The Office of Compliance Inspections and Examinations (“OCIE”) of the Securities and Exchange Commission (“SEC”) has released the SEC Exam Priorities for 2017 (the “SEC Exam Priorities”). In general, the SEC Exam Priorities reflect certain practices, products, and services that OCIE perceives to present potentially heightened risk to investors and/or the integrity of the U.S. capital markets, and not surprisingly, there is substantial overlay of the exam priorities perceived by the SEC and by the Financial Industry Regulatory Authority (“FINRA”).’
OCIE has conducted examinations of a number of regulated entities to promote compliance, prevent fraud, identify risk, and inform policy, and to that end, they selected the 2017 Exam Priorities based on the exam finding and in consultation with the SEC’s Commissioners, senior staff from the SEC’s regional offices, the SEC’s policy making divisions, the enforcement division, the SEC’s Investor Advocate Office, and FINRA.
The 2017 SEC Exam Priorities are organized around three thematic areas: (i) examining matters of importance to retail investors; (ii) focusing on risks specific to elderly and retiring investors; and (iii) assessing market-wide risks. It should be noted that there is substantial commonality between both the SEC and the FINRA exam program, as they both have focused on protecting retail, elderly and retiring investors.
Protecting Retail Investors
It was noted in the SEC Exam Priorities release that retail investors face an evolving set of choices when determining how to invest their money. At the same time, the financial services industry continues to offer an ever-widening array of information, advice, products, and services for retail investors in response to their financial needs. To that end, the SEC is pursuing a variety of examination initiatives to assess potential risks to retail investors that arise in the increasingly complex investment landscape. With that in mind, the SEC anticipates initiatives focused on the following:
- Electronic Investment Advice. Examinations will likely focus on registrants’ compliance programs, marketing, formulation of investment recommendations, data protection, and disclosures relating to conflicts of interest. The SEC will also review firms’ compliance practices for overseeing algorithms that generate recommendations.
- Wrap Fee Programs. It is anticipated that exams will expand the SEC’s focus on registered investment advisers and broker-dealers associated with wrap fee programs, to analyze whether investment advisers are acting in a manner consistent with their fiduciary duty and whether they are meeting their contractual obligations to clients. Areas of interest may include wrap account suitability, effectiveness of disclosures, conflicts of interest, and brokerage practices, including best execution and trading away.
- Exchange-Traded Funds (“ETFs”). The SEC will continue to examine ETFs with a focus on sales practices and disclosures involving ETFs and the suitability of broker-dealers’ recommendations to purchase ETFs with niche strategies.
- Never-Before Examined Investment Advisers. The SEC is expanding its Never-Before Examined Adviser initiative to include focused, risk-based examinations of newly registered advisers as well as of selected advisers that have been registered for a longer period but have never been examined by OCIE.
- Recidivist Representatives and their Employers. There will be a continued effort to identify individuals with a track record of misconduct and examine the investment advisers that employ them. To that end, the SEC will follow FINRA’s path with respect to broker-dealers, and they will assess the compliance oversight and controls of investment advisers that have employed such individuals, including those who have been subject to a regulatory action or barred from associating with a broker-dealer.
- Multi-Branch Advisers. The SEC will continue to focus on registered investment advisers that provide advisory services from multiple locations. The use of a branch office model can pose unique risks and challenges to advisers, particularly in the design and implementation of a compliance program and the oversight of advisory services provided at branch offices.
- Share Class Selection. Finally, the SEC noted that it will continue reviewing conflicts of interest and other factors that may affect registrants’ recommendations to invest, or remain invested, in particular share classes of mutual funds, including the identification and assessment of conflicts that certain investment advisory personnel may have, such as those who also are registered representatives of a broker-dealer, which may influence recommendations in favor of share classes that have higher loads or distribution fees. The SEC also noted that it would also assess the formulation of investment recommendations and the management of client portfolios.
Focusing on Senior and Retirement Investments
As the U.S. population ages and investors become more dependent than ever on their own investments for retirement income, the SEC is devoting increased attention to issues affecting senior investors and those investing for retirement. That focus will include at a minimum, the following:
- ReTIRE Initiative. The SEC will continue its multi-year ReTIRE initiative, focusing on investment advisers and broker-dealers, along with the services they offer to investors with retirement accounts. This year, these examinations will likely focus on, among other things, registrants’ recommendations and sales of variable insurance products as well as the sales and management of target date funds. Additionally, the SEC will also assess controls surrounding cross-transactions, particularly with respect to fixed income securities.
- Public Pension Advisers. Pension plans of states, municipalities, and other government entities hold a large amount of U.S. investors’ retirement assets. The SEC intends to examine investment advisers to these entities to assess how they are managing conflicts of interest and fulfilling their fiduciary duty. To that end, they will also review other risks specific to these advisers, including pay-to-play and undisclosed gifts and entertainment practices.
- Senior Investors. Today’s Americans are more reliant on returns from their investment portfolios to fund their retirement compared to previous generations. The SEC will evaluate how firms manage their interactions with senior investors, including their ability to identify financial exploitation of seniors. SEC Examinations will likely focus on registrants’ supervisory programs and controls relating to products and services directed at senior investors.
Assessing Market Wide Risks
As part of the SEC’s mission to maintain fair, orderly, and efficient markets, the SEC also intends to examine for structural risks and trends that may involve multiple firms or entire industries. In 2017, the SEC will also focus on Money Market Funds, Payment for Order Flow, Clearing Agencies, FINRA oversight, Cybersecurity, Anti-Money Laundering and the Regulation Systems Compliance and Integrity and National Securities Exchanges.
Other Initiatives
In addition to SEC Exam Priorities described above, the SEC expects to allocate examination resources to other priorities, including:
- Municipal Advisors. The SEC will continue to conduct examinations of municipal advisors to evaluate their compliance with SEC and Municipal Securities Rulemaking Board rules.
- Transfer Agents. The SEC plans to continue its examination focus on transfer agents’ timely turnaround of items and transfers, recordkeeping and record retention, and safeguarding of funds and securities; but with an expanded scope to examine transfer agents that service microcap issuers, focusing on detecting issuers that may be engaging in unregistered, non-exempt offerings of securities.
- Private Fund Advisers. The SEC will continue to examine private fund advisers, focusing on conflicts of interest and disclosure of conflicts as well as actions that appear to benefit the adviser at the expense of investors.
Summary
As with FINRA’s 2017 exam priorities letter, it is clear that 2017 will bring another vigorous year of examination oversight by the SEC. The SEC Exam Priorities release reflects aggressive regulatory examination goals for the SEC, and as noted in the release, the SEC expects to allocate significant resources throughout 2017 to the various examination issues described in the release. Both investment advisers and broker-dealers should not ignore the respective priorities, as they will do so at their own peril. Prudent compliance professionals should take this time to compare their respective compliance programs against the roadmap provided by the SEC.