The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) has identified 2017 examination priorities that reflect its views on areas perceived to present heightened risk to the investing public and capital markets[i]. The exam priorities are broad and cut across a range of financial institutions, including investment advisors, investment companies, broker-dealers, transfer agents, clearing agencies, private fund advisers, national securities exchanges, and municipal advisors.
The inclusion of investment advisers and the high level of attention they receive across the priorities cannot be overlooked. Background on these priorities is found in previously issued letters, speeches, risk alerts and other means used by the Commission to communicate current thinking in these matters.
- Robo-Advisors: During a March 2016 address, SEC Chair Mary Jo White, discussed that many robo-advisors bring certain benefits to the investing public through technology in the form of low-cost investment advice with low account minimums, which provides broader and more affordable access to markets. Although this new business model differs from the traditional adviser model, the SEC’s assessment of robo-advisors is no different and their areas of focus will be how these firms meet their continuing Advisers Act obligations and fiduciary duties. The SEC is firm in its resolve to “proactively convey the need for these entities to operate within the regulatory framework of the Advisers Act”[ii].
- Never-Before Examined Registered Investment Advisers: In 2014 the Commission announced the launch of an initiative to examine investment advisers that have never-before been examined, with an emphasis on those that have been registered three years or more[iii]. The Never-Before Examined Initiative includes two distinct approaches: risk-assessment and focused reviews. The risk-assessment includes a high-level review of the overall business activities, with a particular focus on an adviser’s compliance program and assessment of the representations made in Form ADV and other disclosure documents. The focused review approach includes conducting comprehensive examinations of one or more higher-risk areas of the business and operations such as the compliance program, filings and disclosures, marketing, portfolio management, and safety of client assets. of advisers selected for an examination.
- Multi-Branch Advisers: In December 2016, OCIE issued a Risk Alert providing information concerning its Multi-Branch Adviser Initiative [iv]. The use of a branch office model can pose unique risks and challenges to advisers in the design and implementation of a compliance program and the supervision of people and processes across a network of branch offices. Multi-Branch Adviser Initiative examinations will focus on advisers’ compliance programs and the oversight of investment advisory services conducted at branch offices.
- Public Pension Advisers: The issue of “pay to play” has long been identified by regulators as a problem, particularly when investment advisers retain placement agents who have made contributions to government officials who may have the ability to influence the selection process for investment advisers. On December 16, 2015, FINRA filed a proposed rule change with the SEC, to adopt FINRA Rules to establish “pay-to-play” rules that would regulate the activities of such placement firms used by investment advisers. A rule prohibiting pay to play by investment advisers was adopted on July 1, 2010, which prohibited the practices where investment advisers make campaign contributions to elected officials of state or municipal governments in order to influence the award of contracts to manage public pension plan assets and other government investment accounts.
- Private Fund Advisers: During a 2014 address to the Hedge Fund industry, Norm Champ, Director, Division of Investment Management at the SEC [v], noted that the Dodd-Frank Act directed the SEC to implement a number of provisions designed to enhance the oversight of private fund advisers, including registration of advisers to hedge funds, private equity funds and other private funds that were previously exempt from SEC registration. The addition of Form PF has improved the level and quality of private fund data now at the disposal of the SEC (leverage, counterparty credit risk exposure, and trading practices). A new tool for the SEC is the newly formed Risk and Examinations Office (“REO”), a multi-disciplinary office staffed with quantitative analysts, examiners, lawyers, and accountants. REO provides ongoing quantitative and qualitative financial analysis of participants in the investment management industry (such as mutual funds, money market funds, ETFs and private funds) with data collected through regulatory reports and third party providers. In 2014 the Commission announced the launch of an initiative to conduct focused, risk-based examinations of investment advisers to private funds that recently registered with the Commission (“Presence Exams”). The Presence Exams focus on the key areas of marketing, portfolio management, conflicts of interest, safety of client assets, and valuation.
It is noteworthy that the priorities include the recurring themes of conflicts of interests, oversight, and suitability that will be the focus of examinations across several target areas. These recurring themes are outside the traditional scope of the investment portfolio and emphasize the SEC’s view that protection of the investing public is inclusive of more than just the mechanics and operations around stock picking and investment returns. Consequently, investment advisers will have to ensure that these areas are present and accounted for within their governance structure and oversight strategy.
