The Office of Compliance Inspections and Examinations (OCIE) of the U.S. Securities and Exchange Commission (SEC) on January 12, 2017 announced its examination priorities for the current year. The priorities extend to nearly every area of the SEC’s jurisdiction, including registered investment advisers, advisers to private funds, municipal advisors, investment companies, broker-dealers, national securities exchanges, transfer agents and clearing agencies. The 2017 examination priorities focus primarily on:
Protection of retail investors;
Risks specific to elderly and retiring investors; and
Market-wide risk assessment.
OCIE will be launching new examination initiatives, as well as continuing or expanding upon initiatives from previous years. New for 2017 are initiatives bringing increased scrutiny of “robo-advisers,” advisers to public pensions, firms interacting with seniors, money market funds, best execution, and transfer agents that serve microcaps. Prior initiatives being expanded include the “Wrap Fee Programs” and “Never-Before-Examined Investment Advisers” initiatives.
The SEC’s announcement indicates that the 2017 examination priorities were selected based on consultation with the SEC’s Commissioners, senior staff, policy-making and enforcement divisions, Investor Advocate, and other regulatory agencies. OCIE notes that its examination priorities are “not exhaustive and may be adjusted in light of market conditions, industry developments, and ongoing risk assessment activities.” Registrants should therefore not expect examinations to be limited to the initiatives discussed in this OnPoint.
Protection of Retail Investors
OCIE recognizes that retail investors “face an evolving set of choices” when investing in an industry that “continues to offer an ever widening array of information, advice, products, and services.” With a view towards protecting retail investors in an “increasingly complex investment landscape,” OCIE’s 2017 initiatives include:
- Electronic Investment Advice: The most notable new initiative focuses on registered investment advisers and broker-dealers that “primarily interact with clients online” and “utilize automation as a component of their services while also offering clients access to financial professionals.” OCIE will likely focus its examinations on “compliance programs, marketing, formulation of investment recommendations, data protection, and disclosures relating to conflicts of interest.” Further, OCIE will review “compliance practices for overseeing [the] algorithms that generate recommendations.” This initiative builds upon the SEC’s FinTech Forum, held on November 14, 2016, at which several senior OCIE officials took leadership roles and which focused in part on the potential regulatory implications of online investment advice.
- Wrap Fee Programs: This continuing and expanded initiative examines registered investment advisers and broker-dealers providing services for a “single bundled fee” in wrap fee programs. Examinations will likely seek to determine whether investment advisers are complying with their contractual and fiduciary duties to clients. OCIE’s focus areas may include “wrap account suitability, effectiveness of disclosures, conflicts of interest, and brokerage practices, including best execution and trading away.”
- Exchange-Traded Funds: This initiative will review ETFs in connection with their compliance with relevant exemptive relief and “other regulatory requirements.” OCIE will also review ETFs’ unit creation and redemption processes, sales practices and disclosures, as well as “the suitability of broker-dealers’ recommendations to purchase ETFs with niche strategies.”
- Never-Before-Examined Investment Advisers: OCIE is expanding this initiative to include “focused, risk-based examinations” of new advisers, in addition to advisers that have never been examined.
- Recidivist Representatives and their Employers: In this continuing initiative, OCIE will identify and examine investment advisers employing “individuals with a track record of misconduct,” such as those who have been the subject of a regulatory proceeding or barred from association with a broker-dealer. OCIE explains that such examinations will include a review of the adviser’s establishment and implementation of compliance policies and procedures.
- Multi-Branch Advisers: This continuing initiative focuses on registered investment advisers that operate branch offices, which OCIE indicates “can pose unique risks and challenges” for advisers, noting in particular the risks and challenges involved in creating a compliance program and overseeing services provided by branch offices.
- Share Class Selection: This continuing initiative examines “conflicts of interest and other factors that may affect registrants’ recommendations to invest, or remain invested, in particular share classes of mutual funds.” As an example, OCIE notes possible conflicts of interest arising from advisory personnel that are dually registered as broker-dealer representatives, “which may influence recommendations in favor of share classes that have higher loads or distribution fees.” OCIE will also review the “formulation of investment recommendations and the management of client portfolios.” This initiative is particularly noteworthy in light of industry changes prompted by the U.S. Department of Labor’s “Fiduciary Rule,” which precludes certain investment advisers and broker-dealers from recommending to retirement investors investment products that may give rise to a conflict of interest.
