund examination 

are critical work papers, providing the basis for determining areas to 

review in depth and an overall risk rating for a fund. A set of individual 

scorecards has been developed to assist examiners in assessing and 

documenting a fund’s compliance controls in 13 strategic areas and to 

determine the amount of additional testing examiners will do.23 (See table 

1.) 

22GAO, An Audit Quality Control System: Essential Elements, GAO/OP-4.1.6 (Washington, 

D.C.: August 1993).

23When first implemented in October 2002, the risk scorecards covered 10 areas related to 

the asset management function. In July 2003, OCIE developed three additional risk 

scorecards.
Page 20 GAO-05-415 Mutual Fund Oversight

Table 1: Strategic Areas Covered by SEC’s Risk Scorecards as of April 2005

Source: SEC.

If controls in an area are strong, examiners may do limited or no additional 

testing to detect potential abuses, but if weak, additional testing is 

expected to be performed. Collectively, the 13 areas reviewed with the set 

of individual scorecards provides the basis for determining a mutual fund’s 

overall risk rating, which OCIE uses to determine how frequently the fund 

will be examined. While the risk scorecards currently cover 13 areas, SEC 

officials stated that each scorecard serves, in concept, as a model for 

assessing controls in a particular area of a firm’s activities. As such, SEC 

staff could create additional scorecards to assist them in their review of 

areas not covered by existing scorecards or modify existing scorecards not 

suitable for reviewing the controls used by a firm in a critical area. OCIE 

and field office officials told us that all applicable risk scorecards generally 

should be completed during routine examinations, but if there are time 

constraints due to extenuating factors, all scorecards may not be 

completed. 

Even though risk scorecards are important work papers for documenting 

and assessing fund compliance controls, SEC standards do not expressly 

require that they receive supervisory review. Current OCIE standards for 

preparing examination work papers, including scorecards, specify that they 

should be prepared in an organized manner facilitating supervisory review 

Name of scorecard area

Firm Maintains a Strong Compliance Culture

Minimize Ability of Dominant Individual to Override Control System

Consistency of Portfolio Management with Clients’ Mandates

Order Placement Practices Consistent with Seeking Best Execution and Disclosures

Personal Trading of Access Persons Is Consistent with Code of Ethics

Fair Allocation of Blocked and Initial Public Offering Trades

Fund/Advisory Clients’ Assets Are Priced and Fund Net Asset Values Are Calculated 

Accordingly 

Accuracy and Fairness of Performance Information

Information That Is Created, Recorded, Maintained, and Reported Is Protected from 

Unauthorized Alterations

Safety of Clients’ Funds and Assets

Third Party Sends Periodic Account Statement to Clients

Fund/Shareholder Order Processing and Cash-Book Reconciliations

Fund Corporate Governance
Page 21 GAO-05-415 Mutual Fund Oversight

and examination reporting. The standards do not provide further 

supervisory review requirements such as who should do the review, how, 

or when. While the review of scorecards is not expressly required, OCIE 

headquarters and SEC field office officials stated that supervisors do 

review scorecards and other examination work papers but typically do not 

sign or initial them to document that they have been reviewed. In addition, 

we were told that lead examiners and branch chiefs review work papers 

throughout the examination process. These officials also review risk 

scorecards and other work papers when reviewing final examination 

reports, making sure that all findings are adequately supported and 

summaries of the scorecard findings included in the examination reports 

are accurate. After completing their review of examination reports, branch 

chiefs sign a form to document their review.

In contrast to OCIE, federal bank and other regulators have standards 

requiring supervisors to document that they have reviewed examination 

work papers. Examples of the work paper standards include:

• Federal Reserve guidance requires examiners-in-charge or other 

experienced examiners to review all work papers as soon as practicable 

and to sign or initial the applicable documents to evidence their review. 

• OCC guidance requires examiners-in-charge or other experienced 

examiners to sign or initial work paper cover sheets to evidence their 

review. The guidance allows reviewers to tailor the thoroughness of 

their review based on the experience of the examiner preparing the 

work paper.

• According to NYSE and NFA officials, the organizations require senior 

staff to review and sign work papers. NFA officials said that their work 

papers are electronic, so staff mark a checkbox to evidence their work 

paper review.

While SEC officials stated that the review of the scorecards is documented 

indirectly by the supervisor’s signature on the examination report, without 

the supervisor’s signature or initials on the scorecards themselves, there is 

no way to readily verify that the scorecards were reviewed. Our review of 

546 scorecards from 66 routine examinations of funds completed in fiscal 

year 2004 by SEC’s Midwest Regional Office (MRO), Northeast Regional 

Office (NERO), and Philadelphia District Office (PDO) disclosed a number 

of deficiencies potentially stemming from quality control weaknesses. Most 

of the scorecards did not contain evidence of supervisory review as 
Page 22 GAO-05-415 Mutual Fund Oversight

expected, based on statements by SEC officials, but 34 scorecards, or 

about 6 percent, were signed or initialed as evidence of review. Regardless 

of whether the completed scorecards were signed or initialed, we found 

deficiencies in four areas that raise questions about the adequacy or 

completeness of supervisory review. 

• First, each scorecard should be marked as to whether examiners rated 

the compliance controls in the area as highly effective, effective, or 

ineffective. We found 32, or about 6 percent, of the total scorecards 

where the control rating was not marked. 

• Second, copies of scorecards should be included with the work papers 

to facilitate supervisory review, but we found 11, or about 17 percent, of 

the 66 examinations lacked any scorecards and 15, or about 23 percent, 

were missing one or more scorecards.24

• Third, documentary evidence should be cited on scorecards to support 

effective and highly effective ratings, but we found 25, or about 5 

percent, of the total scorecards did not cite documentary evidence 

supporting such ratings. 

• Fourth, scorecard ratings are included in examination reports, but we 

found the ratings marked on 21, or about 4 percent, of the total 

scorecards had ratings that differed from the ones in the examination 

reports. 

SEC supervisors document their review of examination reports, which 

include a summary of the risk scorecard findings. Nonetheless, without 

documenting that the scorecards themselves were reviewed, SEC does not 

know if deficiencies resulted from a lack of or inadequate supervisory 

review. The systematic supervisory review of work papers, particularly risk 

scorecards, is essential for ensuring examination quality. Such reviews help 

to ensure that the work is adequate and complete to support the 

assessment of fund compliance controls as well as report findings and 

conclusions. Likewise, documentation of the review is important to ensure 

24Of the 11 examinations lacking any risk scorecards, 8 of them covered funds organized as 

unit investment trusts. MRO and NERO officials told us that the risk scorecards were not 

designed for unit investment trusts and, thus, staff did not always complete the scorecards 

for such types of funds. In one of the other examinations, staff noted on the scorecards that 

they found extensive violations at the fund and did not have time to complete the 

scorecards. 
Page 23 GAO-05-415 Mutual Fund Oversight

that all critical areas are reviewed. The reviewer’s initials or signature are 

written verification that a specific employee checked the work. 

