On December 20, 2018, the SEC’s Office of Compliance Inspections and Examinations (OCIE), released its examination priorities for 2019. As we know, “OCIE is responsible for conducting examinations of entities registered with the SEC, including more than 13,200 investment advisers, approximately 10,000 mutual funds and exchange traded funds, roughly 3,800 broker-dealers, about 330 transfer agents, seven active clearing agencies, 21 national securities exchanges, nearly 600 municipal advisors, FINRA, the MSRB, the Securities Investor Protection Corporation, and the Public Company Accounting Oversight Board.”
Our focus is on the investment advisers and investment companies. Based on Form ADV filings, more than 3,700 advisers have over one billion dollars in assets under management; approximately 35 percent manage a private fund; more than 50 percent have custody of client assets; more than 60 percent are affiliated with other financial industry firms; and approximately 12 percent provide advisory services to a registered investment company.
Although the SEC’s fiscal year begins in September, this is the earliest release of examination priorities, before the end of the calendar year, which typically have been released in the second quarter of the fiscal year, after the end of the calendar year. This early release allows us more time to consider OCIE’s priorities, whether any of them impact on our operations, and if so, how to address them. Many of the priorities for this year are not new to us, some going back to 2013, when OCIE first published its examination priorities. In addition to the identification of priorities, OCIE has also released risk alerts during the year that further emphasize its examination findings and concerns.
This year, OCIE’s examination priorities are broken down into six categories:
Matters of Importance to Retail Investors, Including Seniors and Those Saving for Retirement
OCIE will focus examinations on policies and procedures in the following areas:
- The adequate disclosure of fees, expenses, and other charges investors pay, including their calculation;
- The adequate disclosure of conflicts of interest, including the use of affiliated service providers and products, securities-backed non-purpose loans and lines of credit, and borrowing funds from clients;
- The oversight of senior investors, retirement accounts, compliance programs, the appropriateness of investment recommendations, and the supervision of employees and independent representatives;
- Portfolio management and trading processes, including fair allocations of investment opportunities, suitability, adequacy and accuracy of disclosures, and investments in line with client objectives;
- Never-before or not recently-examined investment advisers, including those with substantial growth or changing business models;
- Adequate disclosure of the risks involved with investing in registered funds, the activities of their advisers, and oversight of their boards of directors; and
- Municipal advisors’ disclosure of conflicts of interest and compliance with MSRB rules.
Compliance and Risk in Registrants Responsible for Critical Market Infrastructure
OCIE will continue to examine entities that provide services critical to the proper functioning of capital markets. OCIE will conduct examinations of these firms which include, among others, clearing agencies, national securities exchanges, and transfer agents, focusing on certain aspects of their operations and compliance with recently effective rules.
Select Areas and Programs of FINRA and MSRB
OCIE will continue its oversight of FINRA by focusing examinations on FINRA’s operations and regulatory programs and the quality of FINRA’s examinations of broker-dealers and municipal advisors. OCIE will also examine MSRB to evaluate the effectiveness of select operations and internal policies, procedures, and controls.
Given the significant growth and risks presented in this market, OCIE will continue to monitor the offer and sale, trading, and management of digital assets, and where the products are securities, examine for regulatory compliance. OCIE will take steps to identify market participants offering, selling, trading, and managing these products or considering or actively seeking to offer these products and then assess the extent of their activities. OCIE will conduct examinations focused on, among other things, portfolio management of digital assets, trading, custody and safety of client funds and assets, pricing of client portfolios, compliance, internal controls, and the adequacy of disclosures regarding the complexities of these products and the risks of dramatic price volatility.
OCIE is working with firms to identify and manage cybersecurity risks and to encourage market participants to actively and effectively engage in this effort. Examinations will focus on, among other things, proper configuration of network storage devices, information security governance generally, and policies and procedures related to retail trading information security. OCIE will emphasize cybersecurity practices at investment advisers with multiple branch offices, including those that have recently merged with other investment advisers, and continue to focus on, among other areas, governance and risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response.
Anti-Money Laundering Programs
Examiners will review for compliance with applicable anti-money laundering requirements, including whether firms are appropriately adapting their AML programs to address their regulatory obligations.
We are impressed that OCIE was able to provide the fiscal year’s examination priorities prior to the end of the calendar year. The earliest release, prior to this one, was January 9, 2014. During 2018, in addition to the examination priorities, we received five risk alerts, all related to examination findings:
- Risk Alert: Observations from Investment Adviser Examinations Relating to Electronic Messaging
December 14, 2018
- Risk Alert: Risk-Based Examination Initiatives Focused on Registered Investment Companies
November 8, 2018
- Risk Alert: Investment Adviser Compliance Issues Related to the Cash Solicitation Rule
October 31, 2018
- Risk Alert: Most Frequent Best Execution Issues Cited in Adviser Exams
July 11, 2018
- Risk Alert: Most Frequent Advisory Fee and Expense Compliance Issues Identified in Examinations of Investment Advisers
April 12, 2018
The risk alerts can be viewed at: https://www.sec.gov/ocie under Office Resources.
Of course, none of the current priorities are new to us:
- Matters of importance to retail investors, including seniors and those saving for retirement; (First identified in 2014 and on the exam priorities list every year since)
- Compliance and risk in registrants responsible for critical market infrastructure; (Transfer agents and clearing agencies every year since 2015, National securities exchanges since 2017, SCI entities first appeared in 2018)
- Select areas and programs of FINRA and MSRB; (FINRA since 2017, MSRB first appeared in 2018)
- Digital Assets; (First appeared in 2018)
- Cybersecurity; (Every year since 2013) and
- Anti-Money Laundering (Every year since 2015)
As you can see, these exam priorities are not new this year, but the emphasis is deeper in many of these areas as we try to work around or address OCIE’s concerns. The products and the processes around trading of more exotic products suddenly reveals issues with more traditional products.
The more you know, the more you know you don’t know.
During this New Year, we hope your dealings with the SEC are always pleasant, and that CCOs can identify all your compliance issues and correct them quickly, at little or no cost to the firm.