On January 9, 2014, the U.S. Securities and Exchange Commission’s (“SEC”) National Examination Program (“NEP”) of the Office of Compliance Inspections and Examinations (“OCIE”) published its 2014 examination priorities for NEP-wide initiatives for each of the NEP’s four program areas: (1) investment advisers and investment companies, (2) broker-dealers, (3) exchanges and self-regulatory organizations, and (4) clearing agencies and transfer agents. These priorities reflect 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: (i) using quantitative and qualitative tools to enhance fraud detection and prevention; (ii) meeting with senior management and boards of SEC-registered entities and their affiliates to examine corporate governance, conflicts of interest, and enterprise risk management; (iii) examining information technology systems, information security and ability to respond to sudden malfunctions and system outages; (iv) examining registrants that are both broker-dealers and investment advisers and the attendant risk of conflicts of interest that this business model presents; (v) examining issues relating to new laws and regulations, including general solicitation practices and verification of accredited investor status under newly adopted Rule 506(c) under the Securities Act of 1933 (the “1933 Act”), industry developments and compliance with new rules regarding crowdfunding offerings and entities, compliance with new rules governing municipal advisors, and issues relating to new rules regarding security-based swaps dealers and other registered entities created or impacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”); and (vi) examining practices of investment advisers and broker-dealers that target retirement-age investors and investors changing employment, including potential misrepresentations of credentials, IRA plan features, and suitability of investments.
The program area-specific initiatives are divided into core risks, new and emerging risks, and policy topics. 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. New and emerging risks are those arising from changes and developments in the industry. 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 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 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 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. 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. The full publication can be found here.