Risks Specific to Elderly and Retiring Investors
In light of the increasing dependence of seniors on their retirement savings, OCIE’s 2017 initiatives include:
- ReTIRE: The continuing “Retirement-Targeted Industry Reviews and Examinations” initiative examines investment advisers and broker-dealers providing services in connection with investors’ retirement accounts. OCIE’s focus will likely include (among others) variable insurance products and target date funds, as well as cross-transactions involving fixed-income securities.
- Public Pension Advisers: OCIE will assess compliance with fiduciary duties of, and management of conflicts of interest by, investment advisers to state, municipal and other government entities. OCIE identifies as specific risks “pay-to-play and undisclosed gifts and entertainment practices.”
- Senior Investors: OCIE will evaluate investment advisers’ interactions with senior investors, including firms’ “ability to identify financial exploitation of seniors.” OCIE will likely focus its examinations on the supervision of programs involving investment products and services designed for seniors.
Market-Wide Risk Assessment
In support of the SEC’s “mission to maintain fair, orderly, and efficient markets,” OCIE examines the market for “structural risks and trends that may involve multiple firms or entire industries.” OCIE’s 2017 initiatives concerning market-wide risk assessment include:
- Money Market Funds: OCIE will assess compliance by money market funds with the October 2016 amendments to Rule 2a-7 under the Investment Company Act of 1940. In addition to reviewing investment advisers’ and funds’ compliance with new stress testing and periodic SEC reporting requirements, it is notable that OCIE’s examinations will “likely include assessments of the boards’ oversight of the funds’ compliance with these new amendments.”
- Payment for Order Flow: OCIE will examine compliance by select broker-dealers with their duty of best execution. OCIE will focus primarily on broker-dealers executing trades for retail customers, as well as those that act as market makers.
- Clearing Agencies: This continuing initiative examines “systematically important” clearing agencies supervised by the SEC under the Dodd-Frank Act. OCIE indicated it will collaborate with the Division of Trading and Markets and other regulators to develop a risk-based approach to examinations. Following the April 2017 compliance date required under the SEC’s Standards for Covered Clearing Agencies, OCIE will examine clearing agencies for compliance with those standards.
- FINRA: OCIE’s oversight of FINRA will be enhanced to include “inspections of FINRA’s operations and regulatory programs” and assessment of “the quality of FINRA’s examinations of individual broker-dealers.”
- Regulation Systems Compliance and Integrity (SCI): This continuing initiative assesses the policies and procedures of SCI entities regarding the “capacity, integrity, resiliency, availability, and security” of their electronic systems, as well as SCI entities’ enterprise risk management programs. OCIE’s examinations will also review the way these systems record the time of transactions or events, communicate with other systems, and use market data.
- Cybersecurity: Pursuant to this continuing initiative, OCIE will inspect entities’ policies, procedures and controls relating to cybersecurity.
- National Securities Exchanges: OCIE will continue to “focus on selected operational and regulatory programs” in these inspections.
- Anti-Money Laundering (AML): This continuing initiative is designed to assess whether broker-dealers’ AML programs are tailored to their specific risks, including whether such programs are updated to account for current money laundering and terrorist financing risks. In connection with this initiative, OCIE also reviews broker-dealers’ programs to monitor and report “suspicious activities.”
OCIE’s announcement identifies several additional initiatives on which it expects to focus. These include: (i) continuing examinations of municipal advisors, to assess compliance with SEC and Municipal Securities Rulemaking Board rules; (ii) examination of transfer agents’ turnaround times, recordkeeping, and safeguarding of funds and securities; also examining whether transfer agents that service microcap issuers “may be engaging in unregistered, non-exempt offerings of securities;” and (iii) continued examinations of private fund advisers, to assess their management and disclosure of conflicts of interest.
OCIE indicates that its list of examination priorities is “not exhaustive.” Therefore, while the list does indicate where OCIE intends to focus its resources in the coming year, firms should not expect examinations to be limited to the issues highlighted above. With these priorities in mind, firms may wish to review their policies and procedures and conduct internal compliance reviews.