Key Notes:

  • OCIE will examine advisers of mutual funds with poor performance to ensure they are complying with all rules and regulations and providing adequate risk disclosures to investors.
  • Service providers must enforce, test and update their risk mitigation and response programs.

The SEC’s Office of Compliance Inspections and Examinations (OCIE) recently announced how it will prioritize examinations to improve service providers’ compliance with rules and regulations, prevent fraud, identify and monitor risk, and inform policy. Although OCIE’s examination schedule remains flexible to address any emerging or imminent risks to investors, its priorities center around five areas:

  • Matters of importance to retail investors (including advisers of funds with poor performance)
  • Critical market infrastructure compliance and risks
  • The Financial Industry Regulatory Authority’s and Municipal Securities Rulemaking Board’s operations and regulatory programs
  • Cybersecurity
  • Anti-money-laundering programs

This bulletin focuses on the two areas that are most impactful to investment advisers and their clients.

Matters of Importance to Retail Investors

OCIE remains focused on mutual funds and exchange-traded funds (ETFs), retail investors’ primary investment vehicles. It pays close attention to mutual funds experiencing poor performance or liquidity issues and those holding securities difficult to value during stressed markets. OCIE monitors less-experienced advisers, particularly those of mutual funds and ETFs tracking custom-built indexes, and reviews the adviser’s role in selecting and weighting index components and any conflicts between the adviser and index provider. If an ETF has little secondary market trading volume and faces liquidation risk or the possibility of being delisted from an exchange, advisers must adequately disclose to investors the costs of potential liquidation and the risk of a rapid decline.

OCIE reviews how well advisers disclose investment costs, use automated or digital platforms to provide advice, and conduct wrap fee programs in compliance with applicable regulations. For advisers using wrap fee programs that bundle charges into a single fee, OCIE examines the reasonableness of investment recommendations, adequacy of conflict disclosures, and best execution of broker-dealer costs. Advisers must properly disclose fee calculations, expenses and other charges to investors and identify any conflicts of interest incentivizing them to offer certain products. Robo-advisers, including advisers interacting with investors primarily online, should review their computer program algorithms, marketing materials and investor data protection policies and procedures to be sure they are up to date. Out of concern for senior investors, OCIE is taking a closer look at the investment recommendations, variable insurance product sales, and target-date fund management of advisers and broker-dealers offering services and products to investors with retirement accounts.

OCIE checks broker-dealers in municipal bond and corporate bond transactions to ensure they have implemented best execution policies and procedures consistent with regulatory requirements. Broker-dealers and advisers providing cryptocurrency or initial coin offerings should maintain adequate protections against theft and disclose to investors the possibility of investment losses, liquidity risk, price volatility and fraud.

Cybersecurity

OCIE is committed to working with firms to identify cybersecurity risks. Because cybersecurity is critical, OCIE will assess a firm’s access rights, data loss prevention procedures, vendor management, training and incident response.

OCIE believes these areas present the greatest risks to investors in 2018. With the protection of retail investors as its guiding principle, it will examine firms providing products and services to retail investors, particularly seniors, as well as higher-risk products and technological changes in how advisers deliver investment advice. OCIE notes that the SEC has made a concerted effort to publish Risk Alerts that address deficiencies, industry observations and examination findings more frequently. Advisers should consider OCIE’s 2018 examination priorities and relevant Risk Alerts in reviewing their compliance practices and procedures.