On January 13, 2015, the Office of Compliance Inspections and Examinations (OCIE) of the Securities and Exchange Commission (SEC) published its 2015 examination priorities to communicate with investors and regulated entities about certain practices and products that the OCIE perceives to present potentially heightened risk to investors and the integrity of our capital markets. The 2015 examination priorities focus on three areas: (i) protecting retail investors, especially those saving for or in retirement; (ii) assessing market-wide risks; and (iii) using data analytics to identify signs of potential illegal activity. All investment advisers and broker-dealers should carefully review the examination priorities and consider necessary enhancements to their operations, policies and procedures, as well as potential revisions to the substance or focus of training programs. The full text of the examination priorities may be reviewed online here.
Protecting Retail Investors and Investors Saving for Retirement
The OCIE recognizes that market participants are developing and offering to retail investors a variety of new products and services that were formerly characterized as alternative or institutional, and that the financial services industry is offering a broad array of information, advice, products and services to retail investors to help them plan for, and live in, their retirement years. The OCIE is targeting the following examination initiatives, as well as others, to assess risks that can arise from these trends.
Fee Selection and Reverse Churning. Financial professionals serving retail investors are increasingly choosing to operate as an investment adviser or as a dually registered investment adviser/broker-dealer, rather than solely as a broker-dealer. Where these advisers offer a variety of fee arrangements, the OCIE intends to focus on recommendations of account types and whether they are in the best interests of the client at the inception of the arrangement and thereafter, including fees charged, services provided, and disclosures made about such relationships.
Sales Practices. The OCIE will assess whether firms are using improper or misleading practices when recommending the movement of retirement assets from employer-sponsored defined contribution plans into other investments and accounts, especially when they pose greater risks or charge higher fees.
Suitability. The OCIE will evaluate firms' recommendations or determinations to invest retirement assets into complex or structured products and higher yield securities, including whether the due diligence conducted, the disclosures made, and the suitability of the recommendations are consistent with existing legal requirements.
Branch Offices. The OCIE will focus on firms' supervision of registered representatives and financial adviser representatives in branch offices, and will use data analytics to identify branches that may be deviating from compliance practices of the firm's home office.
Assessing Market-Wide Risks
The OCIE recognizes that the SEC's mission includes not only investor protection and capital formation, but also maintaining fair, orderly, and efficient markets. To that end, the OCIE intends to examine for structural risks and trends that may involve multiple firms or entire industries, including the following initiatives.
Large Firm Monitoring. The OCIE will continue to collaborate with other SEC divisions to monitor the largest U.S. broker-dealers and asset managers for the purpose of assessing risks at individual firms and maintaining early awareness of developments industry-wide.
Clearing Agencies. The OCIE will continue to conduct annual examinations of all clearing agencies designated systemically important, with areas of focus as determined in collaboration with the Division of Trading and Markets and other regulators, as appropriate.
Cybersecurity. The OCIE intends to expand its initiative to examine broker-dealers' and investment advisers' cybersecurity compliance and controls to include transfer agents in 2015.
Potential Equity Order Routing Conflicts. The OCIE will assess whether firms are prioritizing trading venues based on payments or credits for order flow in conflict with their best execution duties.
Using Data Analytics to Identify Signals of Potential Illegal Activity
Over the last several years, the OCIE has made significant enhancements in data analytics. It intends to use these capabilities in 2015 to focus on firms that appear to be potentially engaged in fraudulent or other potential illegal activity, including the following examination priorities.
Recidivist Representatives. The OCIE will identify individuals with a track record of misconduct and focus its examinations on the firms that employ them.
Microcap Fraud. The OCIE will continue to examine the operations of broker-dealers and transfer agents for activities that indicate they may be engaged in, or aiding and abetting, pump-and-dump schemes or market manipulation.
Excessive Trading. The OCIE will analyze data obtained from clearing brokers to identify and examine introducing brokers and registered representatives that appear to be engaged in excessive trading.
Anti-Money Laundering ("AML"). The OCIE intends to examine clearing and introducing broker-dealers' AML programs, using its analytic capabilities to focus on firms that have not filed suspicious activity reports or have filed incomplete or late reports. Additionally, the OCIE intends to conduct examinations of the AML programs of broker-dealers that allow customers to deposit and withdraw cash or provide customers direct access to the markets from higher-risk jurisdictions.
In addition to the three primary areas of examination focus discussed above, the OCIE expects to allocate examination resources to other priorities, including the examination of newly registered municipal advisors, investment advisers' compliance with their fiduciary duties in voting proxies on behalf of investors, and fees and expenses in connection with advisers to private equity funds.
Given the multiple areas of supervisory focus for 2015, it is imperative that investment advisers and broker-dealers carefully review their practices, policies and procedures, and corresponding training programs to ensure that all facets of their operations are fully compliant with the examination priorities discussed above.