Each year, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) publishes a list of examination priorities for the coming year. It’s imperative for investment advisers to be familiar with these priorities for a number of reasons. First, and foremost, the list often contains new risks that advisers should be aware of to protect clients and the firm. Advisers should also be prepared to show compliance with each priority since it is certain that it will be tested during any examination. Finally, the Staff of the SEC has often been more aggressive in enforcing areas that have specifically been listed as a priority.
This years letter is a bit more concise than in the past. The letter is less than five pages, whereas the 2014 letter was eleven pages (although that letter included SRO priorities which have been removed). Nothing in this letter should be new to advisers. The letter addresses a four areas of concern and then drills down into specific concerns of each:
- Protecting Retail Investors and Investors Saving for Retirement;
- Assessing Market-Wide Risks;
Using Data Analytics to Identify Signals of Potential Illegal Activity; and
- Other initiatives.
The following are the areas that are important to independent investment advisers and additional guidance on what advisers should consider, if applicable.
- Fee selection and reverse churning. “Where an adviser offers a variety of fee arrangements, we will focus on recommendations of account types and whether they are in the best interest of the client at the inception of the arrangement and thereafter, including fees charged, services provided, and disclosures made about such relationships.”
- This is a follow-up on the emphasis the SEC has been placing on wrap brochures, but it is expanded to include any type of fee relationship. Advisers need to ensure that the fee relationship is in each client’s best interest. If, for example, the adviser has a wrap and non-wrap option, clients that have limited need for transactions may be best served in a non-wrap relationship. A determination should be done initially and ongoing.
- Sales practices. The SEC will assess “whether registrants are using improper or misleading practices when recommending the movement of retirement assets from employer-sponsored defined contribution plans into other investments and accounts, especially when they pose greater risks and/or charge higher fees.”
- This initiatives was included in the 2014 OCIE letter, but appear to make it more clear that the SEC’s focus on retirement accounts is primarily on those that are recommending (or selling) rollovers regardless of a client’s best interest.
- Branch offices. The SEC will focus on supervision of adviser representatives in branch offices. This will include the use of analytics to identify branches that are deviating from the home office.
- Advisers often have “branch offices” that are run somewhat autonomously. The existence of additional offices is a risk that advisers need to consider. Supervision, training and resources should be available to ensure that the culture of compliance is as strong at branches as the home office.
- Cybersecurity. The SEC will continue its cybersecurity initiative.
- While not on the 2014 OCIE list, everyone is familiar with the SEC cybersecurity initiative. As we’ve discussed before, this should be important to advisers for business and liability issues, not just regulatory concerns.
- Recidivist representatives. The SEC will continue to identify individuals with misconduct trackrecords and the firms that employ them.
- Proxy services. The SEC will examine select proxy advisory service firms that advisers may be hiring to vote proxies. In addition, the SEC will examine investment advisers’ compliance with their fiduciary duty in voting proxies on behalf of investors.
- This follows up on a question and answer release by the SEC in July, 2014 which put advisers on notice that firms must do initial and ongoing due diligence on third-party proxy firms. See our summary here.
As mentioned above, none of these should be new topics to advisers. Each, however, should receive specific attention to ensure compliance. In addition, because this letter is less inclusive than in the past, advisers need to keep aware of other examination trends that develop or continue.