On January 9, 2014, the U.S. Securities and Exchange Commission (the SEC) National Examination Program (the NEP) of the Office of Compliance Inspections and Examinations published its 2014 examination priorities for NEP-wide initiatives for investment advisers. These priorities reflected topics that the SEC staff perceives to have heightened risk and to which the NEP expects to allocate significant resources throughout 2014.
The NEP-wide initiatives include:
- Using quantitative and qualitative tools to enhance fraud detection and prevention;
- Meeting with senior management and boards of SEC-registered entities and their affiliates to examine corporate governance, conflicts of interest and enterprise risk management;
- Examining technology systems and controls, information security and the ability to respond to sudden malfunctions and system outages (business continuity plans);
- Examining dual registrants (i.e., the convergence of broker-dealer and investment adviser businesses), and conflicts of interests and other issues that this business model presents;
- Examining issues relating to new laws and regulations (including general solicitation practices and verification of accredited investor status under newly adopted Rule 506(c) of the Securities Act of 1933 (as amended, the Securities Act), industry developments and compliance with new rules; and
- Examining sales practices involving retirement investments and rollovers, including potential misrepresentation of credentials, IRA plan features and suitability of investments.
The NEP also announced its priorities that are specifically applicable to registered investment advisers, including priorities that relate to (1) core risks, (2) new and emerging risks and (3) policy topics:
- Core Risks. Core risks are those risks that are common to the business models of a category of registrants and that have existed for a sustained period and are likely to continue for the foreseeable future. The Investment Adviser/Investment Company Program (the IA-IC Program) core risk initiatives include (i) testing compliance with Rule 206(4)-2 (the Custody Rule) under the Investment Advisers Act of 1940 (as amended, the Advisers Act) and confirming the existence of assets through a risk-based asset verification process; (ii) examining conflict-of-interest risks in compensation arrangements, allocation of investment opportunities, side-by-side management of performance-based and purely asset-based fee accounts, illiquid investments, leveraged investment strategies, and higher risk strategies targeted to retail investors; and (iii) reviewing advisers’ claims about their investment objectives and performance and reviewing marketing efforts arising out of newly effective rules under the Jumpstart Our Business Startups Act of 2012.
- New and Emerging Risks. New and emerging risks are those arising from changes and developments in the industry. New and emerging risk initiatives for the IA-IC Program include (i) examining never-before examined and newly registered advisers; (ii) assessing whether advisers are fulfilling their obligations in relation to wrap fee programs; (iii) examining advisers that rely substantially on quantitative trading models; (iv) reviewing the payments made by advisers and funds to distributors and intermediaries and related disclosure and board oversight to assess whether such payments are “payments for distribution in guise”; and (v) monitoring the risks associated with a changing interest rate environment and its impact on bond funds and related risk disclosures.
- Policy Topics. Policy topics are areas in which the SEC seeks to gain a better understanding of business practices and the application of previously adopted rules and guidance. The IA-IC Program policy topics include (i) money market funds, with focus on the management of potential stress events and funds that exhibit outlier behavior; (ii) funds offering “alternative” investment strategies; and (iii) securities lending arrangements to assess compliance with exemptive orders and no-action letters.
In connection with their annual review, registered investment advisers should review the policies, procedures and practices in light of the NEP IA-AC Program to ensure they are in compliance with the topics that will likely be the focus of examinations in 2014.
The full examination priorities publication can be found here.