Written Examination Plans 

for Fund Examinations Are 

Not Required but Would Be 

Useful for Documenting 

Agreements Reached on 

Review Areas

Written examination plans that document the scope and objectives of 

routine examinations are not required by OCIE. Instead, OCIE officials 

stated that written examination plans are optional. OCIE allows branch 

chiefs and lead examiners to decide whether to prepare written plans, with 

branch chiefs typically meeting with examination teams to discuss the 

preliminary scope of examinations. Each routine examination is somewhat 

different because of the risk-based approach used by OCIE. Under this 

approach, all areas of compliance or fund business activities are not 

reviewed and instead review areas are judgmentally selected based on their 

degree of risk to shareholders. As a result, each examination is customized 

to the activities of the particular fund under examination, with the success 

of routine examinations depending, in part, on proper planning. The 

documentation of this planning is important for tracking agreements 

reached on examination scope and objectives and can be used as a guide 

for the examination team. Furthermore, the plan can be used to determine 

whether the examination was completed in accordance with the planned 

scope. According to OCIE officials, written plans may be helpful in 

planning examinations of large fund complexes, but many of the 

examinations conducted are of small firms that have five or fewer 

employees. For these small firms, the officials said that it may not be 

necessary to prepare a written examination plan, especially if the 

examination team conducting the work consists of one or two persons.

While OCIE does not require the preparation of written examination plans, 

we found that SEC’s NERO requires examiners to prepare a planning 

memorandum to document examination scope and objectives, including 

firms to be examined within a fund complex, areas considered high risk, 

and areas to be reviewed. NERO branch chiefs approve the memorandums 

before the on-site work begins, and the memorandums effectively serve as 

examination plans. In contrast, SEC’s MRO and PDO do not require 

planning memorandums or examination plans. Instead, branch chiefs in 

these two offices meet with the examination teams to discuss the scope of 

examinations and then let the staff decide whether to prepare a written 

plan, according to MRO and PDO officials. MRO officials said that some 

branch chiefs will recommend that for large funds, teams prepare written 

examination plans since it helps coordinate the work. For 66 routine 

examinations we reviewed at these three offices, about half, or 53 percent, 

had written planning memorandums or examination plans. Examinations 
Page 24 GAO-05-415 Mutual Fund Oversight

of the larger fund complexes that were managing more than $1 billion in 

assets also had examination plans for about half, or 54 percent. 

In contrast to OCIE, federal bank and other regulators require their staff to 

prepare written examination plans before conducting examinations. 

Examples of examination plan requirements include:

• FDIC guidance requires the examiner-in-charge to prepare a scope 

memorandum to document, among other things, the preliminary 

examination scope; areas to be reviewed, including the reasons why; 

and areas not to be included in the examination scope, including the 

reasons why.

• Federal Reserve guidance requires that a comprehensive risk-focused 

supervisory plan be prepared annually for each banking organization. 

The guidance also requires the examiner-in-charge, before going on-site, 

to prepare a scope memorandum to document, among other things, the 

objectives of the examination and activities and risks to be evaluated; 

level of reliance on internal risk management systems and internal and 

external audit findings; and the procedures that are to be performed. To 

ensure consistency, the guidance requires the scope memorandum to be 

reviewed and approved by Reserve Bank management.

• OCC guidance requires the examiner-in-charge or portfolio manager to 

develop and document a supervisory strategy for the bank that 

integrates all examination areas and is tailored to the bank’s complexity 

and risk profile. The strategy includes an estimate of resources that will 

be needed to effectively supervise the bank and outlines the specific 

strategy and examination activities that are planned for that supervisory 

cycle. The strategies are reviewed and approved by the examiner-incharge’s or portfolio manager’s supervisor. 

• NYSE and NFA officials told us that staff are required to prepare written 

examination or audit plans. NYSE officials said that staff meet with 

examination directors to reach agreement on the scope of their 

examination plans. NFA officials said that staff complete a planning 

module that includes a series of questions that staff answer to determine 

the scope of the audit, and the completed planning module serves as the 

audit plan.

Examination planning meetings between SEC branch chiefs and 

examination teams are important for providing the opportunity to discuss 
Page 25 GAO-05-415 Mutual Fund Oversight

and reach decisions about critical areas of examination scope and 

objectives. These discussions by themselves, however, do not provide a 

record of the agreements reached and may not result in a clear and 

complete understanding for examiners about the scope and objectives of a 

particular examination. A written examination plan would provide such a 

record—potentially enabling branch chiefs to better supervise 

examinations and assisting lead examiners to better communicate the 

examination strategy to the examination team. Such quality control is 

especially important given that staff must exercise considerable judgment 

for examination scope under SEC’s risk-based approach.

SEC Efforts to Ensure 

Quality Do Not Include 

Review of Work Papers of 

Completed Mutual Fund 

Examinations

SEC uses several methods to ensure the quality of its examinations but 

does not review completed examinations and work papers as done by other 

regulators to determine whether the examinations were conducted 

according to procedures or done consistently across field offices. OCIE has 

issued various policies and procedures to promote examination quality and 

consistency across the 10 SEC field offices that conduct the majority of its 

examinations. To help ensure that these policies and procedures are 

followed, SEC relies on experienced supervisors in its field offices to 

oversee all stages of routine examinations. Specifically, branch chiefs meet 

with examination staff to discuss the preliminary scope of examinations, 

advise staff during the fieldwork, and review all examination reports. 

Assistant directors in SEC field offices also assist in overseeing 

examinations and review all examination reports. Also, associate directors 

and regional or district administrators in SEC field offices may review 

examination reports. In addition, SEC field offices send each report and 

deficiency letter, if any, to an OCIE liaison, who reviews them. Finally, 

OCIE annually evaluates each field office examination program based on 

factors such as the overall quality of the office’s examination selection and 

findings; new initiatives and special projects; use of novel or effective risk 

assessment approaches; and overall productivity, including achievement of 

numerical examination goals. 

In contrast to OCIE, we were told that federal bank and other regulators 

have quality assurance programs that include reviews of completed 

examinations or other activities. Examples of such reviews include: 

• FDIC guidance states that the agency reviews each regional office’s 

compliance examination program every 2 years, in part, to evaluate the 

consistency of supervision across the regions and compliance with 
Page 26 GAO-05-415 Mutual Fund Oversight

policies and procedures. According to the guidance, evaluations include 

a review of examination reports and work papers.

• Federal Reserve officials said that the agency conducts on-site 

operations reviews of the banking supervision function of individual 

Reserve Banks at least every 3 years. The review targets each Reserve 

Bank’s risk-focused supervision program and includes a review of a 

sample of examination reports, work papers, and other supporting 

documentation. It also encompasses the bank’s ongoing quality 

management function, or the processes, procedures, and activities the 

bank uses to ensure that examination reports and related documents are 

of high quality and comply with established policy.

• OCC officials told us that the agency reviews its large bank examination 

program, including specific examination procedures. It conducts 

reviews to determine whether lead examiners are supervising banks 

according to plans. It also assesses specific examination procedures 

across samples of banks. Agency officials said that teams periodically 

review how examiners are conducting certain procedures to ensure that 

they are being implemented consistently throughout all field offices. 

• NASD conducts quality and peer reviews to improve the quality, 

consistency, and effectiveness of its examination program. Under 

quality reviews, each NASD district office annually evaluates its 

performance in two or three areas. Under peer reviews, staff go on-site 

to district offices to evaluate particular program areas. 

• NFA officials told us that the organization randomly selects completed 

audits for review on a quarterly basis and, as part of the review, 

supervisory teams review work papers to determine whether the audits 

complied with established policies and procedures.

