On January 11, 2016, the Securities and Exchange Commission (SEC) announced its Office of Compliance Inspections and Examinations (OCIE) 2016 examination priorities.  The priorities reflect certain practices and products that the OCIE believes present potentially heightened risks to investors and/or the integrity of US capital markets. New areas of focus include liquidity controls, public pension advisers, product promotion, and two investment products – Exchange-Traded Funds (ETFs) and variable annuities. The priorities also reflect a continuing focus on protecting investors in ongoing risk areas such as cybersecurity, microcap fraud, fee selection, and reverse churning.

The OCIE selected their 2016 examination priorities in consultation with Commissioners, senior staff from SEC regional offices, SEC policy-making and enforcement divisions, SEC Investor Advocate, and fellow regulators.

This year, the OCIE’s priorities are organized around the same three thematic areas as in 2015, including:

  1. Examining matters of importance to retail investors, including investors saving for retirement;
  1. Assessing issues related to market-wide risks; and
  1. Using OCIE’s evolving ability to analyze data to identify and examine registrants that may be engaged in illegal activity.

SEC’s Examination Priorities for 2016

The 2016 examination priorities address issues across a variety of financial institutions, including investment advisers, investment companies, broker-dealers, transfer agents, clearing agencies, and national securities exchanges.  Areas of examination include:

I. Retail Investors – Protecting retail investors, including those investing for retirement, remains a priority in 2016.  The OCIE is expected to continue several 2015 initiatives to assess risks to retail investors seeking information, advice, products, and services that would help them plan for and live in retirement. The OCIE has also indicated that it will undertake examinations to review exchange-traded funds (ETFs) and ETF trading practices, variable annuity recommendations and disclosure, and potential conflicts and risks involving advisers to public pension funds.

The OCIE is planning and/or conducting various examination initiatives to assess these risks to retail investors. These include:

  Initiative
ReTIRE In June 2015, the OCIE launched a multi-year examination initiative, focusing on SEC-registered investment advisers and broker-dealers and the services they offer to investors with retirement accounts.  The SEC will continue this initiative, which includes examining the reasonable basis for recommendations made to investors, conflicts of interest, supervision and compliance controls, and marketing and disclosure practices.
ETFs Examine ETFs for compliance with applicable exemptive relief granted under the Securities Exchange Act of 1934 and the Investment Company Act of 1940 and with other regulatory requirements, as well as review the ETFs’ unit creation and redemption process.  The OCIE has also indicated it will also focus on sales strategies, trading practices, and disclosures involving ETFs, including excessive portfolio concentration, primary and secondary market trading risks, adequacy of risk disclosure, and suitability, particularly in niche or leveraged/inverse ETFs.
Branch Offices Continue to review regulated entities’ supervision of registered representatives and investment adviser representatives in branch offices of SEC-registered investment advisers and broker-dealers, including using data analytics to identify registered representatives in branches that appear to be engaged in potentially inappropriate trading.
Fee Selection and Reverse Churning Continue to examine investment advisers and dually-registered investment adviser/broker-dealers that offer retail investors a variety of fee arrangements (e.g., asset-based fees, hourly fees, wrap fees, commissions).  The OCIE has indicated it will focus on recommendations of account types and whether the recommendations are in the best interest of the retail investor at the inception of the arrangement and thereafter, including fees charged, services provided, and disclosures made about such arrangements.
Variable Annuities Variable annuities have become a part of the retirement and investment plans of many Americans.  The OCIE plans to assess the suitability of sales of variable annuities to investors (e.g., exchange recommendations and product classes), as well as the adequacy of disclosure and the supervision of such sales.
Public Pension Advisers The OCIE has also indicated it will examine advisers to municipalities and other government entities, focusing on pay-to-play and certain other key risk areas related to advisers to public pensions, including identification of undisclosed gifts and entertainment.

II. Market-wide Risks – To help fulfill the SEC’s mission of maintaining fair, orderly, and efficient markets, OCIE plans to continue its focus on cybersecurity controls at broker-dealers and investment advisers. New initiatives for 2016 include an evaluation of broker-dealers’ and investment advisers’ liquidity risk management practices, and firms’ compliance with the SEC’s Regulation Systems Compliance and Integrity and Form (SCI), designed to strengthen the technology infrastructure of the US securities markets.

The OCIE has also indicated that it will examine for structural risks and trends that may involve multiple firms or entire industries. In 2016, the OCIE plans to focus on the following initiatives:

  Initiative
Cybersecurity In September 2015, the OCIE launched its second initiative to examine broker-dealers’ and investment advisers’ cybersecurity compliance and controls.  In 2016, the OCIE plans to advance these efforts, which include testing and assessments of firms’ implementation of procedures and controls.
SCI Examine SCI entities to evaluate whether they have established, maintained, and enforced written policies and procedures reasonably designed to sustain the capacity, integrity, resiliency, availability, and security of their SCI systems.  This should include, among other things, assessing the resiliency of their primary and back-up data centers, evaluating whether computing infrastructure components are geographically diverse, and assessing whether security operations are tailored to the risks each entity faces.
Liquidity Controls Examine advisers to mutual funds, ETFs, and private funds that have exposure to potentially illiquid fixed income securities.  The OCIE also plans to examine registered broker-dealers that have become liquidity providers and liquidity providers that have expanded.  According to the OCIE, these examinations should include a review of firms’ controls within their expanded business areas, including controls over market risk management, valuation, liquidity management, trading activity, and regulatory capital.
Clearing Agencies Continue to conduct annual examinations of clearing agencies designated as systemically important, pursuant to the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Areas for review to be determined through a risk-based approach in collaboration with the Division of Trading and Markets and other regulators, as applicable.

