SEC Exam Priorities: What Investment Managers Can Expect in 2016
With the US Securities and Exchange Commission (SEC) down two commissioners, many predict a relatively “quiet” rule-making agenda over the next few months, as the confirmation process continues and the United States rounds the bend into an election year. What’s a major regulator to do?
Keep the industry on track by going to its full examination arsenal, of course.
Earlier this year, the SEC announced its Office of Compliance Inspections and Examinations (OCIE) exam priorities for 2016, with focus on three main areas:
- Protecting retail investors and those saving for retirement
- Assessing marketwide risks
- Using data analytics to identify signals of potential illegal activity.
It also noted new areas for attention, including liquidity controls, the promotion of products, advisers to public pension funds, exchange-traded funds (ETFs), and variable annuities.
Protections for Retail Investors
Following on the Department of Labor’s emphasis on protecting retail investors in the retirement space, OCIE plans to continue its examination focus on the services provided by broker-dealers and investment advisers relating to investment recommendations, conflicts of interest, and marketing efforts. Other areas of particular interest to the examination program include ETFs (including sales strategies, trading practices, and disclosures), branch offices of advisers and broker-dealers, the promotion of various fee arrangements (and the implications for the investor’s best interest), variable annuities (including their suitability for investors), and the activities of advisers to public pensions.
Cybersecurity remains a top focus of OCIE’s examination program. Building on its 2015 program that examined existing controls used by advisers and broker-dealers, OCIE now plans to test and assess how adequate they are, as well as focus on entities that are subject to Regulation Systems Compliance and Integrity (SCI) that requires measures to strengthen the securities market technology infrastructure. The SEC has also expanded its focus on liquidity management by advisers and other entities with “exposure to potentially illiquid fixed income securities.” (CFA Institute recently filed a comment letter on the SEC’s proposal that mutual funds maintain liquidity risk management programs.) And systemically significant clearing agencies have joined the field receiving newfound attention, although OCIE has deferred saying exactly what the focus of their exams will be.
Use of Data Analytics
One of the most interesting developments in OCIE’s examination program is its use of data analytics to hone in on signs that may indicate illegal activity in the market. Using a wide range of sophisticated techniques, OCIE staff can look for patterns of misconduct by individuals, instances of money laundering by firms, activities indicating market manipulation, excessive trading, and promotion and sales practices that may violate fiduciary duties.
Examinations of SROs
As if OCIE’s plate were not full enough, at the same time it announced its 2016 examination priorities, its Office of Market Oversight also provided a letter highlighting examination priorities to US national exchanges and other self-regulatory organizations (collectively, SROs). Among the areas noted were examinations focusing on: exchange regulatory practices and compliance with Regulation SCI; the listing programs of options and equity exchanges; and options exchanges’ openings procedures.
OCIE Staff Speaks
OCIE is headed by Marc Wyatt, CFA, who emphasizes that the examination program is transparent, data-driven, and risk-based. At the recent SEC Speaks conference he and his staff provided additional insights into the department’s approach.
Starting with 160 exams, focus on the retirement area will be a multi-year priority (and a joint effort with the broker-dealer exam program). In particular, the exams tend to focus on misleading market materials about rollovers and mutual fund share class selection.
Noting that this has been a record year for ETFs with $242 billion in inflows, phase one of OCIE’s examination initiative is focusing on liquidity management in mutual funds and ETFs, suitability, sales practices, and disclosures; a second exam phase will follow.
With respect to cybersecurity, staffer Askari Foy noted that OCIE is examining firms for the first time this year for compliance with Regulation SCI; the department intends not to use a “gotcha” approach, but instead seeks to determine that companies will have reasonable policies and procedures to maintain orderly markets in the case of security disruptions. The first examination sweep will use a “geographical” approach, focusing on the New York/New Jersey data centers that serve firms in that region. The second sweep will focus on securities operational centers and their ability to respond to, and maintain, operations in the case of cyber security events.
Often OCIE’s efforts are equated with the success or failure rate of examining registered investment advisers. But its examination scope far exceeds this one group, stretching across investment companies, transfer agencies, broker-dealers, and clearing agencies, in addition to advisers and SROs. This appears to be a serious group of people dedicated to identifying and tracking down those under SEC jurisdiction who may pose a risk to the smooth operation of our capital markets.
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