On February 7, 2018, the U.S. Securities and Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) announced its examination priorities for 2018. The priorities continue to focus on protecting retail investors and assessing market-wide risks.
OCIE organized the 2018 examination priorities around the following themes:
- Retail investors, including seniors and people saving for retirement;
- Compliance and risks in critical market infrastructure;
- The Financial Industry Regulatory Authority (“FINRA”) and Municipal Securities Rulemaking Board(“MSRB”);
- Cybersecurity; and
- Anti-money laundering programs.
These focus areas are similar to OCIE’s priorities for 2016 and 2017. The focus on compliance and risk infrastructure comes as no surprise as ACA has seen recent SEC inquiries regarding newly registered firms as well as Form PF. Cybersecurity has been a priority in recent years, especially given last September’s launch of the SEC’s Cyber Unit and Retail Strategy Task Force.
The 2018 priorities stress the SEC’s increasing use of technology and how SEC staff are continuously looking for ways to employ technology and data analytics to enhance the examination program. SEC examination staff are using data in areas such as risk assessment and exam scoping, planning, and execution. For example, the SEC is rapidly advancing its ability to use data to analyze regulatory filings and trading activity. The SEC’s Quantitative Analytics Unit (QAU), the SEC’s primary source of data analysis, is made up of financial engineers who, in addition to developing surveillance tools, directly assist exam teams with the analysis of trading activity. The SEC, and in particular the QAU, is rapidly advancing its ability to use data to analyze regulatory filings, trading information, and other data points to better identify high-risk exam candidates and to more efficiently analyze information during examinations.
2018 Priorities in Detail
Protecting Retail Investors, Including Seniors and Those Saving for Retirement
- OCIE will pursue a variety of examination initiatives to assess potential risks to retail investors that arise in an increasingly complex investment landscape. Among other things, the SEC’s National Exam Program (“NEP”) will focus on the following:
Disclosure of the Costs of Investing
- Examiners will review whether fees and expenses are calculated and charged in accordance with disclosures provided to investors. Of particular interest for 2018 will be practices or business models that create conflicts of interest and increased risks of inadequately disclosed fees, expenses, or other charges (e.g., advisory personnel who receive incentives to recommend certain mutual fund share classes that pay higher sales loads or distribution fees).
Electronic Investment Advice
- OCIE will continue to examine robo-advisers or registered investment advisers and broker-dealers that primarily interact with clients online, as well as those firms that offer a combination of automated investment and traditional advisory services. Examiners will focus their reviews on compliance programs, marketing, data protection, disclosures relating to conflicts of interest, and the formulation of investment recommendations, including compliance oversight, over algorithms that generate recommendations. For instance, on Monday February 5, some robo-advisers underwent their biggest stress test ever when the Dow Jones Industrial Average dropped nearly 1,600 points before closing down 1,175 points (by far the worst point decline ever), dramatically increasing the volume of investors trying to access their accounts and causing some robos’ websites to crash. This experience could lead to a broader reassessment by regulators of robos’ services/systems in down markets.
Wrap Fee Programs
- Examiners will continue to review whether investment advisers are acting in a manner consistent with their fiduciary duty and whether they are meeting their contractual obligations to clients. Focus areas will include account suitability, disclosures, conflicts of interest, and trading practices.
Never-Before Examined Investment Advisers
- OCIE will continue to conduct examinations of newly registered advisers, as well as advisers that have been registered for some time but have never been examined.
Mutual Funds and Exchange Traded Funds (ETFs)
- Examiners will focus on mutual funds and ETFs and whether advisers are properly disclosing investment risks to investors. The SEC staff will also focus on mutual funds managed by advisers that have little experience managing registered investment companies.
Municipal Advisors and Underwriters
- OCIE will continue to examine municipal advisors’ compliance with registration, recordkeeping, and supervision requirements, with a focus on municipal advisors that are not registered broker-dealers.
Cryptocurrency, Initial Coin Offerings (ICOs), Secondary Market Trading, and Blockchain
- OCIE will continue to monitor the sale of cryptocurrency and ICO products, as well as assess the compliance of those products that are deemed to be securities.
Compliance and Risks in Critical Market Infrastructure
- OCIE will continue to examine firms that provide services that directly impact the functioning of critical markets with a focus on those firms’ operations and compliance with recently effective rules.
- Examiners will focus on transfer agent operations, including transfers, recordkeeping, and the safeguarding of funds and securities.
Regulation Systems Compliance and Integrity (SCI) Entities
- Examiners will continue to review SCI entities and assess the effectiveness of their written policies and procedures as relates to Regulation SCI.
FINRA and MSRB
- OCIE will continue to oversee FINRA and MSRB.
- OCIE examinations of FINRA will focus on FINRA’s operations and regulatory programs, including the quality of their examinations of broker-dealers and municipal advisors that are also registered as broker-dealers.
- OCIE examinations of MSRB will focus on the effectiveness of MSRB’s operational and internal policies, procedures, and controls.
- The NEP will continue to prioritize cybersecurity across the firms it oversees. Focus areas will include governance and risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response, among others. In September 2017, the SEC announced two cyber initiatives, including the formation of a cyber unit and a retail strategy task force.
Anti-Money Laundering Programs
- Examiners will continue to review whether firms are in compliance with applicable anti-money laundering requirements, with a focus on the compliance and testing of these firms’ AML programs.
Activus’ Practical Guidance
Advisers are urged to review and incorporate the 2018 examination priorities into the following to ensure the scope of issues s are covered under their respective compliance and risk management programs:
- risk assessments,
- written policies and procedures,
- monitoring and testing plans and
- annual review processes
Advisers are also urged to coordinate with internal business units to determine whether they are engaging in any of activities covered under the SEC’s exam priorities.
For more information, please contact Paula Bosco at Activus Risk Management or your ACTIVUS consultant.