SEC’s OCIE Announces Its 2015 Examination Priorities
The SEC’s Office of Compliance Inspections and Examinations (OCIE), which is responsible for conducting regulatory examinations of investment advisers, investment companies, broker-dealers, SROs, clearing agencies and transfer agents, recently published its examination priorities for 2015, which are focused on three main areas of interest: (i) retail investors and investing for retirement, (ii) market-wide risks and (iii) data analytics. The examination priorities provide a useful map of areas where SEC-regulated entities should pay special attention in evaluating their business practices, compliance infrastructure and controls.
Retail Investors and Retirement Products – OCIE intends to focus on investment products and services being developed for, and marketed to, retail investors, particularly investors that are investing for retirement, and the various conflicts of interest presented for SEC regulated entities in this context. OCIE plans to review fee structures for client accounts, as well as sales, due diligence and disclosure practices of advisers, brokers and registered representatives in recommending or selecting investment products, and whether appropriate suitability determinations are being made, among other issues. In particular, OCIE indicates that it will be taking a closer look at examinees’ recommendations regarding the movement of retirement assets from employer sponsored accounts into other types of investments. Of particular interest to OCIE are the various products and services that have typically been offered only to institutional investors, but are now being offered to retail investors in various forms. For example, OCIE intends to focus on “alternative” investment funds, which are funds sold to retail investors that offer alternative investments or that have an underlying alternative investment (e.g., hedge fund) strategy. OCIE plans to review these funds to assess the adequacy of the funds’ leverage, liquidity and valuation policies and procedures, the adequacy of their internal controls and the manner in which the funds are marketed to investors. Fixed income funds will also be an area of OCIE focus due to concern over the funds’ potential interest rate exposure in a rising interest rate environment, and OCIE will be reviewing the funds’ disclosure for consistency with their liquidity profiles and trading controls, among other things. OCIE also indicates that it will review registrants’ supervision of registered representatives and financial advisors in branch offices for deficiencies in compliance practices, and will employ data analytics in doing so.
Market-Wide Risks – OCIE intends to examine firms with a view toward structural risks and trends that may impact a multitude of market participants or entire industries. In coordination with the Division of Trading and Markets and the Division of Investment Management, OCIE expects to review large broker-dealers and asset managers as potential sources of systemic risk, and will continue its risk-based examinations of systemically important clearing agencies as required by the Dodd-Frank Act. Cybersecurity will also be a continuing area of focus for OCIE, which will expand last year’s initiative to assess cybersecurity controls across a range of firms, including broker-dealers and investment advisers. Finally, OCIE will evaluate broker-dealers’ compliance with their best execution duties in routing equity order flow, examining whether brokers are prioritizing trading venues based on credits or payments for order flow.
Data Analytics – OCIE reports that significant enhancements to its data analytics capabilities made over the past several years have enabled it to more efficiently analyze large amounts of data. OCIE intends to use these capabilities to focus on broker-dealers and registered representatives, among others, that appear to be engaged in potentially fraudulent or illegal activity. Data analytics will be used by OCIE to locate registered representatives with checkered disciplinary histories, and to examine firms that employ them. Data analytics will also be used to monitor broker and transfer agent activity in order to identify potential microcap fraud (e.g., pump and dump schemes and other market manipulation), as well as excessive trading. Additionally, OCIE intends to employ data analytics to more effectively monitor clearing brokers’ and introducing brokers’ compliance with anti-money laundering (AML) regulations.
Other Initiatives – In addition to the three main areas of focus listed above, the examination priorities list includes a number of other areas where OCIE intends to allocate resources in 2015, including newly-registered municipal advisors, proxy services, never-before-examined investment companies, private equity fees and expenses (an area where OCIE has apparently found a high level of deficiencies during exams) and transfer agents (particularly those involved with microcap securities and private offerings).
Conclusion – OCIE notes that the priorities list is not exhaustive and may evolve over the course of the coming year based on market conditions, ongoing risk assessments and industry developments, as well as tips, complaints and referrals from investors and others. Moreover, data analytics, which have also been successfully deployed by the SEC’s Division of Enforcement, will undoubtedly have a significant ongoing influence on OCIE’s priorities. In any event, SEC-regulated entities would be well-served to take the 2015 examination priorities list into account when evaluating their current and planned business activities, and assessing the sufficiency of their compliance infrastructure and controls.
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