Recently, the Office of Compliance Inspections and Examinations (“OCIE” or “Examiners”) announced its annual examination priorities, highlighting areas of focus for its investigative and regulatory efforts this year. The OCIE, an inspection division of the Security and Exchange Commission (“SEC” or “Commission”), facilitates regulatory compliance with SEC rules and investigates potential abuse by market service providers, such as investment advisers, broker dealers, clearing agencies, national securities exchanges, and the like.  This annual report lists the OCIE’s top priorities, indicating which areas of the market leave the most room for investor risk. Broadly, the themes published in the report this year highlight specific emerging risks concerning asset verification, developments in cryptocurrency, and retail investors.

The five areas highlighted for the 2018 report are the following:

1. Risks to retail investors and those on Main Street, especially those saving for retirement,
2. Compliance and risks in critical market infrastructure and market service providers,
3. Increased oversight of FINRA and MSRB,
4. Cybersecurity, and
5. Anti-Money laundering programs.

This alert summarizes these five areas of focus, which are discussed in full in the 2018 OCIE Examination Report here.  

Risks to Retail Investors

Protecting the interests of retail investors remains a top priority for the OCIE. The OCIE will continue to scrutinize firms that provide advice and counsel to these Main Street investors, especially firms that employ new products and mechanisms that have changed how investment transactions are presented. Particularly, the OCIE identified the following areas of potentially high risk to retail investors:

• Disclosure of the Costs of Investing. Ensuring the transparent calculation of fees and disclosure of costs to investors remains a high priority to Examiners this year. Financial professionals must comply with any obligations to disclose fees, costs, and conflicts of interest, including incentive structures that might persuade financial professionals to recommend one type of service or product than another and particularly where the fee is dependent on the value of the account.
• “Robo-Advisors” and Other Electronic Investment Models. The Examiners emphasized that online algorithm-based investment advice continues to pose risks to investors. The OCIE will monitor investment advisers and broker-dealers that offer services through partially- or wholly-automated platforms to ensure compliance in the computer programs that generate investment recommendations, online advertising materials, and personal and financial data storage and transmission.
• Wrap Fee Programs. The OCIE will continue to monitor investment advisory and brokerage programs that charge a single bundled (wrapped) percentage fee for their services. This oversight includes an examination of whether advisers are fulfilling their fiduciary duty and meeting the contractual obligations to clients.
• Never-Before-Examined Investment Advisers. Newly-registered investment advisers will be more likely subject to OCIE examination this year, as the Examiners intend to select and monitor these newer investment advisers with higher or unknown risk profiles.
• Senior Investors. The OCIE intends to protect these saving for and during retirement by ensuring that broker-dealers and their firms are equipped to identify the financial exploitation of elderly investors. In this regard, firms should carefully draft and enforce internal policies that reduce the risk of abuse to senior investors.
• Mutual Funds and ETFs. The OCIE will monitor and examine mutual funds and exchange traded funds (ETFs), the primary investment tools for Main Street investors, to ensure that these widely-used investment vehicles are properly managed and do not pose unreasonably high risk to investors due to undisclosed fees or costs.
• Municipal Advisors and Underwriters. Examinations of municipal advisors— those who advise municipal entities or their agents regarding bonds and financial products— will be focused on ensuring compliance with registration, recordkeeping, and supervision policies and the MSRB rules for qualification and standards of conduct.
• Fixed Income Investors. When investing on behalf of those with fixed income, broker-dealers must comply with requirements for the proper execution of customer orders. The OCIE will inspect broker-dealers to ensure the best execution policies and procedures are in place for both municipal and corporate bond transactions.
• Cryptocurrency and Initial Coin Offerings (ICOs). As the cryptocurrency market has grown exponentially, the risk to retail investors participating in the market remains largely unknown. With the increase of firms and broker-dealers offering products and services in this space, the OCIE continues to examine the sale of these products and whether these offerings constitute a security. In particular, the Examiners are assessing whether financial advisers in this market maintain adequate controls and systems to prevent theft or loss of assets, whether proper policies and structure exist to supervise representatives selling and promoting these products, and whether consumers and investors are fully briefed on the known and unknown risks of investing. 

