The Office of Compliance Inspections and Examinations (“OCIE”) of the U.S. Securities and Exchange Commission (“SEC”) announced its 2020 examination priorities on January 7. As expected, the 2020 examination priorities reflect certain familiar themes, including a particular focus on the protection of retail investors; the adequacy and accuracy of disclosures concerning fees, services and expenses; a firm’s management and handling of conflicts of interest for SEC-registered investment advisers (“RIAs”); and sales and trading practices and execution quality issues for broker-dealers. The release is not just a retread of the prior year, however. The 2020 examination priorities release contains a new section that focuses on private fund managers, so RIAs to private funds should anticipate a renewed and increased focus on their compliance programs and cultures.
Below are certain key priorities from and other issues from the 2020 examination priorities release:
Retail Investors, Including Seniors and Individuals Saving for Retirement
OCIE will again emphasize the protection of retail investors, particularly seniors and those saving for retirement. To this end, OCIE will focus on RIAs, broker-dealers and other registered firms that serve as intermediaries to retail investors and investments that are specifically marketed to retail investors (e.g., mutual funds, ETFs, fixed income securities, municipal securities and microcap securities).
For RIAs that are dually registered as, or affiliated with, broker-dealers, or have supervised persons who are registered representatives of unaffiliated broker-dealers, compliance programs should address best execution, prohibited transactions, fiduciary advice and disclosure of conflicts regarding such arrangements.
RIAs to Private Funds
OCIE will examine RIAs to private funds for compliance risks, including controls to prevent the misuse of material non-public information and conflicts of interest. Disclosures surrounding fees and expenses and conflicts of interest, including the use of affiliated service providers, are paramount. In addition, OCIE intends to focus on the accuracy and adequacy of disclosures of RIAs that offer clients new types of emerging investment strategies (e.g., environmental, social and governance (“ESG”) investments).
Never Before and Not Recently-Examined RIAs
OCIE will continue to conduct risk-based examinations of new RIAs and RIAs that have never been examined. OCIE will also prioritize previously examined RIAs that have not been examined in a number of years to determine, among other things, whether such RIAs adapted their compliance programs to address their growing and changing businesses.
Mutual Funds and ETFs
In line with its ongoing emphasis on retail investors and assets, OCIE will prioritize examinations on the governance and oversight of mutual funds and ETFs, with particular attention to RIAs that use third-party administrators as sponsors and RIAs to private funds that manage registered investment companies with similar investment strategies that have similar strategies as the RIA’s private fund clients.
Third-Party Asset Managers
OCIE will prioritize examining firms that utilize third-party asset managers to advise clients’ investments to assess, among other things, the extent of such RIAs’ due diligence practices, policies and procedures.
Broker-Dealer Financial Responsibility
OCIE will continue to focus on brokers dealers that hold customer cash and securities in compliance with Rules 15c3-3 and 15c3-1 under the U.S. Securities Exchange Act of 1934 (also known as the Customer Protection Rule and the Net Capital Rule, respectively), including the adequacy of internal processes, procedures and controls.
Trading and Broker-Dealer Risk Management
OCIE will examine firms’ trading activities, including trading in “odd lots” (orders under 100 shares), as well as compliance with applicable laws and regulations (e.g., best execution). OCIE will also examine how broker-dealers implement controls and supervise algorithmic trading activities, including the development, testing, implementation, maintenance, and modification of the computer programs that support their automated trading activities.
OCIE will continue to identify SEC-registered firms engaged in the digital assets market. Examinations will focus on, among other things, investment suitability, portfolio management and trading practices, safety of client funds and assets, pricing and valuation, effectiveness of compliance programs and controls and supervision of employee outside business activities.
For RIAs that provide services to their clients through automated investment tools and platforms, OCIE will prioritize, among other things, SEC registration eligibility, cybersecurity policies and procedures, marketing practices, adherence to fiduciary duties (including adequacy of disclosures) and effectiveness of compliance programs.
OCIE has stated that as firms use new data sources, “alternative data,” that may influence investment decision-making, OCIE exams of financial technology and innovation will focus on firms’ use of such alternative data sets and technologies to interact with investors, firms and other service providers.
OCIE will continue to prioritize information and cybersecurity. OCIE will focus on, among other things, proper configuration of network storage devices, information security governance and retail trading information security. OCIE will also prioritize the protection of clients’ personal information and the adequacy of a firm’s governance and risk management, access controls, data loss prevention, vendor management (including oversight of service providers and network solutions), training and incident response and resiliency.
OCIE will continue to prioritize examining the anti-money laundering (“AML”) programs of broker-dealers and investment companies for compliance with their AML obligations with the goal of ensuring that policies and procedures are reasonably designed to identify suspicious activity and illegal money-laundering activities. OCIE will focus on customer identification programs, due diligence procedures, compliance with beneficial ownership requirements and whether firms conduct adequate and independent tests of their AML programs.
OCIE’s examination priorities remain, as they have always been, wide and varied. Despite the listing of priorities noted above, RIAs and broker-dealers must always be prepared for the possibility that any 2020 OCIE examinations will focus on many familiar topics from previous examinations. Private fund advisers should diligently and proactively review their compliance programs and procedures, as OCIE will continue to prioritize examinations of private fund advisers in 2020. While all of these items deserve attention, the repeat items from prior OCIE guidance and the newly included priorities from the 2020 announcement warrant particular attention.