On December 20, 2018, the Office of Compliance Inspections and Examinations (“OCIE”) of the Securities and Exchange Commission (“SEC”) published its examination priorities for 2019 (the “2019 Priorities”). OCIE's examination priorities are released annually and are designed to provide a preview of key areas where OCIE intends to focus its limited resources. This year's priorities address the following six themes: (1) retail investors, including seniors and those saving for retirement; (2) registered entities responsible for critical market infrastructure, including clearing agencies, transfer agents, and national securities exchanges; (3) Financial Industry Regulatory Authority (“FINRA”) and the Municipal Securities Rulemaking Board (“MSRB”); (4) digital assets; (5) cybersecurity; and (6) anti-money laundering (“AML”) for broker-dealers.
We remind our clients that OCIE's list of priorities is not exhaustive and that many of the focus areas discussed in the 2019 Priorities are also applicable to private fund adviser firms and will sound familiar to them. We highlight below the areas from the 2019 Priorities that may be of particular interest to our clients and briefly summarize the remaining areas.
1. Retail investors, including seniors and those saving for retirement
With retail investors in mind, OCIE will focus on the following areas:
- Disclosure of the costs of investing. OCIE will review fees and expenses charged to advisory accounts, and whether investment advisers are assessing them in accordance with client agreements and firm disclosures. OCIE will examine firms with practices or business models that may create increased risks of inadequately disclosed fees, expenses, and other charges, including investment advisers participating in wrap fee programs.
- Conflicts of interest and fiduciary obligations to clients. OCIE will review policies and procedures addressing (i) use of affiliated service providers and products; (ii) borrowing from clients; and (iii) securities-backed non-purpose loans and lines of credit to clients. OCIE will examine these practices and assess, among other things, whether the related conflicts of interest have been adequately disclosed.
- Portfolio management and trading. OCIE will review whether investment advisers are allocating investment opportunities fairly, ensuring investments are consistent with the clients’ objectives, disclosing critical information to clients, and complying with other legal restrictions. OCIE will also examine whether investment or trading strategies are (i) suitable for, and in the best interests of, investors based on their investment objectives and risk tolerance; (ii) contrary to, or have drifted from, disclosures to investors; (iii) venturing into new, risky investments or products without adequate risk disclosure; and (iv) appropriately monitored for attendant risks.
- Never-before or not recently-examined advisers. OCIE will conduct risk-based examinations of certain newly-registered investment advisers and those who have not been examined for a number of years.
Other examination priorities discussed under the retail investor theme include (i) broker-dealers’ interactions with senior investors, including their ability to identify financial exploitation of seniors; (ii) mutual funds and exchange traded funds, including advisers that provide advice to both registered investment companies and private funds with similar investment strategies; (iii) municipal advisers that have never been examined; (iv) broker-dealers entrusted with customer assets; and (v) broker-dealers involved in selling stocks of companies with a market capitalization of under $250 million.
2. Compliance and risk in registered entities responsible for critical market infrastructure
OCIE will examine entities that provide services critical to the proper functioning of capital markets. This includes clearing agencies, entities subject to Regulation Systems Compliance and Integrity, transfer agents, and national securities exchanges. OCIE will focus on various aspects of their operations and compliance.
3. Focus on select areas and programs of FINRA and MSRB
OCIE will focus on FINRA’s operations and regulatory programs, as well as the quality of FINRA’s examinations of broker-dealers and municipal advisors that are also registered as broker-dealers. OCIE will also conduct inspections of MSRB to evaluate the effectiveness of select operations and internal policies, procedures, and controls.
4. Digital Assets
Noting a significant growth of market participants in the digital asset space, OCIE will monitor, through high level inquiries, the offering, selling, trading, and managing of digital assets. Where the products are securities, OCIE will examine for regulatory compliance. For firms actively engaged in the digital asset market, OCIE will conduct examinations focused on, among other things, portfolio management of digital assets, trading, safety of client funds and assets, pricing of client portfolios, compliance, and internal controls.
OCIE will prioritize cybersecurity and focus on proper configuration of network storage devices, information security governance generally, and policies and procedures related to retail trading information security. In addition, OCIE will emphasize cybersecurity practices at investment advisers with multiple branch offices, including those that have recently merged with other investment advisers. OCIE will focus on, among other areas, governance and risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response.
6. Anti-Money Laundering for Broker-Dealers
OCIE will prioritize examining broker-dealers for compliance with their AML obligations with the goal of ensuring that they have policies and procedures in place that are reasonably designed to identify suspicious activity and illegal money laundering activities.
The scope of any examination is determined through a risk-based approach, both in selecting registered entities to examine and in determining the scope of risk areas to examine. OCIE notes that this approach remains flexible in order to cover emerging and exigent risks to investors and the marketplace as they arise. Firms should take this time to review their policies and procedures, as well as investor documentation and disclosures, to ensure compliance with applicable requirements, particularly in those areas that OCIE has placed on its 2019 Priorities.