OCIE’s priorities are organized around the same three thematic areas as last year:
- Examining matters of importance to retail investors, including investors saving for retirement;
- Assessing issues related to market-wide risks; and
- Using its evolving ability to analyze data to identify and examine registrants that may be engaged in illegal activity.
Protecting Retail Investors and Investors Saving for Retirement
Protecting retail investors and retirement savers continues to be a priority for the SEC in 2016, and into the future. As investors are more dependent than ever on their own investments for retirement (an estimated $24 trillion in retirement assets), there is a huge menu of information, advice, products, and services to retail investors.
OCIE is planning and/or conducting various examination initiatives to assess risks to retail investors that could arise from these trends.
ReTIRE. Exchange-Traded Funds (“ETFs”). Branch Offices. Fee Selection and Reverse Churning. Variable Annuities. Public Pension Advisers.
Launched in June 2015, this is a multi-year examination initiative, focusing on SEC-registered investment advisers and broker-dealers and the services they offer to investors with retirement accounts. This initiative includes examining the reasonable basis for recommendations made to investors, conflicts of interest, supervision and compliance controls, and marketing and disclosure practices.
The SEC will be examining ETFs for compliance with applicable exemptive relief granted under the Securities Exchange Act of 1934 and the Investment Company Act of 1940 and with other regulatory requirements, as well as the ETFs’ unit creation and redemption process. This initiative focuses on sales strategies, trading practices, and disclosures involving ETFs, including excessive portfolio concentration, primary and secondary market trading risks, adequacy of risk disclosure, and suitability.
Examiners will be reviewing supervision of registered representatives and investment adviser representatives in branch offices of registered investment advisers and broker-dealers. This initiative includes using data analytics to identify registered representatives in branches that appear to be engaged in potentially inappropriate trading.
The SEC will be examining investment advisers and dual-registrants that offer retail investors a variety of fee arrangements. This initiative focuses on recommendations of account types and whether those recommendations are in the best interest of the retail investor at the inception of the arrangement and thereafter, including fees charged, services provided, and disclosures made about such arrangements.
Assessing the suitability of sales of variable annuities to investors (e.g., exchange recommendations and product classes), as well as the adequacy of disclosure and the supervision of such sales.
The SEC will be examining advisers to municipalities and other government entities, focusing on pay-to-play and certain other key risk areas, including identification of undisclosed gifts and entertainment.
Exchange-Traded Funds (“ETFs”).
Fee Selection and Reverse Churning.
Public Pension Advisers.
Assessing Market-Wide Risks
The SEC will examine for structural risks and trends that may involve multiple firms or entire industries, focusing on the following initiatives:
Cybersecurity. Liquidity Controls.
In September 2015, the SEC launched an initiative to examine broker-dealers’ and investment advisers’ cybersecurity preparedness including firms’ ability to protect client information. In 2016, the SEC will include testing to assess the adequacy and implementation of firm procedures and controls.
The SEC will examine advisers to mutual funds, ETFs, and private funds that have exposure to illiquid fixed income securities, including a review of various controls, such as those over market risk management, valuation, liquidity management, and trading activity.
Using Data Analytics to Identify Signals of Potential Illegal Activity
In all of the SEC’s examination initiatives, data and intelligence from SEC examinations, as well as from regulatory filings, will be used to identify registrants that appear to have elevated risk profiles. Those areas include:
Recidivist Representatives and their Employers.
The SEC will continue to use analytic capabilities to identify individuals with a track record of misconduct and examine the firms that employ them, and assess the compliance oversight and controls of investment advisers that have employed such individuals after they have been disciplined or barred from a broker-dealer.
The SEC will continue to examine clearing and introducing broker-dealers’ AML programs, focusing on firms that have not filed the number of suspicious activity reports (“SARs”) that would be consistent with their business models or have filed incomplete or late SARs. Should the Investment Adviser AML Rule proposed by FinCEN go effective during this fiscal year, the SEC will assess those programs.
In addition to examinations related to the themes described above, the SEC has identified other priorities, including:
The SEC will continue to conduct examinations of newly-registered municipal advisors to assess their compliance with recently adopted SEC and Municipal Securities Rulemaking Board rules.
Examiners will review private placements, including offerings involving Regulation D of the Securities Act of 1933 or the Immigrant Investor Program (“EB-5 Program”) to evaluate whether legal requirements are being met in the areas of due diligence, disclosure, and suitability.
Never-Before-Examined Investment Advisers and Investment Companies.
The SEC will continue conducting focused, risk-based examinations of selected registered investment advisers and investment company complexes that we have not yet examined.
Private Fund Advisers.
The SEC will examine private fund advisers, maintaining a focus on fees and expenses and evaluating, among other things, the controls and disclosure associated with side-by-side management of performance-based and purely asset-based fee accounts.
There were no big surprises, partly because the themes are carried over, and partly because those concerns that have arisen since last year have been talked about since last year. Of course, the SEC staff concludes with the information that:
This description of OCIE priorities is not exhaustive. While we expect to allocate significant resources throughout 2016 to the examination issues described herein, our staff will also conduct examinations focused on risks, issues, and policy matters that arise from market developments, new information learned from examinations or other sources, including tips, complaints, and referrals, and coordination with other regulators.
Essentially, these are the SEC staff’s priorities at this time, but subject to change based on whatever issues happen to pop up.
This is not the first time that the SEC has wanted a deeper look into variable annuities. About 20 years ago (while an examiner with the SEC Philadelphia Office), I was part of a team that conducted examinations of several insurance companies with variable annuities products, looking at essentially the same things the SEC is looking at now. The examination module we used was developed in conjunction with the SEC’s Office of Insurance Products, whose staff has probably been working with OCIE staff to develop request lists and workpapers for this round. I also find it particularly ironic that excessive trading (also known as churning in commission paying accounts) and reverse churning (not making trades in assets based fee arrangements) have both been identified as SEC concerns, rather than one or the other.
As we proceed through the year, we will continue to update you on changes that will occur within the SEC examination program and how they will impact us.