On February 21, 2013, the National Examination Program (the “NEP”) published its examination priorities for 2013 (the “Exam Priorities”). The NEP identified several market-wide priorities that address issues relevant to nearly all SEC registrants, as well as specific priorities for each of the NEP’s distinct program areas, including, among other programs, the program applicable to investment advisers and investment companies.
According to the Exam Priorities, the NEP will focus examinations on several key risk areas applicable to the entire market, including:
- Fraud Detection and Prevention. The NEP will seek out fraudulent and unethical behavior of market participants through the continued use and enhancement of its quantitative and qualitative tools and analyses.
- Corporate Governance and Enterprise Risk Management. The NEP will initiate meetings with senior management and boards of SEC registrants to discuss and assess registrants’ governance and management of financial, legal, compliance, operational and reputational risks, which, according to the Exam Priorities, allow the NEP to better assess overall risk management at such firms and conduct more informed examinations.
- Conflicts of Interest. The NEP will focus on registrants’ conflicts of interest and the steps registrants have taken to mitigate their conflicts, as well as whether registrants have sufficiently disclosed their conflicts to investors and the registrants’ overall risk governance framework.
- Technology. The NEP may conduct examinations on registrants’ governance and supervision of information technology systems, including with respect to operational capability, market access and the security of information (such as risks of system outages and data integrity).
The NEP also identified specific examination priorities for investment advisers and investment companies, including certain ongoing focus areas and certain new and emerging focus areas.
Ongoing Focus Areas. According to the Exam Priorities, the NEP’s ongoing focus areas will include an emphasis on: (i) the custody and safety of client assets, including compliance with Rule 206(4)-2 under the Advisers Act, (ii) identifying undisclosed compensation arrangements and related conflicts of interest, (iii) the accuracy of advertised performance (including as it relates to changes in advertising practices that may result from the Jumpstart Our Business Startups Act signed into law in 2012), (iv) ensuring investment advisers have controls in place to monitor the allocation of investment opportunities, including in situations in which an investment adviser manages funds with similar investment objectives but where one fund pays performance fees and the other fund does not and (v) ensuring investment advisers make full and accurate disclosures to fund boards and that fund boards conduct reasonable reviews of such information when approving contracts, overseeing service providers, valuing fund assets and assessing expenses or viability.
New and Emerging Focus Areas. According to the Exam Priorities, the NEP intends to launch a twoyear national examination initiative focused on newly registered investment advisers. The NEP will also focus on dually registered investment advisers and broker-dealers and the attendant conflicts of interests raised by such businesses. According to the Exam Priorities, the suitability obligations related to recommendations of brokerage or advisory accounts, the adequacy of related policies and procedures and the disclosure of conflicts of interest by such dually registered firms will be reviewed by the NEP during examinations.
According to the Exam Priorities, the NEP will also focus on the increasing use of alternative and hedge fund investment strategies in open-end funds, exchange-traded funds and variable annuity structures, including an assessment of whether (i) leverage, liquidity and valuation policies and practices comply with regulations, (ii) compliance personnel, back-office support and board oversight are in place for such strategies and (iii) applicable regulations are being followed as it relates to the marketing of such funds. Also, the Exam Priorities specified that examinations of investment advisers will focus on so-called “revenue sharing” payments and similar payments to distributors and intermediaries, including a focus on the disclosure of such payments to a fund’s board and the board’s oversight of such payments, as well as whether such payments comply with applicable regulations.
In addition, according to the Exam Priorities, the NEP will also seek to review certain “policy topics,” including whether (i) money market funds are conducting stress testing of their ability to maintain stable share prices based on hypothetical events (as well as the factors considered for and the results of such tests), (ii) SEC exemptive orders (including with respect to co-investments by fund advisers and their affiliates) are being followed and (iii) investment advisers are complying with the SEC’s pay-to-play rules.
According to the NEP, the focus areas identified in the Exam Priorities are not exhaustive, although the NEP expects to use a significant portion of its resources to focus examinations on the issues identified in the Exam Priorities.