The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations’ long-awaited examination priorities for 2018 will focus on five principal areas: retail investors; infrastructure risks; FINRA and MSRB; cybersecurity; and anti-money laundering programs. Among other things, the Office of Compliance Inspections and Examinations (OCIE) will focus on mutual funds with poor performance or liquidity and those managed by inexperienced investment advisers, and on conflicts of interest that may arise when a fund tracks a proprietary index created or maintained by the fund’s investment adviser.
New for 2018, OCIE stated its stance on four “pillars”: (1) promoting compliance; (2) preventing fraud; (3) identifying and monitoring risk; and (4) informing policy.
OCIE also enumerated five “principles” on which it will abide in executing the examination priorities:
- Risk-based. To effectively oversee all of the varying market participants within OCIE’s jurisdiction, OCIE will use a risk-based strategy.
- Data-driven. As a complement to its risk-based strategy, OCIE will use data analytics to help better understand and focus examinations.
- Transparency. OCIE will continue to publish information about what they are doing, why they are doing it, and what they have found and learned in the process, including the publication of more Risk Alerts to promote compliance.
- Efficient resource use. OCIE will continue to assess its allocation of resources in ways that are intended to advance investor protection and fulfill the SEC’s mission.
- Innovation and new technology. OCIE will assess new technologies, both in the context of the impact on the financial markets and investors, and in how to adapt to emerging risks and concerns.
This alert summarizes the key points of OCIE’s examination priorities. As OCIE noted, however, this list is not exhaustive. OCIE will remain flexible, and it will add priorities throughout the year as emerging and exigent risks to investors and the marketplace arise.
OCIE will focus on examining firms that sell investment products to retail investors, particularly seniors and retirement savers, emphasizing the following areas:
- Disclosure of investment costs. These include fees and expenses that take shape in various forms. Among other things, OCIE will look at whether firms encourage investors to remain in higher-priced products when lower-priced options may be available.
- Robo-advisers and other automated or digital platforms. OCIE will target robo-adviser compliance programs, including the oversight of computer program algorithms.
- Wrap-fee programs, including suitability of recommendations and conflicts arising out of trading practices.
- “NBE Advisers.” OCIE will focus on “never-before-examined” investment advisers, using risk-based assessments to prioritize examinations that have “elevated risk profiles.”
- Senior investors and retirement accounts. OCIE will continue to focus on investment adviser and broker-dealer interactions with senior investors, as well as variable insurance products and target date fund recommendations.
- Mutual funds and ETFs. OCIE will focus on funds that have experienced poor performance or are managed by inexperienced advisers. It will also look at funds that hold securities that are difficult to value during times of market stress. OCIE will also focus on funds that track custom-built indices to review for conflicts the adviser may have with the index provider and the adviser’s role with respect to the selection and weighting of index components.
- Municipal advisors and underwriters. OCIE will review municipal advisors, particularly unregistered advisers, for compliance with registration, recordkeeping and supervision, and compliance with MSRB rules regarding professional qualification requirements.
- Fixed income order execution. OCIE will assess whether broker-dealers have implemented best execution policies and procedures.
- Blockchain and ICOs. Recognizing the rapid growth of cryptocurrency and initial coin offering (ICO) markets, OCIE will target “financial professionals” to ensure they maintain safeguards to protect assets from theft or misappropriation, and to ensure that they disclose all relevant risks to investors.
Compliance and Risks in Critical Infrastructure
- Clearing agencies. Working with the SEC’s Division of Trading and Markets and other regulators, OCIE will continue to conduct annual examinations of “systemically important” clearing agencies under SEC jurisdiction.
- National securities exchanges. OCIE will focus on internal audits conducted by the exchanges, fees paid, and the governance and operation of certain National Market System (NMS) plans.
- Transfer agents. OCIE will target transfer agents, including those that serve as paying agents or that service microcap or crowdfunding issuers.
- Regulation Systems Compliance and Integrity (SCI) entities. OCIE will continue to examine SCI entities to evaluate whether they have established and implemented appropriate written policies and procedures that cover, among other things, controls relating to how systems record the time of transactions or events and how they synchronize with other systems, and their readiness and business continuity plans.
FINRA and MSRB
- FINRA. OCIE will keep its eye on FINRA, focusing on its operations and regulatory programs, and the quality of FINRA’s examinations of broker-dealers and municipal advisers that are also registered as broker-dealers.
- MSRB. OCIE will examine the MSRB to evaluate the effeteness of select operational and internal policies, procedures and controls.
- A perennial favorite, cybersecurity is again an OCIE priority.
Anti-Money Laundering (AML) Programs
- In 2018, OCIE will continue to focus “a portion of [its] resources” to ensure that regulated entities have adapted their AML programs to address their obligations, including the requirement to understand the nature and purpose of customer relationships and to address risks.
Notably absent from the 2018 examination priorities as compared to 2017 are references to money market funds and the examination of private fund advisers for potential conflicts of interests. While dropping money market funds as a stated priority probably does signal that the multi-year attention to implementing reforms in that sector is at a close, we do not interpret the absence of last year’s “private fund advisers” initiative as an indication of reduced attention. Industry participants should assume that OCIE will continue to devote resources and attention to private fund adviser issues.
OCIE’s priorities evolve over time to address changes in technology and the marketplace, with a focus on risk assessment and consumer protection. Its priorities continue to evolve with the rise of cryptocurrency offerings, automated investment advice and other innovations.
As a closing point, it is worth taking a moment to open the 2018 and 2017 papers side by side. Yes, the new format is more polished. But more than that, the authors seemed to want the opening pages to do something of a “reset” in explaining how OCIE’s work connects to the mission and how that—plus realities, like the “hard choices” that go into allocating resources—informs the annual exercise of publishing priorities.