03.07.2018 | Client Alert
On February 7, 2018 the Securities and Exchange Commission (SEC) issued its 2018 Regulatory and Examination Priorities — identifying areas it will focus on to improve compliance, inhibit fraud, monitor risk, and inform policy. This product of the Office of Compliance Inspections and Examination (OCIE) can serve as a guideline for investment advisors and broker-dealers to examine and adjust compliance and risk management functions in order to better protect investors and organizations.
As a measure of the rigor with which it intends to pursue its goals, the SEC is budgeting to increase its examinations to encompass 13% of all registered investment advisors. In prior years that number was 10-11%. As market conditions change and new risks and trends present themselves, the SEC may adjust or add to its current examination priorities, which are described in more detail below.
Announced SEC 2018 Priorities fall into five categories:
1) Matters Important to Retail Investors (Including seniors and those saving for retirement). This is a particular priority for the SEC and the focus will be on high-risk products as well as changes in technology that impact the delivery of investment advice. Specific areas of focus will include:
- Disclosure of the Costs of Investing. Examinations will seek to determine whether fees and expenses are calculated and charged in accordance with the disclosures provided to investors. Examiners will review fees charged to advisory accounts — particularly where the fees depend 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. Attention will be paid to practices or business models that may create increased risks that investors will pay inadequately disclosed fees, expenses, or other charges.
- Electronic Investment Advice. The SEC will look at investment advisors and broker-dealers offering advice through automated or digital platforms such as the so-called “robo-advisors” and other online businesses. Areas of focus include registrants’ compliance programs, marketing products, investor data protection, and conflict-of-interest disclosures.
- Wrap Fee Programs. These programs charge investors a single bundled (or wrapped) fee based on a percentage of assets for advisory and brokerage services. Reviews will seek to determine whether advisors are acting in a manner consistent with their fiduciary duty and are meeting contractual obligations to their clients.
- Never-Before-Examined Investment Advisors. With a high percentage of newly registered and never-before-examined investment advisors, the SEC will conduct risk-based assessments and select those with elevated risk profiles for examination.
- Senior Investors and Retirement Accounts and Products. These investors rely heavily on returns from their investments. Reviews will look at how broker-dealers oversee their interactions with senior investors and those with retirement accounts, including potential exploitation. Attention will be paid to internal controls, particularly relating to sales of products and services directed at senior investors. Examinations will focus on investment recommendations, sales of variable insurance products, and sales and management of target date funds.
- Mutual Funds and Exchange Traded Funds (ETFs). The SEC will examine funds that have performed poorly or have liquidity issues, are managed by advisors with little experience managing registered investment companies, and hold securities which may be difficult to value during periods of market stress—including securitized auto, student, or consumer loans, or collateralized mortgage-backed securities. The Commission will also focus on ETFs and mutual funds that track custom-built indexes to review them for any conflicts the advisor may have with the index provider and the advisor’s role in selecting and weighting index components.
- Municipal Advisors and Underwriters. The Commission will evaluate municipal advisors’—in particular those not registered as broker-dealers—compliance with registration, recordkeeping, and supervision requirements. Examinations will also review for compliance with the Municipal Securities Rulemaking Board (MSRB) rules regarding professional qualification requirements, continuing education requirements, and core standards of conduct and duties of municipal advisors when engaging in municipal advisory activities.
- Fixed Income Order Execution. Examinations will assess whether broker-dealers have implemented best execution policies and procedures, consistent with regulatory requirements, for both municipal bond and corporate bond transactions.
- Cryptocurrency, Initial Coin Offerings (ICOs), Secondary Market Trading, and Blockchain. The Commission will monitor the sale of these products, and where the products are securities, examine for regulatory compliance. Examinations will look to determine whether financial professionals maintain adequate controls and safeguards to protect these assets from theft or misappropriation, and whether financial professionals are providing investors with disclosures about the risks associated with these investments.
2) Compliance and Risks in Critical Market Infrastructure. Within this category, examinations will focus on:
- Clearing Agencies. The SEC will look into compliance with the standards for Covered Clearing Agencies to learn if they have taken corrective action in response to prior examinations.
- National Securities Exchanges. The OCIE, in conjunction with the Division of Trading and Markets, will examine the equities and options consolidated market data plans. They will pay close attention to governance, revenue and expense generation, and revenue and expense allocation procedures.
- Transfer Agents. Examinations will center on transfers, recordkeeping, and the safeguarding of funds and securities. Candidates for examinations will include transfer agents that serve as paying agents or that service microcap or crowdfunding issuers.
- Regulation Systems Compliance and Integrity (SCI) Entities. When SCI events occur, entities are required to take corrective action and alert the SEC that this has taken place. Examinations will evaluate whether these entities have effectively implemented written policies and procedures. The OCIE will also review controls for how systems record the time of transactions or events and how they synchronize with other systems. The OCIE will also assess readiness and business continuity plan effectiveness, vendor risk management — particularly in cloud environments — and enterprise risk management.
3) FINRA and MSRB. For the Financial Industry Regulatory Authority (FINRA) examinations will center on the Authority’s operations and regulatory programs as well as the quality of its examinations of broker-dealers and municipal advisors that are registered as broker-dealers. For MSRB the focus will be on evaluating the effectiveness of selected operational and internal policies, procedures, and controls.
4) Cybersecurity. With the size and impact of cyberattacks still increasing, examiners will work with firms to identify and manage risks and encourage market participants to actively engage in this effort. Examinations will focus on:
- Governance and risk assessment;
- Access rights and controls;
- Data loss prevention;
- Vendor management;
- Training; and
- Incident response.
5) AML Programs. 2018 examinations will focus on whether entities are adapting their anti-money laundering (AML) programs to address their regulatory obligations. For example, reviews will look into the customer due diligence requirement and whether the entities are taking reasonable steps to understand the nature and purpose of customer relationships and to properly address risks. Examinations will also assess the quality of their Suspicious Activity Reports (SARs) and evaluate the testing of AML programs.
Questions? If these priorities have raised questions or concerns relating to your particular business, contact Alexander Moshinsky at 212.331.7448 | firstname.lastname@example.org.