The U.S. Securities and Exchange Commission has released their annual list of examination priorities for 2017. These priorities indicate areas in which SEC staff will focus attention during their examinations of registered investment advisers, broker-dealers, transfer agents, and investment companies, among other registrants. The priority list is developed by staff from the SEC’s Office of Compliance Inspections and Examinations (OCIE), and is not an official announcement of priorities from the commissioners at the SEC. In OCIE’s words, “the priorities reflect certain practices, products, and services that OCIE perceives to present potentially heightened risk to investors and/or the integrity of the U.S. capital markets.”
Registered investment advisers, broker-dealers, and other SEC registrants should review the priorities in this letter, and consider whether they need to make changes to their internal systems and controls, including their supervisory systems and procedures to ensure compliance with applicable rules and regulations. We will not attempt to discuss all of the identified priorities, but will share some highlights. And, as you review these highlights, remember that the SEC staff will examine (and prosecute) violations of other industry regulations not appearing on their annual priority list.
Protecting Retail Investors
OCIE identifies protecting retail investors as a key area of focus in their exam program. In that section, they identify the following examination initiatives:
Electronic Investment Advice. The staff will examine RIAs and B-Ds that offer investment advice through automated platforms, including “robo-advisers.” A concern here in addition to data protection, is compliance practices concerning supervision of algorithms that will generate investment advice/recommendations.
RIAs Never-Before Examined. OCIE states that they are expanding their never-before examined RIA initiative to examine more RIA firms that have not yet been examined by the SEC. This has been a priority for the SEC staff for several years, and SEC registered RIA firms that have not yet been examined should prepare for the SEC staff to get around to them, sooner rather than later.
Recidivist Representatives. The staff announces that they will identify those representatives with a track record of misconduct, and examine the investment advisers that employ them. Here, they will include a focus on investment adviser representatives who had been barred from association with a broker-dealer, or had another regulatory action against them. This priority is not surprising, as the staff had announced a concern about supervision of these individuals at RIAs in September 2016.
The takeaway for RIAs is this: your hiring and supervision practices – if you employ persons who have been the subject of enforcement actions in the broker-dealer industry – will be under the microscope. To that end, ensure that you are properly vetting candidates for registration, verifying background information, and properly supervising them to ensure compliance with industry rules and regulations.
Multi-Branch Advisers. Here, the SEC staff asserts that RIS firms that use a branch office model may face unique risks relating to their implementation of a compliance program and the supervision of the provision of advisory services.
Share Class Selections. The SEC staff advises that they will focus reviews on conflicts of interest that might affect a recommendation to invest – or remain invested – in a particular share class of a mutual fund. From the letter, it appears that the staff is concerned that those financial advisors who are dually registered with both a broker-dealer and a RIA firm might be improperly influenced to recommend share class that comes with a higher load or distribution fee. It appears that these dually-registered representatives should be careful to document their rationale for choosing share classes when making recommendations to clients, as this will be an area of scrutiny by the SEC staff.
Focus on Senior Investors
The emphasis on protection of senior investors continues for another year, and this initiative gets its own category in the 2017 priorities letter from the SEC. Here, the staff advises that they will focus on advice given and products sold for retirement accounts, naming specifically variable insurance products and target date mutual funds.
The staff also reports that they will conduct evaluations of how firms are able to manage their interactions with their clients who are senior investors, including being able to identify financial exploitation of these clients. Here, the staff reports that their exams will likely focus on internal supervisory procedures and controls for products that are directed at senior investors.
Based on the priorities letter, the SEC staff is concerned about various market-wide risks. Two of those risks are FINRA’s oversight and cybersecurity issues.
First, for broker-dealers, the SEC staff reports in the letter that, “We will enhance our oversight of FINRA.” To this end, they write that they will conduct inspections of FINRA’s operations and will also review the quality of FINRA’s exams of broker-dealer firms.
Second, the staff is continuing to make cybersecurity an issue for 2017. Broker-dealers and RIA firms should be cautious to ensure that they have reasonable systems and procedures in place for preventing cybersecurity failures. I expect that we will see increased enforcement action for cybersecurity issues.
There are other 2017 priorities listed in the SEC’s letter and those in management, compliance and legal sections of broker-dealers, RIAs and transfer agents should certainly review and consider the staff’s letter. Remember that items not listed in this priorities letter will still be investigated by the SEC staff, and they will continue to pursue regulatory actions against those registrants who violate rules not mentioned in this letter.