On February 7, 2018 the SEC Office of Compliance Inspections and Examinations (OCIE) issued the 2018 National Exam Program Examination Priorities. In introducing the examination priorities for 2018, OCIE describes the four pillars upon which the work of OCIE is based: promoting compliance; preventing fraud; identifying and monitoring risk; and informing policy.
OCIE includes in the examination priorities factual data relating to the increase in examinations of investment advisers. As an example, in 2017 the SEC achieved examination coverage of approximately 15 percent of all federally registered investment advisers, up from 8 percent five years ago. In addition, in 2017 more than 2,100 examinations of investment advisers were completed, which is an increase of approximately 46 percent from 2016.
The 2018 examination priorities are organized around five themes:
- Matters of importance to retail investors, including seniors and those saving for retirement;
- Compliance and risks in critical market infrastructure;
- Financial Industry Regulatory Authority (FINRA) and Municipal Securities Rulemaking Board (MSRB);
- Cybersecurity; and
- Anti-money laundering programs.
The priorities applicable to investment advisers are matters of importance to retail investors, including seniors and those saving for retirement and cybersecurity.
Matters of Importance to Retail Investors, Including Seniors and Those Saving for Retirement
Regarding this category of investment adviser clients, OCIE will particularly focus on the following areas.
Disclosure of the Costs of Investing
Some of the most important information a retail investor receives relates to the fees charged and other compensation an investment adviser may receive, such as compensation from transactions involving affiliates of the adviser. The proper disclosure and calculation of fees, expenses and other charges investors pay is critically important. In addition, OCIE reiterates the importance of any financial professional to inform investors of any conflicts of interest that might provide incentives for the financial professional to recommend certain types of products or services to investors, including any higher cost or riskier products.
Examination teams will review, among other things, whether fees and expenses are calculated and charged in accordance with the disclosures provided to investors. In addition, examination teams will review fees charged to advisory accounts, particularly where the fee is dependent on the value of the account, to assess whether assets are valued in accordance with investor agreements, disclosures and the firm’s policies and procedures. OCIE will also focus on firms that have practices or business models that may create increased risks that investors will pay inadequately disclosed fees, expenses or other charges. These models include accounts where investment advisory representatives have departed from a firm, and the accounts have not been assigned to a new representative to properly oversee them, as well as private fund advisers that manage funds with a high concentration of investors investing for the benefit of retail clients, including non-profit organizations and pension plans.
Electronic Investment Advice
For robo-advisers and financial services firms that offer investment advice through automated or digital platforms, examinations will focus on compliance programs, including oversight of computer program algorithms that generate recommendations, marketing materials, investor data protection and disclosure of conflicts of interest.
Wrap Fee Programs
OCIE areas of interest relating to wrap fee programs include whether: the recommendations to invest in a wrap fee program and to continue in the program are reasonable; conflicts of interest are disclosed in compliance with applicable regulatory requirements; and investment advisers are obtaining best execution and disclosing costs associated with executing trades through another broker-dealer.
Never-Before-Examined Investment Advisers
OCIE will continue to make risk-based assessments and select for examination those never-before-examined investment advisers that have elevated risk profiles.
Senior Investors and Retirement Accounts and Products
OCIE will continue to focus on the services investment advisers provide to seniors and those saving for retirement. OCIE will focus on internal controls designed to supervise investment adviser representatives, particularly relating to the provision of services to senior investors. Also, OCIE will continue to conduct examinations of investment advisers that offer services and products to investors with retirement accounts. These examinations will focus on investment recommendations, sales of variable insurance products and sales and management of target date funds. In addition, OCIE will examine investment adviser facilitation and involvement in retirement vehicles that primarily serve state and local government entity employees and non-profit employees, including 403(b) and 457 plans.
Mutual Funds and Exchange Traded Funds (ETFs)
Mutual funds and ETFs are the primary investment vehicles for retail investors. Therefore, OCIE will focus examinations on mutual funds: that have experienced poor performance or liquidity in terms of subscriptions and redemptions relative to their peer groups; that are managed by advisers with little experience managing registered investment companies; and that hold securities which may be hard to value during times of market stress. OCIE will also focus on ETFs and mutual funds that seek to track custom-built indexes to review for any conflicts the adviser may have with the index provider and the adviser’s role with respect to the selection and weighting of index components. In regards to ETFs, OCIE will focus on funds that have little secondary market trading volume and face the risk of being delisted from an exchange and having to liquidate assets.
Cryptocurrency, Initial Coin Offerings (ICOs), Secondary Market Trading and Blockchain
While not utilized by many advisers, cryptocurrencies, Bitcoin, ICOs and Blockchain have been in the news as of late. In monitoring these areas, OCIE will focus on whether financial professionals maintain adequate controls and safeguards to protect these assets from theft or misappropriation, and whether financial professionals are providing investors with disclosure about the risks associated with these investments, including the risk of losses, liquidity risks, price volatility and potential fraud.
As in previous years, OCIE will continue to prioritize cybersecurity in its examination program. Examinations will continue to focus upon governance and risk assessment, access rights and controls, data loss prevention, vendor management, training and incident response.