The National Exam Program of the SEC’s Office of Compliance Inspections and Examinations (OCIE) published its examination priorities for 2016 this week. (FINRA published its priorities last week, discussed here.) Much like last year’s letter, this year’s letter is organized around three key thematic areas of focus:
Protecting Retail Investors—Including Those Saving for Retirement.
As in 2015, OCIE will focus attention on retail investors, specifically those saving for retirement. OCIE identified several areas of particular interest and specific initiatives, including:
- The ReTIRE multi-year examination initiative, originally announced in June 2015, which focuses on the services offered by registered investment advisers and broker-dealers to investors with retirement accounts. The initiative evaluates, among other things, whether recommendations made to investors have a reasonable basis, conflicts of interest, supervision and compliance controls.
- Exchange-traded funds (“ETFs”) and compliance with regulatory requirements, in addition to reviewing creation/redemption processes, sales strategies, trading practices and disclosure of concentration, primary and secondary market trading risk and suitability of leveraged/inverse ETFs.
- Regulated entities’ supervision of registered representatives and investment advisers inbranch offices.
- Varying fee arrangements offered to retail investors by investment advisers and dually registered investment adviser/broker-dealers and recommendations of account types, both initially and throughout the relationship, including fees charged, services provided and disclosures made about such arrangements. This includes last year’s focus on reverse churning concerns.
- Suitability of sales of variable annuities products to investors, adequacy of disclosure and supervision of such sales.
- Advisers to municipalities and government entities focusing on pay-to-play (also, see our post here) and certain other key risk areas related to advisers to public pensions, includinggifts and entertainment.
In order to maintain fair, orderly and efficient markets, OCIE will examine structural risks and trends that involve multiple firms or entire industries, including, among others:
- Broker-dealers’ and investment advisers’ cybersecurity compliance and controls, including testing and assessments of firms’ implementation of procedures and controls.
- Systems compliance and integrity (“SCI”) entities to evaluate the establishment, maintenance and enforcement of policies and procedures.
- Advisers to mutual funds, ETFs and private funds and their liquidity controls and procedures, including registered broker-dealers that have become new or expanding liquidity providers in the marketplace.
Using Data Analytics to Identify Signals of Potential Illegal Activity.
Much like 2015, OCIE intends to continue to develop and use its enhanced data analytics to identify firms that appear to be engaged in fraudulent or other illegal activity. OCIE will:
- Continue to use its analytical capabilities to identify those firms that hire individuals with a record of misconduct. Firms should review their own hiring records to determine if they are likely to draw OCIE’s attention.
- Examine clearing and introducing broker-dealers’ anti-money laundering programs to focus on firms that have not filed the number of suspicious activity reports (“SARs”) that would be consistent with their business models or have filed incomplete or late SARs.
- Use its data to examine operations of broker-dealers and transfer agents to uncover incidences of market manipulation.
- Use its data from clearing firms to identify brokers that are engaged in excessive trading.
- Continue to focus on detecting the promotion of new, complex and high-risk products and related sales practices for suitability or potential breaches of fiduciary obligations.
In addition to the themes described above, OCIE expects to examine:
- Newly registered municipal advisers to assess compliance with the recently adopted SEC and Municipal Securities Rulemaking Board rules.
- Private placements (including Regulation D and EB-5 Program offerings) for due diligence, disclosure and suitability legal requirements. Changes to relevant U.S. securities regulation offer a variety of new distribution possibilities; regulators have expressed some interest in determining whether these privately placed securities are being sold properly.
- Never-before-examined investment advisers and investment companies.
- Private fund advisers, with a focus on fees and expenses and the controls and disclosure associated with side-by-side management of performance-based and purely asset-based fee accounts.
- Transfer agents’ safeguarding of security-holder funds, among others.
As we noted last year when we reviewed OCIE’s examination priorities, little about the 2016 priorities should come as a surprise. We note, however, that OCIE’s published list is not exhaustive. Although OCIE dropped its explicit focus on alternative investment companies, it would be prudent to assume that OCIE will continue to focus on them, especially in light of the proposed rules for liquidity management and derivatives. We also note that OCIE added variable annuities, pay-to-play and gifts and entertainment, among other issues, to its list of priorities, which may indicate a subtle shift to a more refined emphasis on conflicts of interest.