The SEC’s Priority List and How to Prepare for Possible Scrutiny

The Office of Compliance Inspections and Examinations (OCIE) of the Securities and Exchange Commission (SEC) recently announced its 2020 Examination Priorities reflecting OCIE’s assessment of key risks and trends, market and regulatory developments and policies, findings from past examinations, and information gathered from other sources and regulators. The list of priorities is not exhaustive and will not be the only issues addressed in examinations; however, it provides an insight into the key areas where OCIE intends to focus its limited resources.

Grounded in its four pillars – promoting compliance, preventing fraud, identifying and monitoring risk, and informing policy – OCIE will continue examinations into the priority areas that support the SEC’s mission to protect investors, facilitate capital formation, and maintain fair, orderly, and efficient markets. The 2020 exam priorities are organized around 8 themes:

  1. RETAIL INVESTORS, INCLUDING SENIORS AND INDIVIDUALS SAVING FOR RETIREMENT
  2. INFORMATION SECURITY
  3. FINANCIAL TECHNOLOGY (FINTECH) AND INNOVATION, INCLUDING DIGITAL ASSETS AND ELECTRONIC INVESTMENT ADVICE
  4. ADDITIONAL FOCUS AREAS INVOLVING RIAS AND INVESTMENT COMPANIES
  5. ADDITIONAL FOCUS AREAS INVOLVING BROKER-DEALERS AND MUNICIPAL ADVISORS
  6. AML PROGRAMS
  7. MARKET INFRASTRUCTURE
  8. FOCUS ON FINRA AND MSRB

The seriousness and frequency of past years’ exam findings demonstrated the need for OCIE to continue to be vigilant in these areas. In 2019, OCIE completed 3,089 examinations of:

  • 2,180 registered investment advisers (RIAs) – 15% of the RIA population;
  • 150 investment companies;
  • 350 examinations of broker dealers;
  • 110 examinations of national securities exchanges;
  • 90+ examinations of municipal advisors and transfer agents;
  • 160 examinations of the Financial Industry Regulatory Authority (FINRA), including critical program areas and oversight reviews of FINRA examinations; and
  • 15 examinations of clearing agencies.

Due to a lapse in government appropriations in 2019 the examination coverage rate declined from 17% to 15%. OCIE is expecting that number to continue to decline since it currently lacks sufficient resources to keep pace with the rapid growth in the industry and its complexities. In the past five years, the population of registered investment advisers has grown from approximately 11,500 to 13,475 with an increase in assets under the management from approximately $62 trillion to $84 trillion. OCIE is also facing examination challenges related to non-U.S. registrants and off-shore registered investment advisers.

We will review the exam priorities most relevant to investment advisors.

RETAIL INVESTORS, INCLUDING SENIORS AND INDIVIDUALS SAVING FOR RETIREMENT

Fraud, Sales Practices, and Conflicts

Examinations will focus on disclosures, conflict of interest and fees and expenses and assessing whether RIAs, as fiduciaries, are fulfilling their duties of care and loyalty, including assessing whether RIAs are providing advice in the best interest of its clients, eliminating or exposing all conflicts of interests, and acting in a manner consistent with contractual obligations and fiduciary duty. RIAs must not only provide investors with adequate and required disclosures, but also ensure that effective systems and controls are in place that ensure disclosures are made and the firm’s actions are in accordance with its disclosures.

Retail-Targeted Investments

OCIE will continue to focus on certain investment products that pose a higher risk to investors: mutual funds and ETFs, municipal securities and other fixed income securities, and microcap securities (companies with a market capitalization under $250 million). Examinations areas will include:

  • transfer agent handling of microcap distributions and share transfers;
  • broker-dealer sales practices;
  • broker-dealer supervision of high-risk registered representatives; and
  • broker-dealer compliance with regulatory requirements, including those concerning quotations under Rule 15c2-11 Exchange Act, the locate requirement of Regulation SHO, and the obligation to file suspicious activity reports (SARs).

OCIE will also focus on reviewing for pump and dump schemes, market manipulation, and illegal distributions of securities.

Standards of Care

During examinations, OCIE will be assessing progress towards the adoption and implementation of Regulation Best Interest, the Interpretation Regarding Standard of Conduct for Investment Advisers, and the content and delivery of Form CRS Relationship Summary, including policies and procedures regarding conflicts disclosures.

INFORMATION SECURITY

RIAs must ensure compliance with Regulations S-P and S-ID as OCIE will focus on assessing a RIAs’ ability to protect its clients’ personal financial information, including:

  • governance and risk management;
  • access controls;
  • data loss prevention;
  • vendor management;
  • training; and
  • incident response and resiliency.

FINANCIAL TECHNOLOGY (FINTECH) AND INNOVATION, INCLUDING DIGITAL ASSETS AND ELECTRONIC INVESTMENT ADVICE

Digital Assets

Examinations will assess:

  • investment suitability;
  • portfolio management and trading practices;
  • safety of client funds and assets;
  • pricing and valuation;
  • effectiveness of compliance programs and controls; and
  • supervision of employee outside business activities.

Electronic Investment Advice (“robo-advisers”)

Areas of focus include, but not limited to:

  • SEC registration eligibility;
  • cybersecurity policies and procedures;
  • marketing practices;
  • adherence to fiduciary duty;
  • including adequacy of disclosures; and
  • and effectiveness of compliance programs.

ADDITIONAL FOCUS AREAS INVOLVING RIAS AND INVESTMENT COMPANIES

RIA Compliance Programs

RIAs must develop compliance programs and policies and procedures reasonably designed, implemented, and maintained to effectively address the risks associated with its business practices, services and products. OCIE will be assessing due diligence practices as it relates to third-party asset managers, the accuracy and adequacy of disclosures particularly those provided by advisers offering clients new or emerging investment strategies, such as strategies focused on sustainable and responsible investing with an environmental, social, and governance (ESG) criteria. “OCIE will continue to prioritize examinations of RIAs that are dually registered as, or are affiliated with, broker-dealers, or have supervised persons who are registered representatives of unaffiliated broker-dealers.”

Never-Before and Not Recently-Examined RIAs

Continuing its risk-based examinations of never-before and not recently-examined RIAs, “OCIE will also prioritize examinations of RIAs that were previously examined but have not been examined for a number of years to focus on whether the RIAs’ compliance programs have been appropriately adapted in light of any substantial growth or change in their business models.”

Mutual Funds and ETFs

Examinations will focus on:

  • RIAs that use third-party administrators to sponsor the mutual funds they advise or are affiliated with;
  • Mutual funds or ETFs that have not previously been examined; and
  • RIAs to private funds that also manage a registered investment company with a similar investment strategy.

RIAs to Private Funds

OCIE will continue to assess RIAs to private funds compliance risks, including controls to prevent the misuse of material, non-public information; conflicts of interest, fees and expenses, and the use of affiliates to provide services to clients.

If you have questions about this and other compliance matters, contact ICSGroup. Our team or compliance experts are available to provide assistance. 

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