III. Data Analytics – OCIE’s enhanced ability to analyze large amounts of data will assist with examiners’ ongoing initiatives to assess anti-money laundering compliance, detect microcap fraud, and review for excessive trading.  Data analytics should also facilitate examinations focused on the promotion of new, complex, and high-risk products.

Furthermore, since the OCIE’s examination program is risk-based, this SEC office strives to detect risks across those industries and within those firms that it oversees. Among all of OCIE’s stated examination initiatives, including those highlighted in this section, data and intelligence from each examination and regulatory filings should be used to identify registrants that appear to have elevated risk profiles.  A few of the planned initiatives that should leverage the OCIE’s capabilities in the area of data analytics include:

  Initiative
Anti-Money Laundering (AML) Continue to examine clearing and introducing broker-dealers’ AML programs, using the firm’s analytic capabilities and focus on firms that have not filed the number of suspicious activity reports (SARs) that would be consistent with their business models or have filed incomplete or late SARs.  The OCIE will also continue to assess broker-dealers’ AML programs, with a particular emphasis on: (1) the adequacy of the independent testing obligation, to strengthen these programs and target them to each firm’s specific business model; and (2) the extent to which firms consider and adapt, as appropriate, their programs to current money laundering and terrorist financing risks.
Microcap Fraud Continue to examine the operations of broker-dealers and transfer agents for activities that indicate they may be engaged in, or aiding and abetting, pump-and-dump schemes or market manipulation.  The OCIE also plans to assess whether broker-dealers are complying with their obligations under the federal securities laws when publishing quotes for, or trading securities in the over-the-counter markets.
Excessive Trading Continue to analyze data, including data obtained from clearing brokers, to identify and examine firms and their registered representatives that appear to be engaged in excessive or otherwise potentially inappropriate trading.
Product Promotion Plan to focus on detecting the promotion of new, complex, and high risk products and related sales.

IV. Other Initiatives

In addition to examinations related to the themes described above, the SEC expects to allocate examination resources to other priorities, including:

  Initiative
Municipal Advisors Continue to conduct examinations of newly-registered municipal advisors to assess their compliance with recently adopted SEC and Municipal Securities Rulemaking Board rules.  This initiative should continue to include industry outreach and education.
Private Placements Review private placements, including offerings involving Regulation D of the Securities Act of 1933 or the Immigrant Investor Program (EB-5 Program) to evaluate whether legal requirements are being met in the areas of due diligence, disclosure, and suitability.
Never-Before-Examined Investment Advisers and Investment Companies Continue conducting focused, risk-based examinations of selected registered investment advisers and investment company complexes that we have not yet examined.
Private Fund Advisers Examine private fund advisers, maintaining a focus on fees and expenses and evaluating, among other things, the controls and disclosure associated with side-by-side management of performance-based and purely asset-based fee accounts.
Transfer Agents In addition to OCIE’s examinations of transfer agents’ timely turnaround of items and transfers, recordkeeping and record retention, and safeguarding of funds and securities, the OCIE plans to examine transfer agents providing paying agent services for their issuers, focusing on the safeguarding of security-holder funds.

Disclosure

The published priorities for 2016 are not exhaustive and may be adjusted in light of market conditions, industry developments and ongoing risk assessment activities. These priorities do not address OCIE’s examination priorities for the national securities exchanges, which are addressed separately.

Key Take-aways

The three main themes for the OCIE this year are protecting retirement savers and other retail investors, market-wide risks and more data analysis to identify illegal activity.

For retirement savers, SEC officials have indicated that they will continue looking at conflicts of interest and marketing practices, exchange-traded funds practices, fee arrangements and sales of variable annuities, along with public pension adviser risks such as pay-to-play and undisclosed gifts.

On market risks, SEC examiners are expected to continue a cybersecurity initiative and annual exams of clearing agencies, plus look at liquidity controls among advisers to mutual funds, ETFs and private funds with exposure to potentially illiquid fixed-income securities.

For all exam activity, the SEC has indicated that it will continue to rely on data analytics to track misconduct and excessive trading, and to assess anti-money-laundering programs.

SEC examiners are also expected to scrutinize private placements for adherence to rules on due diligence, disclosure and suitability.

Reference

  1. “SEC Announces 2016 Examination Priorities,” U.S. Securities and Exchange Commission, press release, January 11, 2016. Access at: http://www.sec.gov/news/pressrelease/2016-4.html. “Examination Priorities for 2016,” National Exam Program, Office of Compliance Inspections and Examinations. Access at: http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2016.pdf.

Newsletter Author: Nghi Pham

Newsletter Contact Person: Craig Unterseher

Disclaimer

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