While OCIE staff evaluate all completed examinations by reviewing the 

final examination report, they do not review a sample of completed 

examinations and work papers to periodically assess examination quality 

and consistency across SEC’s field offices. SEC officials stated that afterthe-fact reviews of underlying work papers may not be a cost-effective use 

of resources, given that key findings and evidentiary materials should be 

discussed and described in the examination report itself, which is reviewed 

by OCIE staff. Further, it would be difficult to second-guess decisions made 

by examiners when on-site, since reviewers would not have access to the 

same information. Finally, agency officials said that OCIE resources are 
Page 27 GAO-05-415 Mutual Fund Oversight

limited, and time spent reviewing completed examination work papers 

would result in less time spent on conducting examinations. While 

reviewing completed examination work papers involves resource 

tradeoffs, it may yield important benefits. OCIE may be able to better 

determine whether its examiners are complying with established policies 

and procedures and whether its built-in quality controls are working. A 

review of underlying work papers also may allow OCIE to better assess the 

consistency of examination quality within and across SEC’s field offices as 

well as the extent to which existing quality controls are helping to ensure 

that quality is maintained.

According to SEC officials, the agency is implementing a computer-based 

document management system. Under this system, it is anticipated that 

most, if not all, of the work papers created during examinations will be 

converted into electronic files, and these files will be maintained in a 

consistent manner online for a number of years. SEC officials said that 

when the system is fully operational, estimated to be some time in 2006, all 

work papers created during an examination will be available electronically 

to OCIE staff. At that point, OCIE liaisons could review electronic 

examination work papers on a sample basis in conjunction with their 

review of examination reports. In addition, electronic work papers would 

eliminate the need to be on-site to review underlying examination 

documentation and work papers across SEC’s examination program. 

Importantly, deficiencies we found during our review of risk scorecards 

highlight the need for OCIE to periodically assess the consistency of 

examination staff’s use of scorecards and other steps being taken during 

examinations. While the requirement to complete risk scorecards became 

effective in October 2002, SEC has not yet evaluated, for instance, whether 

the risk scorecards are being completed according to the guidance 

provided, whether changes to the design of the scorecards are needed, and 

whether additional guidance or training is needed. In March 2003, OCIE 

provided one training course on the scorecards, which was attended by 98 

examiners, or about 20 percent of the SEC examiners devoted to fund and 

adviser examinations. According to SEC officials, two senior OCIE staff 

visited each field office during the spring and summer of 2003 and provided 

a full day of training on the scorecards to all examination staff. 

Nevertheless, the scorecard deficiencies we found during our review may 

indicate that additional training is needed. 

In addition, the scorecards may have design weaknesses that result in 

inconsistencies across SEC field offices. For example, field office officials 
Page 28 GAO-05-415 Mutual Fund Oversight

stated that scorecards are designed for investment companies organized as 

mutual funds and do not readily apply to investment companies organized 

as unit investment trusts.25 NERO examiners did not complete scorecards 

for unit investment trusts, but MRO examiners did by modifying the 

scorecards as needed. Similarly, SEC field office officials stated that while 

the scorecards are designed to cover a broad range of fund compliance 

controls, fund controls for detecting and preventing market timing do not 

fall squarely under any of the 13 areas covered by the scorecards. As a 

result, staff have used work papers other than the risk scorecards to 

document their assessment of market timing controls. SEC officials said 

that the scorecards are models created to assist examiners in assessing 

fund controls. As such, scorecards are not intended to exist necessarily for 

every conceivable control and examiners have the flexibility to modify the 

scorecards as necessary. Moreover, the officials said that some 

inconsistencies in the preparation of risk scorecards are expected because 

not all funds and advisers are the same. In that regard, SEC officials told us 

that the approach taken by MRO staff in modifying a scorecard to fit the 

circumstances of an examination appears to be consistent with the 

approach to scorecard use expected by OCIE.

SEC’s Oversight 

Examinations of 

Broker-Dealers Provide 

Limited Information on 

the Adequacy of SRO 

Oversight

To assess SRO oversight of broker-dealers, including their mutual fund 

sales practices, SEC conducts examinations of broker-dealers shortly after 

they have been examined by SROs. However, these SEC broker-dealer 

examinations, which involve a significant commitment of agency 

examination resources, provide limited information on the adequacy of 

SRO oversight and impose duplicative regulatory costs on the securities 

industry. SEC and SROs’ broker-dealer examinations often cover different 

time periods, and generally employ different sampling methodologies and 

use different examination guidelines. Consequently, SEC cannot reliably 

determine whether its examination findings are due to weaknesses in SRO 

examination procedures or some other factor. Another deficiency we found 

regarding SEC’s SRO oversight of broker-dealer mutual fund sales practices 

is that the agency does not have automated information on the full scope of 

areas reviewed during its broker-dealer oversight examinations and, 

therefore, cannot readily and reliably track useful examination 

information. 

25A unit investment trust is an investment company that (1) is organized under a trust 

indenture, (2) does not have a board of directors, and (3) issues only redeemable securities, 

each of which represents an undivided interest in a unit of specified securities.
Page 29 GAO-05-415 Mutual Fund Oversight

SEC Often Cannot Attribute 

Broker-Dealer Oversight 

Violations It Finds to 

Weaknesses in SRO 

Examination Programs, 

Because Different 

Examination Procedures 

Are Used

SEC performs two types of activities to review the quality of SRO oversight 

of broker-dealers, including their sales of mutual funds. First, SEC 

conducts inspections of NASD and NYSE on a 3-year cycle that cover 

various aspects of their compliance, examination, and enforcement 

programs. These SRO oversight inspections are designed to determine 

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. When conducting these 

inspections, SEC reviews a sample of the SRO’s examination reports and 

work papers to identify problems in examination scope or methods. As a 

result of these inspections, SEC has identified deficiencies in SRO 

examinations, including ones related to the SROs’ examinations of mutual 

fund sales practices, and communicated those to the SRO to remedy the 

problem. Second, SEC conducts broker-dealer oversight examinations, 

during which it examines some broker-dealers from 6 to 12 months after an 

SRO examines the firms. The purpose of broker-dealer oversight 

examinations is to help the SROs improve their examination programs by 

identifying violations that the SROs did not find and also by assisting them 

in evaluating improvements in how SRO examiners perform their work. 

SEC officials told us that a secondary goal of these examinations is to 

supplement the SROs’ enforcement of broker-dealer compliance with 

federal securities laws and regulations. 

SEC’s broker-dealer oversight examinations involve a significant 

commitment of agency resources and expose firms to duplicative 

examinations and costs. In addition to conducting broker-dealer 

examinations for the purposes of assessing SRO oversight (including for 

mutual fund sales practices), SEC conducts cause, special, and surveillance 

examinations of broker-dealers to directly assess broker-dealer compliance 

with federal securities laws and regulations, including those related to 

mutual fund sales. SEC currently has an internal goal of having oversight 

examinations account for 40 percent of all broker-dealer examinations 

each year. In 2004, 250, or 34 percent, of its 736 broker-dealer examinations 

were oversight examinations.26 Broker-dealers that are subject to similar 

SEC and SRO examinations that may take place within a 6 to 12 month 

26As of October 2004, about 40 percent of OCIE’s total examination staff of 810 individuals 

was assigned to broker-dealer, transfer agent, and clearing agency examinations (315 

examiners dedicated to broker-dealer, transfer agent, and clearing agency examinations and 

495 individuals assigned to mutual fund and investment adviser examinations).
Page 30 GAO-05-415 Mutual Fund Oversight

period incur the costs associated with assigning staff to respond to 

examiner inquiries and to make available relevant records as requested.

