On February 27, 2018, the Office of Compliance Inspections and Examinations (OCIE) of the U.S. Securities and Exchange Commission (SEC) released their Exam Priorities for 2018. The priorities reflect certain practices, products and services that the OCIE believes may present potentially heightened risks to investors and to the integrity of the U.S. capital markets.1 The report is based on four pillars; promoting compliance, preventing fraud, identifying and monitoring risk, and informing policy, and in 2018 are organized around the following five themes.2
- Matters of importance to retail investors, including seniors and those saving for retirement
- Compliance and risks pertaining to critical market infrastructure
- Financial Industry Regulatory Authority (FINRA) and Municipal Securities Rulemaking Board (MSRB)
- Anti-Money laundering (AML) programs
What this means
While the OCIE will focus on these five themes, they would remain flexible in order to cover emerging and exigent risks to investors and the market as they arise, as rapid institutional and technological change demands a responsive approach.3 Cryptocurrencies, for example, made this years’ priorities list for the first time, as the crypto market is growing rapidly, and the number of advisors and broker-dealers “engaged in this space” continues to grow as well.
1. Retail investors, including seniors and those saving for retirement4
- Costs of investing disclosure – OCIE examinations is expected to target firms with practices/business models that may increase the risk that investors might pay inadequately disclosed fees, expenses or other charges, such as where advisers may receive financial incentives.
- Advise on electronic investment – OCIE is expected to focus on robo-advisors and broker-dealers that offer investment advice through automated or digital platforms. Their examinations will seek to assess computer program algorithms that generate recommendations, investor data protection, and conflicts of interest disclosure.
- Wrap fee programs – Examinations seek to focus on whether investment advisers associated with wrap fee programs are acting in a manner consistent with their fiduciary duty, disclosing conflicts of interest in compliance with regulatory requirements, and obtaining best execution.
- Never-before-examined investment advisers – OCIE will seek to select newly registered advisers for examination that have elevated risk profiles.
- Senior investors, retirement accounts and products – OCIE is expected to continue their examination of investment advisers and broker-dealers offering products and services to investors with retirement accounts. They will seek to also focus on investment recommendations, sales of insurance products and target date funds.
- Mutual funds and ETFs – Mutual funds and ETFs are the primary investment vehicle for retail investors, and OCIE will seek to focus on those vehicles with poor performance and liquidity in terms of subscriptions and redemptions, and those that have little secondary market trading volume, and so face the risk of being delisted from an exchange. Their examinations will seek to identify whether investment risks are adequately disclosed to investors.
- Municipal advisors and underwriters – OCIE is expected to continue to examine municipal advisors to evaluate their compliance with registration, recordkeeping, and supervision requirements, in accordance with MSRB and SEC rules.
- Fixed income order execution – Examinations are expected to be conducted to assess whether broker-dealers have implemented best execution policies and procedures, consistent with regulatory requirements for both municipal and corporate bond transactions.
- Cryptocurrency, initial coin offerings (ICOs), secondary market trading and blockchain – Cryptocurrency and ICO markets have seen important growth, as have the number of broker-dealers and investment advisors marketing these products. Their examinations will seek to include whether financial advisers maintain adequate controls and safeguards to protect these assets from theft or misappropriation, and whether advisers are providing investors with disclosure about the risks associated with these investments, including the risk of investment losses, liquidity risks, price volatility, and potential fraud.
2. Compliance and Risks in Critical Market Infrastructure5
- Clearing agencies – OCIE will seek to continue to conduct annual examinations of the agencies declared systemically important by the Financial Stability Oversight Council (FSOC) and where the SEC is the supervisory agency.
- National securities exchanges – The focus here is on internal audits conducted by the exchanges, and the OCIE is expected to conduct examinations of the equities and options consolidated market data plans, with specific regard to governance, revenue and expense generation, and revenue and expense generation procedures.
- Transfer agents – Efficient transfer agent operations are critical to secondary securities markets, and OCIE examinations are expected to target transfers, recordkeeping, and the safeguarding of funds and securities. Candidates for examination should include transfer agents that service microcap or crowdfunding issuers.
- Regulation systems compliance and integrity (SCI) entities – OCIE examinations will seek to evaluate SCI entities’ policies and procedures for their systems’ capacity, integrity, resiliency and security. They are also expected to assess entities’ readiness and business continuity plan effectiveness, vendor risk management, particularly in cloud environments, and enterprise risk management, particularly whether these programs cover appropriate business units, subsidiaries, and interconnected infrastructure.
3. Focus on FINRA and MSRB6
- FINRA – OCIE examinations of FINRA are expected to focus on their operations and regulatory programs, and the quality of their examinations of broker-dealers and municipal advisors registered as broker-dealers.
- MSRB – Given the responsibility of the MSRB to regulate the municipal securities markets, the OCIE examinations will seek to evaluate the effectiveness of their operational and internal policies, procedures and controls.
Cybersecurity protection is critical to financial markets, and as such the OCIE will seek to be working with institutions to identify and manage cybersecurity risks. Their examinations are expected to target governance and risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response.
5. Anti-Money Laundering Programs8
Under the Bank Secrecy Act, some financial institutions are required to establish AML programs, in which they must identify their customers, perform customer due diligence, and monitor accounts for suspicious activity, and where necessary file Suspicious Activity Reports (SARs). OCIE examinations are expected to target customer due diligence requirements and determine whether the institutions are taking reasonable steps to understand the nature of customer relationships, and to properly address risks. Examinations will seek to also assess that the filing of SARs are complete, accurate and timely, and that institutions are conducting robust and independent tests of their AML programs
The OCIE concludes that this priorities list is not exhaustive, and in addition examinations are expected to be conducted which focus on risks, issues, and policy matters that arise from market and regulatory developments, new information learned from examinations, or other sources, including tips, complaints, and referrals, and coordination with other regulators.9 With regard to crypto compliance, the OCIE has said it plans to monitor the sale of such products, “and where the products are securities, examine for regulatory compliance.”10 SEC Chairman Jay Clayton told a senate committee in early February that all Initial Coin Offerings are securities, and as none have registered with the SEC, they are illegal.11 Both Jay Clayton, and Commodity Futures Trading Commission (CFTC) Chairman Christopher Giancarlo have asked Congress to explore the SEC and CFTC’s oversight of the cryptocurrency market, and to look at legislation to expand the agencies authority.12
- “2018 National Exam Program Examination Priorities,” U.S. Securities and Exchange Commission, Office of Compliance Inspections and Examinations. Access at: https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2018.pdf
- “SEC Releases 2018 Exam Priorities List,” ThinkAdvisor, February 7, 2018. Access at: https://www.thinkadvisor.com/2018/02/07/sec-releases-2018-exam-priorities-list/
- “SEC and CFTC Give Testimonies at Senate Hearing on Virtual Currencies,” Bitcoin Magazine, February 6, 2018. Access at: https://bitcoinmagazine.com/articles/sec-and-cftc-give-testimonies-senate-hearing-virtual-currencies/
- “Written Testimony of Chairman J. Christopher Giancarlo before the Senate Banking Committee, Washington, D.C.” U.S. Commodity Futures Trading Commission, Release, February 6, 2018. Access at: http://www.cftc.gov/PressRoom/PressReleases/opagiancarlo37
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