The U.S. Securities and Exchange Commission is doing a better job communicating with the mutual fund industry; however, it should consider making its registrant complaints hotline more independent, according to a report from the Government Accountability Office.

The GAO report reviews changes implemented by the SEC’s Office of Compliance, Inspections and Examinations following the mutual fund trading scandals uncovered in late 2003. Since the detection of mutual fund trading abuses in late 2003, the OCIE shifted its approach to examinations of investment companies and advisors from routinely examining all registered firms to a risk-based approach, focusing more frequently on examining firms and industry practices at higher-risk for compliance issues.

The GAO found that the method that the OCIE employs to predict the level of risk for the majority of investment advisors has some limitations, in that it relies on proxy indicators of compliance risks without incorporating information about the relative strength of a firm’s compliance controls. It notes that the OCIE has taken steps to assess the effectiveness of this method for predicting risk levels and to seek additional indicators of compliance risks. “GAO continues to believe that implementing GAO’s prior recommendation to obtain and use compliance reports from firms — a source of information on the effectiveness of their compliance controls — could potentially help OCIE better identify higher-risk firms,” it says.

The report also considers concerns some registrants have raised about the lack of communication from SEC examiners regarding the status, and results of, examinations. The OCIE has implemented several initiatives since January 2006 intended to improve communication with registrants and other aspects of the examination program. For example, it established a hotline for registrants to make complaints, began requiring examiners to contact registrants when examinations extend past 120 days, and implemented tools and protocols designed to reduce duplicating examinations.

It found that for investment company, investment advisor, and broker-dealer examinations conducted from 2003 through 2006, examiners generally follow OCIE’s exit procedures for communicating deficiencies to registrants and providing written notice of the examination’s outcome.

In an estimated 9% of investment company and investment advisor examinations however, the OCIE directed examiners to forgo these procedures. These examinations were part of a series of examinations that probed specific activities across a number of firms and were initiated in response to the widespread unlawful trading practices that had surfaced at that time, it noted.

In addition, the GAO estimated that in 7% of broker-dealer examinations, either examiners did not follow exit procedures or OCIE officials were not able to provide evidence that they did.

The GAO’s review indicated that examiners generally complied with the new requirement to notify registrants when an examination extends past 120 days. Comments from industry representatives on OCIE’s initiatives suggested some concerns about the hotline, it said. “Specifically, several registrants questioned the independence of the hotline, as it is located within OCIE, and said that as a result they would hesitate to use it.”

The GAO recommends that SEC consider relocating its registrant complaint hotline to an independent office, such as an ombudsman function, within the agency or within a division or office outside of OCIE. It reports that the SEC generally agreed and is taking steps to address the intent of the recommendation.

The report was released on Wednesday by U.S. congressmen Vito Fossella and Spencer Bachus (ranking member of the House Financial Services Committee). Several of the new policies at the SEC came in response to legislation Fossella introduced in 2005.

“I am pleased by GAO’s findings and I commend [SEC chairman Christopher] Cox for his efforts,” Fossella said. “Communication between the SEC and registered firms is improving — an outcome that is in the best interest of investors and in creating a more amicable regulatory environment.

“While the GAO report shows significant progress, there is certainly still room for improvement,” he added. “The SEC should continue to work towards an open-door policy that keeps registered firms informed about proceedings and encourages them to come forward with compliance questions without fear of retribution.”