Although SEC broker-dealer oversight examinations involve a significant 

commitment of agency examination resources and impose costs on 

securities firms, our past work questioned their cost-effectiveness. In a 

1991 report, we found that the way SEC conducted oversight examinations 

of broker-dealers provided limited information to help SROs improve the 

quality of their broker-dealer examination programs.27 Specifically, during 

its oversight examinations of broker-dealers, SEC often found violations 

not identified by SROs and frequently could not attribute the violations it 

found to weaknesses in SRO examination programs. Because SEC and 

SROs used different examination procedures or covered different time 

periods of broker-dealer activity, SEC examiners often could not determine 

whether the violations they found resulted from the improper 

implementation of procedures by SRO examiners or differences between 

the procedures used or the activity period covered. We previously 

recommended that SEC directly test SRO examination methods and 

results. However, based on its efforts to replicate some examinations 

conducted by SROs, the agency concluded that this was unproductive 

because it only confirmed findings identified by SROs during their 

examinations. 

Our current review has shown that despite our 1991 findings, SEC 

continues to conduct oversight examinations in a similar manner—by using 

different examination guidelines and time periods. First, SEC continues to 

review firm activities during the time between the completion of the SRO 

examination and its own examination. Next, when SEC is reviewing a firm’s 

transactions or customer accounts to identify potential abuses, it generally 

does not duplicate the sampling technique used by the SRO, but instead 

selects its own sample of transactions or customer accounts based on its 

own procedures. Finally, SEC examiners ask different questions to identify 

potential abuses. For example, although SEC and NASD both direct their 

examiners to ask questions to assess potential weaknesses in a firm’s 

internal controls to prevent market timing and late trading, their 

procedures call for examiners to ask about different potential internal 

control weaknesses. 

27GAO/GGD-91-52.
Page 31 GAO-05-415 Mutual Fund Oversight

According to SEC officials, its examiners do not use the same procedures 

as SROs because using different procedures allows them to find violations 

that would not otherwise be found if they just duplicated the SRO 

procedures. Also, SEC officials stated that SEC has an obligation to review 

the broker-dealer’s activities at the time of the SEC examination to ensure 

compliance with securities laws at that time. However, as a result, SEC 

often cannot determine the specific reason why the SRO did not find the 

violations, limiting its ability to suggest improvements to SRO programs. 

SEC routinely provides SROs copies of deficiency letters it sends to brokerdealers as a result of oversight examinations. These deficiency letters 

sometimes include oversight comments that include steps the SRO can 

take to enhance its program. SRO officials stated they can often identify the 

reasons why SEC found the violations, but in many cases the reason is due 

to SEC’s use of different procedures, such as different review periods or 

samples. Consequently, SEC often cannot attribute a violation it finds to a 

problem with the SRO’s examination program. SEC officials said in some 

cases when SEC identifies a violation, it is able to determine whether the 

violation was occurring at the time of the original examination and should 

have been detected by the SRO. For example, in some cases when SEC 

finds an error in a broker-dealer’s net capital calculation, it is able to trace 

the error to previous calculations and determine whether it existed during 

the SRO examination. Even in cases when SEC can attribute a violation it 

found to a weakness in the SRO examination, it does not track this 

information in its automated examination tracking system and, as a result, 

cannot use it to identify trends in SRO problems it discovered during 

oversight examinations. SEC officials stated that they have a staff 

committee conducting a comprehensive review of oversight examination 

procedures and plan to add a feature to SEC’s examination tracking system 

to allow it to more systematically track identified weaknesses in SROs’ 

examination programs. 

Although SEC’s oversight examinations continue to find violations at 

broker-dealers and, thus, provide investor protection benefits, the 

violations provide limited information for assessing the quality of the SRO 

program. This information is particularly important given that the number 

of violations that SEC has found during its oversight examinations and 

determined as not found by NASD has increased in recent years. As shown 

in figure 2, the number of these violations that SEC found but has 

categorized as not found by NASD more than doubled between fiscal years 

2002 and 2004.
Page 32 GAO-05-415 Mutual Fund Oversight

Figure 2: Violations Found by SEC during Oversight Examinations of NASD but Not 

Found by NASD, and SEC Oversight Examinations Conducted of NASD, Fiscal Years 

2002-2004

Despite this significant increase, SEC officials could not explain why the 

number of these violations increased but stated that the increase did not 

necessarily represent a decrease in the quality of NASD’s examination 

program. They said some of the increase is due to a significant increase in 

the number of rules applicable to broker-dealers. SEC officials told us that 

SRO officials have noted, and they agree, that the number of these 

violations, alone, is not always an appropriate measure of the quality of 

SRO examination programs. Accordingly, SEC officials told us that the 

agency recently began tracking findings deemed to be significant to allow it 

to better assess the materiality of an increase in the number of missed 

violations. If SEC had tested NASD’s examination methods or better 

tracked the reasons why NASD did not find a violation, SEC would have 

more information to assess the quality of NASD’s examination program. 

0

50

100

150

200

250

2002 2003 2004

Year

SEC oversight examinations conducted of NASD

Violations found by SEC during oversight examinations of NASD but not found by NASD

Source: SEC.

100

222

192

214

235

211

Number
Page 33 GAO-05-415 Mutual Fund Oversight

SEC Does Not Track the 

Full Scope of Work 

Performed during Its 

Oversight Examinations

Another deficiency we found regarding SEC’s SRO oversight is that the 

agency cannot readily and reliably track key examination information. In 

assessing the quality of SEC’s oversight of broker-dealer sales of mutual 

funds, we asked SEC to provide data on which of its broker-dealer 

oversight examinations in recent years included reviews of mutual fund 

sales practices. The data would help determine the extent that SEC has 

reviewed mutual fund sales practices. SEC was not able to provide this 

information because it does not have automated information on the full 

scope of areas reviewed during its broker-dealer oversight examinations. 

SEC maintains a broad range of automated information about its 

examinations in its Super Tracking and Reporting System (STARS), 

including basic information about the firm, SEC staff assigned to conduct 

the examination, and the deficiencies and violations found during the 

examination. STARS identifies examinations that reviewed specific areas 

of special interest to SEC, called “focus areas,” as identified by senior SEC 

staff in headquarters, and new areas are added in part based on the 

emergence of new abuses. For example, SEC added breakpoints as a focus 

area in January 2003 and market timing and late trading in 2004.28 Although 

focus area designations provide useful information about how often SEC 

reviews some areas, focus areas do not cover all areas potentially reviewed 

by SEC during its examinations. Without methodically tracking the full 

scope of work performed during oversight examinations, SEC lacks 

information for determining how effective its oversight is in two important 

areas. 

First, because SEC does not know how often it has reviewed particular 

areas such as mutual fund sales practices during its oversight 

examinations, it cannot ensure that it has adequately reviewed all areas it 

considers important. When SEC reviews particular areas, its examiners 

generally refer to a set of written procedures, known as examination 

modules that provide information to guide examiners’ work. STARS does 

not include data fields to track whether staff use the module on mutual 

funds during an examination. Therefore, the extent of coverage of mutual 

funds is unknown. As a result, SEC officials could not determine how many 

of the approximately 1,400 broker-dealer oversight examinations 

conducted between 2000 and 2004 included a review of mutual fund sales 

28Breakpoints are discounts offered to investors on up-front sales charges on certain mutual 

fund shares when an investor makes a large purchase. 
Page 34 GAO-05-415 Mutual Fund Oversight

practices. SEC officials stated that they have a separate database 

containing examination reports that can be electronically searched to 

identify relevant examinations containing a search term such as “mutual 

fund,” which would yield an estimate of the number of examinations that 

reviewed broker-dealer mutual fund sales practices. However, according to 

an official, not all examinations covering mutual fund sales practices would 

be captured because some examination reports that included reviews of 

mutual fund sales practices would not necessarily include any mention of 

mutual funds, especially if SEC identified no deficiencies or violations in 

that area. 