The following represents a high-level overview of 2017 priorities and broad categories around which they are organized:
Matters of importance to retail investors
- Electronic Investment Advice, including “robo-advisers” to include marketing, investment recommendations, data protection, and disclosures relating to conflicts of interest.
- Wrap Fee Programs which charge investors a single bundled fee for advisory and brokerage services, including suitability, disclosures, conflicts of interest, and brokerage practices.
- Exchange-Traded Funds (“ETFs”) regarding unit creation and redemption processes as well as sales practices, disclosures, and the suitability of ETFs with niche strategies.
- Never-Before Examined Investment Advisers including risk-based examinations of newly registered advisers as well as those previously registered but never examined by OCIE.
- Recidivist Representatives and their Employers to assess compliance oversight and controls of investment advisers that have employed such individuals.
- Multi-Branch Advisers concerning the design and implementation of a compliance program and the oversight of advisory services provided at branch offices.
- Share Class Selection including conflicts of interest that may influence recommendations in favor of share classes that have higher loads or distribution fees.
Risks specific to elderly and retiring investors
- ReTIRE initiative, focusing on investment advisers and broker-dealers and sales of variable insurance products, target date funds, and fixed income securities.
- Public Pension Advisers to pension plans of states, municipalities, and other government entities to assess how they are managing conflicts of interest and fulfilling their fiduciary duty as well as compliance with pay-to-play and gifts and entertainment practices.
- Senior Investors including how firms manage their interactions with senior investors, including supervisory programs and controls relating to products and services directed at senior investors.
Market-wide risks
- Money Market Funds including assessments of the boards’ oversight of the funds’ compliance with recently enacted regulations as well as compliance policies and procedures relating to stress testing and funds’ periodic reporting of information to the Commission.
- Payment for Order Flow including how market-makers are complying with their duty of best execution when routing customer orders for execution.
- Clearing Agencies including compliance with the SEC’s Standards for Covered Clearing Agencies.
- FINRA including the SEC’s oversight of FINRA and assessing the quality of FINRA’s examinations of individual broker-dealers.
- Regulation Systems Compliance and Integrity (“SCI”) including compliance with policies and procedures to ensure these SRO’s have levels of capacity, integrity, resiliency, availability, and security adequate to maintain operational capacity and promote maintenance of fair and orderly markets.
- Cybersecurity including compliance procedures and controls and the testing of the implementation of those procedures and controls.
- National Securities Exchanges to include risk-based inspections of the national securities exchanges with a focus on selected operational and regulatory programs.
- Anti-Money Laundering (“AML”) will include examinations of broker-dealers to assess how AML programs address specific risks and their adaptability to evolving risks as well as compliance with suspicious activity report (“SAR”) requirements.
Other Initiatives
- Municipal Advisors will include compliance with SEC and Municipal Securities Rulemaking Board rules.
- Transfer Agent examinations will include timely turnaround of items and transfers, recordkeeping, and record retention, and safeguarding of funds and securities.
- Private Fund Adviser examinations will focus on conflicts of interest and disclosure of conflicts as well as actions that appear to benefit the adviser at the expense of investors.
[i] Office of Compliance Inspections and Examinations. Examination Priorities for 2017 . U.S. Securities and Exchange Commission. [Online] Jan 12, 2017. https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2017.pdf
[ii] White, Mary Jo. Keynote Address at the SEC-Rock Center on Corporate Governance Silicon Valley Initiative. U.S. Securities and Exchange Commission. [Online] Mar 31, 2016. https://www.sec.gov/news/speech/chair-white-silicon-valley-initiative-3-31-16.html
[iii] Jarcho, Jane E. OCIE’s Letter to Never-Before Examined Investment Advisers. U.S. Securities and Exchange Commission. [Online] Feb 20, 2014. https://www.sec.gov/about/offices/ocie/nbe-final-letter-022014.pdf
[iv] Office of Compliance Inspections and Examinations. OCIE Risk Alert, “Multi-Branch Adviser Initiative,”. U.S. Securities and Exchange Commission. [Online] Dec 12, 2016. https://www.sec.gov/ocie/announcement/risk-alertmulti-branch-adviser-initiative.pdf
[v] Champ, Norm. Remarks to the Practicing Law Institute, Hedge Fund Management Seminar 2014. U.S. Securities and Exchange Commission . [Online] Sep 11, 2014. http://www.sec.gov/News/Speech/Detail/Speech/1370542916156