Compliance and Risks in Critical Market Infrastructure

To ensure the proper functioning of the markets, the OCIE will examine those entities that provide critical services to market infrastructure, such as clearing agencies, national securities exchanges, transfer agents, and SCI entities.

• Clearing Agencies. Because of the vital role of clearing agencies in ensuring trades settle on time and as agreed, the OCIE will conduct its annual examinations of clearing agencies in accord with the Commission’s Standards for Covered Clearing Agencies. Specifically, Examiners will assess whether the agencies have taken appropriate and timely corrective action in response to prior examinations.
• National Securities Exchanges. The OCIE’s focus among the national securities exchanges will be examining internal audits, fees paid under Exchange Act Section 31, and the implementation of National Market System (NMS) plans. These NMS plans will be scrutinized by the Examiners in partnership with the Division of Trading and Markets to examine the equities and options consolidated market data plans, particularly with regard to procedures for revenue and expense generation and allocation.
• Transfer Agents. Efficient and trustworthy markets depend largely on the critical services of transfer agents that record and track an issuer’s security bonds, cancel and issue certificates, and make distributions to security holders. This year, the Examiners will focus on the effectiveness of the transferring, recording, and safeguarding of funds and securities, particularly by those transfer agents that serve as paying agents or service microcap or crowdfunding issuers.
• SCI Entities. Certain national securities exchanges, clearing agencies, and alternative trading systems are required by the Commission to comply with Regulation Systems Compliance and Integrity (SCI), a regulatory scheme designed to strengthen the technology and information infrastructure of the securities markets. The Examiners will continue to assess these SCI entities’ compliance, particularly in their implementation of policies and procedures that boost their systems’ integrity and security. To this end, the Examiners will evaluate the effectiveness of SCI entities’ business continuity plans, vendor risk and enterprise risk management systems.

Oversight of FINRA and MSRB

Another of the OCIE’s examination priorities is assessing market-wide structural risks and inspecting the governing bodies that oversee operational and regulatory policies of the markets, particularly FINRA and the MSRB.

• FINRA. The Financial Industry Regulatory Authority (FINRA) is the primary regulator of SEC-registered broker-dealers and is responsible for issuing rules and policies that govern its members. This year, the OCIE’s oversight of this regulator will focus on the SRO’s examinations of broker dealers and municipal advisers, particularly those who are also registered broker-dealers.
• MSRB. The Municipal Securities Rulemaking Board (MSRB) regulates broker-dealers and their advisors that buy, sell, and underwrite municipal products and services. The OCIE’s examination in this area will focus on the effectiveness of the MSRB’s select operational and internal policies and practices. 

Cybersecurity

As cybersecurity threats continue to increase in frequency and severity, companies and firms acting in the market must be vigilant in adopting policies and practices that protect employee and customer data. A cybersecurity breach often creates a ripple effect beyond the firm that was compromised, impacting other market participants and retail investors who may be unaware and uninformed of these risks and consequences. Because of these high stakes, the OCIE will continue to focus this year on coordinating with firms to identify and manage their cybersecurity risks through internal policies and practices. Specifically, OCIE examinations will scrutinize firms’ governance and risk assessment of cybersecurity threats; internal policies regarding data access, control, and loss prevention; management of vendors with access to data; and employee training and incident response.

Anti-Money Laundering Programs

Certain financial institutions must comply with regulations under the Bank Secrecy Act tailored to combat the rise of money laundering schemes. These anti-money laundering program (“AML program”) regulations often require entities to investigate and report suspected incidents of money laundering. To ensure these entities fulfill this obligation, the OCIE will continue its oversight of AML programs.

Conclusion

The Examiners believe that sharing the above information helps registered firms – particularly those that have not been examined recently – sharpen their identification and correction of deficient practices, maximizing the impact of the examination program and resulting in better protection for investors.  As a result, these priorities should guide such firms in identifying and setting their own priorities this year. Investment advisers, broker dealers and other market participants affected by these priorities should assess how each of these risks affect their companies and industries and design and continue to improve their internal policies and procedures to mitigate those risks.