In contrast to SEC, both NASD and NYSE have systems with capability to 

track the full scope of examinations including the use of mutual fund and 

other examination modules. For NASD, some of its offices are able to track 

which of its broker-dealer examinations were followed by an SEC oversight 

examination. At 8 of its 15 district offices, which account for 55 percent of 

its examinations, NASD tracked this information and SEC conducted 

oversight examinations of approximately 5 percent of the 2,602 NASD 

examinations conducted between January 1999 and August 2004 that 

reviewed mutual fund sales practices. The remaining seven offices were 

not able to track this information because, according to an NASD official, 

the SEC field office conducting oversight examinations did not always 

provide a letter informing them that an oversight examination was 

conducted. With mutual fund sales practices being a regulatory priority, the 

percentage of SEC examinations reviewing these practices would be a 

useful measure for ensuring that the agency is addressing this priority. 

Second, because SEC does not track the full scope of work performed 

during its oversight examinations, it is limited in its ability to assess the 

significance of deficiencies and violations it finds. Because SEC does not 

know how often it has reviewed a particular area, the data it tracks on the 

number of deficiencies and violations it finds in a particular area are less 

meaningful. For example, it would be less significant if SEC found 

violations in a particular area during 5 out of 100 examinations as opposed 

to finding violations during 5 out of 5 examinations during which it 

reviewed the area. Without knowing the full scope of each oversight 

examination and therefore the number of times a particular area was 

reviewed, data tracked by SEC on the number of deficiencies and 

violations it finds are less meaningful. 

In addition to conducting broker-dealer oversight examinations to evaluate 

the adequacy of SRO activities, SEC conducts other types of examinations, 
Page 35 GAO-05-415 Mutual Fund Oversight

including cause and sweep examinations, which are designed to directly 

assess broker-dealer compliance with the law. SEC tracks the number of 

firms it targets during its examination sweeps along with the number of 

violations and deficiencies it finds. SEC officials told us that the agency 

tracks the number of findings from these examinations as a percentage of 

the number of firms examined, and that tracking such information helps 

SEC assess the prevalence of the findings relative to the number of firms. 

However, without tracking the scope of work performed during its 

oversight examinations, SEC is unable to make similar assessments about 

the prevalence of violations and deficiencies identified during those 

reviews. 

Appendix II provides information you requested about (1) how SEC, NASD, 

and NYSE share information, including written examination guidance, 

related to their review of mutual fund sales practices and other 

examination priorities; (2) how SEC distributes and stores examination 

guidance for use by its broker-dealer examiners; and (3) what training SEC 

has provided to broker-dealer examiners on mutual funds and other topics 

and how it tracks and assesses such training.

Conclusions In the wake of the market timing and late trading abuses, SEC staff 

implemented significant changes to the agency’s mutual fund examination 

program in the view that doing so would help ensure the earlier detection 

and correction of violations. These changes—including conducting 

additional sweep examinations and continuously monitoring large 

companies—reflect a practical approach designed to focus SEC’s limited 

resources on higher risk funds and activities and have the potential to 

strengthen SEC’s oversight practices in certain regards. Nonetheless, the 

changes also involve tradeoffs, such as limiting the agency’s capacity to 

review funds perceived to be lower risk and conduct risk assessments of all 

funds in a timely manner. Moreover, SEC’s capacity to effectively monitor 

the hedge fund industry is open to question, given the tradeoffs that the 

agency has had to make in overseeing the mutual fund industry. While we 

recognize that SEC at some point may need to request additional resources 

from Congress to carryout its mutual fund and other oversight 

responsibilities, such requests should only occur after the agency has 

explored and achieved all available efficiencies within its existing resource 

limitations. Whether SEC’s utilization of resources under its revised 

examination program will provide effective oversight remains to be seen. 

Future adjustments by SEC to resources devoted to various oversight 

activities, such as sweep examinations and randomly selected lower risk 
Page 36 GAO-05-415 Mutual Fund Oversight

fund examinations, are likely to occur as the agency gains experience 

through conducting these oversight activities and changing conditions in 

the mutual fund industry. However, SEC has had extensive experience with 

its broker-dealer oversight examinations, and the effectiveness of these 

examinations for improving the quality of SRO oversight remains unclear. 

This situation raises concern, particularly in light of the significant level of 

resources devoted to oversight examinations and the resource challenges 

faced by SEC’s fund and adviser examination program.

We also identified basic weaknesses in SEC’s approaches to conducting 

mutual fund and broker-dealer examinations. For mutual fund 

examinations, SEC does not require staff to document their examination 

plans to facilitate supervisory review. Second, SEC has issued work paper 

standards but lacks guidance on their supervisory review. Moreover, 

despite the importance of risk scorecards in determining the depth of work 

done during examinations, SEC has not yet assessed whether they are 

prepared according to standards since implementing the scorecards in 

2002. For broker-dealer examinations, SEC has not developed an 

automated system to track the full scope of work completed during 

examinations and therefore lacks useful information about SRO oversight. 

Without addressing these deficiencies, SEC’s capacity to effectively 

oversee the mutual fund industry and SROs is reduced.

Recommendations for 

Executive Action

To improve SEC’s oversight of mutual funds and SRO oversight of brokerdealers that sell mutual funds, we are making four recommendations to the 

SEC Chairman. First, we recommend that SEC periodically assess the level 

of resources allocated to the various types of examinations in light of their 

regulatory benefits to help ensure that the agency is using its resources 

efficiently and effectively to oversee the mutual fund industry, including 

broker-dealers that offer mutual funds. As part of this assessment, SEC 

should seek to ensure that it allocates sufficient resources to mitigate any 

regulatory gaps that may currently exist concerning the timely examination 

of mutual funds perceived to represent lower risk, complete mutual fund 

risk assessments within a more reasonable period, and fulfill its new 

oversight responsibilities for the hedge fund industry. Second, in so doing, 

we recommend that the agency assess its methodology for conducting 

broker-dealer oversight examinations and whether some portion of the 

resources currently devoted to these examinations could be better utilized 

to perform mutual fund examinations.
Page 37 GAO-05-415 Mutual Fund Oversight

Third, to strengthen SEC’s approach to mutual fund examinations, we 

recommend that SEC

• establish a policy or procedure for supervisory review of work papers 

prepared during routine examinations and for documenting such 

reviews;

• establish a policy or procedure for preparing a written plan for each 

routine examination, documenting at a minimum the preliminary 

objectives and scope of the examination; and

• consider reviewing on a sample basis completed routine examinations 

and work papers to assess the quality and consistency of work within 

and across the field offices conducting examinations.

Fourth, to assess and improve the effectiveness of SEC’s oversight of SRO 

broker-dealer examination programs, we recommend that the Chairman, 

SEC, electronically track information about the full scope of work 

performed during broker-dealer oversight examinations, including all 

major areas reviewed, to determine whether areas are receiving adequate 

review and to more fully assess the significance of deficiencies and 

violations found.

Agency Comments and 

Our Evaluation

SEC provided written comments on a draft of this report, which are 

reprinted in appendix III. SEC also provided technical comments that we 

incorporated into the final report, as appropriate. SEC focused most of its 

comments on providing further elaboration on the potential benefits of its 

examination strategy for overseeing mutual funds and investment advisers 

and on the benefits obtained from its broker-dealer oversight examinations. 

