On January 9, 2014, the Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations (OCIE) released a list of its examination priorities for 2014,1 the second annual release of such a list. While the 2014 list includes many of the issues historically of concern to OCIE, there are several new areas of focus. The list includes market-wide priorities and also specific priorities for various sectors within the industry. Across the market, examiners will focus on:
- Fraud Detection and Prevention: Examiners will utilize a number of quantitative and qualitative tools to identify market participants engaging in fraud or other unethical behavior.
- Corporate Governance, Conflicts of Interest and Enterprise Risk Management: OCIE will continue to meet with senior management of entities registered with the SEC to discuss how each firm identifies and mitigates conflicts of interest and legal, compliance, financial and operational risks. This initiative is designed to (i) evaluate firms’ control environment and “tone at the top,” (ii) understand firms’ approach to conflict and risk management, and (iii) initiate a dialogue on key risks and regulatory requirements.
- Technology: Examinations will increasingly focus on evaluating the system of checks and safeguards employed by firms in their use of technology, including operational capability, information security, and preparedness to respond to malfunctions and system outages, such as those that may arise during natural disasters.
- Dual Registrants: The SEC will be closely evaluating firms that provide both broker-dealer and investment adviser services to see whether customers have been placed in an inappropriate type of brokerage or investment advisory account.
- New Laws and Regulation: OCIE will review, among others, general solicitation practices and the verification of accredited investor status under newly adopted Rule 506(c) under the Securities Act of 1933 to the extent conducted by a regulated entity. OCIE will also be conducting reviews to assess compliance with the recently adopted rules concerning municipal advisors and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).
- Retirement Vehicles: Examiners will evaluate the sales practices of investment advisers related to 401(k)s and other retirement vehicles, and check for improper or misleading marketing and advertising, among others, when recommending the movement of assets from a retirement plan into an IRA rollover account.
Specifically when examining Investment Advisers, OCIE will focus on compliance with the “Custody Rule,” the conflicts of interest that frequently arise in the investment adviser business model, and the accuracy of marketing materials. While these areas are not surprises, OCIE also listed new focuses based on the current state of the market and regulation. Included in these industry-specific focus areas are:
- Presence Exams: OCIE will continue its two-year initiative to examine investment advisers registered since july 21, 2011, the effective date of Dodd-Frank. These exams focus on marketing, portfolio management, conflicts of interest, safety of client assets and valuation, and are shorter than the traditional examinations. OCIE will also continue to prioritize examinations of private fund advisers that pose, in its view, higher risks to investors or where there are indications of fraud, broker-dealer status concerns or other serious wrongdoing.
- Never-Before Examined Advisers: OCIE will undertake an initiative to examine the 40% of firms that have been registered for over three years and have never been examined.2 These firms are not part of the Presence Exam initiative referenced above.
- Wrap Fee Programs: Examiners will look to verify that advisers are complying with their fiduciary and contractual obligations to their clients with respect to monitoring wrap fee programs recommended to clients and will review the processes in place for such monitoring.
- Quantitative Trading Models: For those investment advisers that rely substantially on quantitative trading models, the examiners will assess the firm’s adoption and implementation of compliance policies and procedures specifically tailored to the performance and maintenance of those proprietary models.
- Payments for Distribution in Guise: OCIE will continue its review of the variety of payments made by advisers and funds to distributors and intermediaries, the adequacy of disclosure about these payments, and oversight of them. OCIE will assess whether such payments are, in fact, payments for distribution and preferential treatment.
- Fixed Income Investment Companies: Examiners will monitor the impact that changing interest rates have on bond funds and related disclosure of such risks to investors.
OCIE has also highlighted some policy-related focus areas for the upcoming year. They will be monitoring how money market funds react to actual and potential stress events. They will keep a close watch on investment companies that use an “alternative” model, and they will examine any securities lending arrangement to check for compliance with exemptive orders and no-action letters.
These 2014 exam priorities are a good starting point to begin readying your firm in anticipation of an upcoming examination. It is important to note, however, that examiners are not limited to these focus areas and may decide to investigate other aspects of a firm’s compliance depending on market developments and information acquired during examinations.