In addition, SEC briefly commented that it will consider our 

recommendation directed at improving its quality controls for routine fund 

examinations and that it has formed a working group to explore ways to 

enhance the value of its broker-dealer oversight examinations, including 

their ability to identify the reasons that violations may have been missed by 

SRO examinations.

First, SEC stated that it is not possible for the agency to conduct timely, 

comprehensive routine examinations of every mutual fund and adviser, 

given the size of the industry and agency resources. Further, it expects its 

risk-targeted examinations to provide an effective means of addressing 

risks in the securities industry. Specifically, it believes that looking at the 
Page 38 GAO-05-415 Mutual Fund Oversight

same type of risk at a number of different firms is a better approach than 

examining a single firm in depth. According to SEC, this approach will 

provide benefits by promptly identifying emerging trends and compliance 

problems, and individual firms can be compared to their industry peers. 

The agency believes this approach has already yielded benefits in 

identifying and addressing significant compliance problems before 

becoming major crises. In addition, SEC stated that the program it is 

developing to randomly select a sample of lower risk firms for routine 

examination will address our concern that such firms may not be given 

sufficient attention under its revised oversight strategy. According to SEC, 

this approach will provide a deterrent effect, enable the agency to test 

assumptions and techniques used throughout its examination program, and 

allow the agency to draw inferences about compliance in the adviser 

community, based on statistically valid sampling techniques. 

We recognize that SEC’s revised examination strategy for mutual funds and 

advisers offers potential benefits, including focusing its limited resources 

on firms and activities that are perceived to pose higher risks. Nonetheless, 

we continue to be concerned about SEC’s ability to examine all mutual 

funds within a reasonable period and accurately assess the relative risk of 

each fund on a timely basis. Unlike broker-dealers, mutual funds are 

regulated and examined solely by SEC. Under SEC’s current plans to 

randomly sample 10 percent of the firms perceived to be lower risk for 

routine examination each year, it is possible that up to a third of the total 

number of firms would not be selected for examination within a 10-year 

period. We believe that this is a lengthy time period for firms to conduct 

business without being examined. Similarly, SEC’s inability to conduct 

examinations of all mutual funds within a reasonable period will limit its 

capacity to accurately distinguish relatively higher risk funds from lower 

risk funds and effectively target its limited examination resources on those 

funds posing the highest risks. Therefore, we continue to believe that, as 

recommended, SEC should periodically assess the level of resources 

allocated to its various types of examinations and in so doing ensure that it 

allocates sufficient resources to mitigate any regulatory gaps that currently 

exist in the timely examination of funds perceived to represent lower risks 

and to ensure that it completes mutual fund risk assessments within a more 

reasonable time period.

Second, SEC stated that its broker-dealer oversight examinations provide 

quality control over SRO examinations and serve other important goals. 

For example, SEC stated that oversight examinations allow it to detect 

violations that otherwise might not be detected, conduct routine 
Page 39 GAO-05-415 Mutual Fund Oversight

examinations of new products or services, and test and validate 

assumptions and techniques used throughout the broker-dealer 

examination program. In addition, SEC expressed concern about our 

suggestion that it should reproduce SRO examinations if its oversight 

examinations are to provide accurate quality control information. SEC 

stated that this suggested approach would result in redundancies for 

broker-dealers being examined and limit the agency’s ability to reach 

conclusions about SRO examination programs. By conducting its 

examinations as independent compliance reviews, SEC stated that it can 

assess whether SRO procedures were followed and whether SRO 

procedures need to be modified or enhanced. The agency stated that 

through its oversight program it has identified SRO procedures that need to 

be modified or enhanced and its examiners meet regularly with SRO 

examiners to review the results of oversight examinations. Finally, SEC 

commented that it has formed a working group to explore ways to gain 

additional value from its broker-dealer oversight examinations, such as by 

better identifying the reasons that a violation may not have been detected 

by an SRO examination, aiding the SRO in improving its program, and 

minimizing burden on the firm examined.

We recognize that SEC’s oversight examinations serve more than one goal 

and provide investor protection benefits. While such examinations serve a 

variety of purposes, one of their primary purposes is to assess the quality of 

SRO examinations. In fulfilling this purpose, we remain concerned that 

SEC’s approach provides limited ability to identify the reasons why an SRO 

did not find violations that SEC found and, in turn, provide suggestions for 

improving SRO examinations. SEC is responsible for overseeing SROs that 

examine broker-dealers on a regular basis, and it conducts oversight 

examinations of only a small percentage of the total number of brokerdealers. Thus, it is critical for SEC to ensure that SROs conduct effective 

examinations. As discussed, SEC has formed a working group to evaluate 

its oversight examinations. We believe this is a step in the right direction 

and also provides the agency with the opportunity to evaluate its approach 

and level of resources devoted to broker-dealer oversight examinations. 

Finally, regarding our recommendation that SEC strengthen three aspects 

of its quality control framework for routine fund examinations, the agency 

stated it will fully consider the recommendation. Specifically, in 2006, the 

agency plans to deploy an electronic system for work papers. In 

preparation for this effort, it plans to review how new technology can be 

used to improve the quality of examinations and it will consider our 

recommendation in its review. While SEC did not directly comment on our 
Page 40 GAO-05-415 Mutual Fund Oversight

recommendation that it electronically track information about the full 

scope of work performed during its broker-dealer oversight examinations, 

we believe that this would provide SEC important information to determine 

whether areas are receiving adequate review and the relative significance 

of violations found in each area. 

As agreed with your office, unless you publicly announce the contents of 

this report earlier, we plan no further distribution of this report until 30 

days from the report date. At that time, we will provide copies of this report 

to the Chairman of the House Committee on Financial Services; the 

Chairman of the Subcommittee on Capital Markets, Insurance and 

Government Sponsored Enterprises, House Committee on Financial 

Services; and the Chairman and Ranking Minority Member of the Senate 

Committee on Banking, Housing, and Urban Affairs. We also will provide 

copies of the report to SEC, FDIC, the Federal Reserve Board of 

Governors, NASD, NYSE, and OCC and will make copies available to others 

upon request. In addition, the report will be available at no cost on GAO’s 

Web site at http://www.gao.gov.

If you or your staff have any questions about this report, please contact me 

at (202) 512-8678 or hillmanr@gao.gov. 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 key contributions to this report are 

listed in appendix IV.

Richard J. Hillman

Director, Financial Markets and

Community Investment 
Page 41 GAO-05-415 Mutual Fund Oversight

Appendix I

Scope and Methodology ApApenednxidexiIs

To identify and assess the changes SEC has made to or is planning for its 

mutual fund examination program, we reviewed SEC testimony, speeches, 

reports, and other documents related to the agency’s mutual fund 

examination program. We also reviewed federal securities laws and 

regulations applicable to mutual funds and analyzed SEC data on the 

number, types, and results of its fund and adviser examinations. We also 

interviewed officials from SEC’s Office of Compliance Inspections and 

Examinations (OCIE), Division of Investment Management, and Office of 

Risk Assessment and representatives from the Investment Company 

Institute to obtain information on the significance of planned changes. In 

addition, we interviewed federal bank regulatory officials from the Federal 

Deposit Insurance Corporation (FDIC), Board of Governors of the Federal 

Reserve System, and Office of the Comptroller of the Currency (OCC) and 

self-regulatory organization (SRO) officials from NASD, the New York 

Stock Exchange (NYSE), and the National Futures Association (NFA) to 

discuss their examination programs and supervisory tools.

To assess key aspects of the quality control framework of SEC’s routine 

mutual fund examinations, we reviewed policies, procedures, and other 

guidance applicable to those examinations. We also reviewed routine fund 

examinations completed in fiscal year 2004 by SEC’s Midwest Regional 

Office (MRO), Northeast Regional Office (NERO), and Philadelphia District 

Office (PDO). We selected these field offices because they were the three 

largest in the number of completed routine fund examinations in fiscal year 

2004. The three offices completed 66 routine fund examinations, 

accounting for about 72 percent of all routine fund examinations 

completed in fiscal year 2004.1

 Where appropriate, we also reviewed 

examinations of advisers to the funds we reviewed.2

 We used a 

standardized data collection instrument to document the methods 

examiners used to conduct examinations and areas examiners reviewed 

during examinations. In addition, we interviewed officials from OCIE and 

three SEC field offices—MRO, NERO, and PDO—about their examination 

policies and procedures and representatives from a mutual fund company 

and consulting firm about fund examinations. To gather information and 

compare SEC examinations with those of other regulators, we interviewed 

1

MRO, NERO, and PDO completed 40, 17, and 9 routine fund examinations, respectively, in 

fiscal year 2004. 

2

SEC focuses its examinations on fund complexes, or groups of funds that generally share 

the same adviser. SEC officials told us they examine both the fund complex and affiliated 

adviser at the same time when both are located at the same site.
Appendix I

Scope and Methodology

Page 42 GAO-05-415 Mutual Fund Oversight

officials from FDIC, the Board of Governors of the Federal Reserve System, 

OCC, NYSE, and NFA about their quality controls and reviewed some of 

their quality control policies and procedures.

To determine the adequacy of SEC’s oversight of NASD and NYSE in 

protecting shareholders from mutual fund sales practice abuses, we 

reviewed SEC policies, procedures, and other guidance related to its 

broker-dealer oversight examinations and inspections and interviewed 

officials from SEC’s OCIE and Boston District Office, NASD, and NYSE. We 

also reviewed judgmentally selected SEC broker-dealer oversight 

examinations conducted by SEC’s Boston District Office in 2003 and 2004, 

and reviewed all reports of SRO inspections conducted of NASD and NYSE 

between 2001 and 2003. To gather information on SEC’s automated tracking 

system, Super Tracking and Reporting System, we interviewed SEC staff 

responsible for the system in headquarters and received an overview of the 

system and its capabilities at the Boston District Office. In addition, we 

reviewed reports generated from the system and training documents for 

the system. To help assess the extent to which SEC, NASD, and NYSE have 

shared written guidance, we compared and contrasted the examination 

modules they used to examine for certain mutual fund sales practice 

abuses. As part of our assessment of the training received by broker-dealer 

examiners, we obtained and analyzed SEC’s training attendance rosters 

and list of examiners employed by SEC since 1999. 

To ensure that data provided about the number, nature, and results of 

examinations conducted by SEC, NASD, and NYSE were reliable, we 

reviewed written materials describing these systems and reviewed the data 

provided to check for missing or inaccurate entries. We also interviewed 

agency staff responsible for maintaining the information systems that track 

such data. We determined that the data were sufficiently reliable for use in 

this report.

We performed our work in Boston, Massachusetts; Chicago, Illinois; New 

York, New York; Philadelphia, Pennsylvania; and Washington, D.C. We 

conducted our work between February 2004 and July 2005 in accordance 

with generally accepted government auditing standards.
Page 43 GAO-05-415 Mutual Fund Oversight

Appendix II

Securities and Exchange Commission’s (SEC) 

Broker-Dealer Examination Guidance and 

Training ApendxiI

You asked us to provide information about aspects of SEC’s oversight of 

the broker-dealer industry, including (1) how SEC, NASD, and the New 

York Stock Exchange (NYSE) share information, including written 

examination guidance, related to their review of mutual fund sales 

practices and other examination priorities; (2) how SEC distributes and 

stores examination guidance for use by its broker-dealer examiners; and 

(3) what training SEC has provided to its broker-dealer examiners on 

mutual funds and other topics, and how it tracks and assesses such 

training.

Sharing of Written Mutual 

Fund Examination 

Guidance among Regulators 

SEC, NASD, and NYSE have developed guidance for examiners to use in 

assessing compliance by broker-dealers with mutual fund sales practice 

rules. Each regulator has developed its own examination module, or set of 

procedures, covering various topics related to mutual fund sales. Moreover, 

all three regulators recently revised their modules to include procedures to 

detect market timing and late trading abuses. In addition, the regulators 

periodically have provided their staff with other written guidance related to 

mutual fund sales. For example, SEC issued internal memorandums in 1997 

and 2001 to inform staff about abuses related to breakpoints1

 and other 

mutual fund sales practices and provide them with procedures for 

detecting such abuses. 

Through its oversight role, SEC reviews aspects of the self-regulatory 

organization (SRO) examination modules, including the mutual fund sales 

practice module. First, SEC officials told us that NYSE and NASD e-mail 

SEC copies of their examination modules when they make material 

changes to them. Second, during SEC’s on-site inspections of SRO 

examination programs, staff generally review SRO examination modules in 

connection with their review of completed SRO broker-dealer 

examinations and work papers. Third, as part of their broker-dealer 

oversight examinations, SEC staff generally review the SRO broker-dealer 

examinations and applicable examination modules before going on-site to 

conduct examinations of such broker-dealers.

SEC and the SRO officials meet at least semiannually to discuss significant 

examination findings, customer complaints, trends in the industry, 

enforcement cases, and examination guidance. SEC officials told us that 

1

Breakpoints are discounts offered to investors on up-front sales charges on certain mutual 

fund shares when an investor makes a large purchase.
Appendix II

Securities and Exchange Commission’s 

(SEC) Broker-Dealer Examination Guidance 

and Training

Page 44 GAO-05-415 Mutual Fund Oversight

agency staff have met with NASD and NYSE officials semiannually and 

quarterly, respectively, to discuss, among other things, examination 

findings and guidance. The officials also said that they hold frequent 

telephone conversations to coordinate their examination efforts. For 

example, SEC, NASD, and NYSE staff talked with each other immediately 

following NASD’s discovery of breakpoint abuses in 2002, and established a 

joint task force to determine the extent of the abuses by conducting 

examinations of firms designed to identify failures to provide breakpoint 

discounts. Similarly, SEC, NASD, and NYSE staff talked with each other in 

their efforts to respond to the late trading and market timing abuses 

uncovered in 2003. In addition, SEC and SRO staff jointly attended 

conferences and training that included examination guidance as a topic of 

discussion. Finally, SEC, NASD, and NYSE have jointly developed a number 

of examination modules to enforce recent changes in laws and rules 

applicable to broker-dealers. 

Although SEC, NASD, and NYSE coordinate in these ways to oversee 

broker-dealers, they generally do not provide copies of their written 

examination materials to each other. That is, SEC typically does not 

provide copies of its modules or other internal written guidance to the 

SROs, nor do NASD and NYSE generally provide copies of such guidance to 

each other. Officials at these agencies shared benefits and drawbacks of 

providing written copies of examination materials to each other. The 

regulators agreed that sharing information about their examination 

approaches and outcomes is overall a positive way to more effectively 

oversee the broker-dealer industry. They cautioned, however, that certain 

drawbacks should be considered regarding the sharing of written 

examination materials. SEC officials said that sharing SEC examination 

modules could compromise its supervision of the SROs. According to the 

officials, if SEC shared its modules, the SROs may be less innovative and 

motivated to improve their methods. They said, for example, that the SROs 

may view SEC’s procedures as the most that they would need to do. NASD 

officials strongly disagreed with SEC’s assertions about the sharing of 

examination modules, saying they always seek the most effective 

examination procedures, regardless of those used by SEC; and an NYSE 

official said that while NYSE understands the SEC’s position in this regard, 

the sharing of SEC’s examination module would only enhance NYSE’s preexisting examination procedures related to mutual funds. NASD and NYSE 

officials said it would be helpful if SEC shared copies of its modules and 

other guidance it shares with its own examiners. However, SEC and NASD 

officials said that NASD and NYSE may not want to share their examination 

modules with each other because of competitive reasons. For example, if 
Appendix II

Securities and Exchange Commission’s 

(SEC) Broker-Dealer Examination Guidance 

and Training

Page 45 GAO-05-415 Mutual Fund Oversight

one SRO shared its modules with another SRO, it would run the risk that its 

competitor could be able to adopt similar procedures without the cost of 

developing them. Finally, NASD officials told us that differences exist 

between NASD’s and NYSE’s membership, culture, priorities, and strategies 

that can lead to differences in examination procedures, and the same is 

true for financial institutions overseen by the banking regulators. 

Distribution and Storage of 

Broker-Dealer Examination 

Guidance 

SEC’s Office of Compliance Inspections and Examinations (OCIE) 

oversees and directs SEC’s broker-dealer examination program, but SEC’s 

11 field offices conduct the vast majority of the broker-dealer 

examinations. Among other things, OCIE creates and updates brokerdealer examination modules, or policies and procedures; issues other 

examination guidance; and reviews broker-dealer examination reports. 

Currently, when OCIE develops and issues policy changes and examination 

guidance, it typically distributes such guidance to the field offices by 

e-mail. In turn, each field office separately stores the guidance on one of its 

shared computer drives or in some other way to provide its examiners 

access to the information. Field office examiners generally are responsible 

for keeping abreast of changes in guidance and reviewing it as needed in 

performing examinations.

To better ensure that SEC examiners across all field offices have access to 

current and complete broker-dealer examination guidance, OCIE is 

developing an internal Web site to serve as a central repository for all 

broker-dealer examination guidance. According to agency officials, OCIE 

launched its internal Web site in April 2005 on a pilot basis to select brokerdealer examiners nationwide to obtain their comments about its 

organization and comprehensiveness. Subsequently, SEC made the Web 

site available to all examiners in July 2005. According to SEC officials, the 

Web site will allow broker-dealer examiners to access not only all guidance 

at one location but also links to databases and numerous other examiner 

tools. 

Broker-Dealer Examiner 

Training and Tracking

SEC’s OCIE has a training branch that provides routine and specialized 

training to its broker-dealer examiners, with some of the training related to 

mutual funds. More specifically, OCIE’s training branch provides a twophased training program for broker-dealer examiners that is designed to 

teach examiners how to handle increasingly complex examination issues. 

According to an SEC official, the phase-one course is designed for new 

examiners and includes some training on mutual fund operations and 
Appendix II

Securities and Exchange Commission’s 

(SEC) Broker-Dealer Examination Guidance 

and Training

Page 46 GAO-05-415 Mutual Fund Oversight

mutual fund sales practices of broker-dealers. OCIE’s training branch also 

offers a range of specialized training delivered in a variety of formats. For 

example, it offers classroom training sessions and videoconferences taught 

by senior examiners or vendors, such as NASD, as well as training videos 

that examiners can view when convenient. An SEC official told us that 

since 1999 the training branch has offered over 25 training sessions that 

have included mutual fund topics, such as breakpoints.

In addition, SEC periodically has coordinated its training efforts with SROs, 

including NASD and NYSE. For example, examiners representing SEC, 

NASD, NYSE, and other SROs, as well as state regulators have met annually 

for a 3-day joint regulatory seminar to receive training about emerging and 

recurring regulatory issues. In 2003 and 2004, the seminars provided 

training on mutual fund sales practice abuses, including late trading, 

market timing, and failure to provide breakpoint discounts. Finally, SEC 

examiners attend or participate in external training, such as industry 

conferences.

Separate from OCIE’s training branch, SEC has a central training center 

called SEC University that oversees the agency’s training programs.2

 SEC 

University uses an electronic database to track training received by SEC 

staff. According to SEC officials, the database has a number of weaknesses 

that limits its usefulness in helping SEC to track and assess the training 

received by examiners. For example, the database cannot be used to 

generate reports on which examiners have taken or not taken a particular 

course. Also, the database is not directly accessible to examiners or their 

supervisors and, thus, does not allow them to review their training records 

or enter external training they may have taken. Because of these 

weaknesses, OCIE’s training branch uses training rosters as needed to 

manually track which examiners have taken particular courses. SEC 

training staff said that they are requesting that the agency purchase a 

learning management system that would better enable it, including OCIE, 

to track and assess all training and other developmental opportunities. 

According to one of the officials, the initiative is currently tabled and may 

or may not receive funding this year. 

2

As part of its 2004-2009 Strategic Plan, SEC is implementing SEC University—a 

comprehensive redesign of the agency’s training and orientation programs—to help the 

agency develop and reinforce a strong operating culture, enhance employee performance, 

and broaden staff knowledge.
Appendix II

Securities and Exchange Commission’s 

(SEC) Broker-Dealer Examination Guidance 

and Training

Page 47 GAO-05-415 Mutual Fund Oversight

Despite challenges in its ability to track training in an automated way, OCIE 

takes some steps to evaluate the training needs of its examiners. It gathers 

and evaluates training participants’ reactions to and satisfaction with 

training programs and uses that information to decide on what training to 

offer in the future. Training branch staff told us that at the end of each 

course, they hand out course evaluation forms to participants. These forms 

include closed-ended questions about the extent to which participants 

found the course helpful and open-ended questions about what additional 

training needs they have. The training branch uses the information to 

improve individual classes and the program as a whole. In addition, training 

staff attend monthly meetings with management and staff from all field 

offices, in part, to identify training needs and opportunities, and they also 

attend yearly meetings with examination program managers to discuss the 

examiners’ training needs.
Page 48 GAO-05-415 Mutual Fund Oversight

Appendix III

Comments from the Securities and Exchange 

Commission ApendxiI
Appendix III

Comments from the Securities and Exchange 

Commission

Page 49 GAO-05-415 Mutual Fund Oversight
Appendix III

Comments from the Securities and Exchange 

Commission

Page 50 GAO-05-415 Mutual Fund Oversight
Appendix III

Comments from the Securities and Exchange 

Commission

Page 51 GAO-05-415 Mutual Fund Oversight
Page 52 GAO-05-415 Mutual Fund Oversight

Appendix IV

GAO Contact and Staff Acknowledgments ApendxiIV

GAO Contact Richard J. Hillman (202) 512-8678 

Staff 

Acknowledgments

In addition to the contact named above, John Wanska, Randall Fasnacht, 

Joel Grossman, Christine Houle, Marc Molino, Wesley Phillips, David 

Pittman, Paul Thompson, Richard Tsuhara, and Mijo Vodopic made key 

contributions to this report.

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