SEC Publishes 2014 Examination Priorities for Investment Advisers

On January 9, 2014, the U.S. Securities and Exchange Commission (SEC) published its 2014 examination priorities letter (“SEC Letter”) for its National Examination Program (NEP).The NEP covers all markets and entities examined by the SEC and includes the SEC exam program for SEC-registered investment advisers. 

The SEC Letter identifies six “NEP-Wide Initiatives” generally applicable to all industry participants. The following discussion focuses on those initiatives applicable to investment advisers:

  • Fraud detection and prevention, particularly with respect to scams, theft, and unfair advantage.
  • Corporate governance, conflicts, and risk management, with a focus on a registrant’s “tone at the top” and approach to conflict and risk management.
  • Technology, particularly governance and supervision of information technology systems, and preparedness to respond to sudden market malfunctions and system outages.
  • In the case of dual registrants (firms registered as both broker-dealers and investment advisers), influences affecting whether a customer establishes a brokerage or investment advisory account. The SEC Letter indicates concern that firms are putting customers in account types that may produce more revenue for the firm, but not provide benefits to customers.
  • Compliance with recently adopted laws and regulations, such as the changes to Rule 506 and the adoption of municipal advisor rules. 
  • Retirement vehicles and rollovers, particularly the targeting of retirement-age workers and the use of potentially misleading professional designations when recommending the movement of assets from a retirement plan to an IRA “rollover.” 

The SEC Letter also identifies a number of “core risks,” “new and emerging issues,” and “policy topics” for investment advisers that will receive focus in its 2014 examination program, as summarized below.

Core Risks for Investment Advisers

  • Safety of customer assets, following up on the NEP’s March 2013 Risk Alertregarding compliance with the investment adviser custody rule.3  
  • Conflicts of interest involving compensation arrangements for investment advisers (including undisclosed compensation arrangements and their effect on recommendations made to customers); allocation of investment opportunities; and higher risk products or strategies targeted to retail investors.
  • Marketing and performance practices, with a particular focus on statements of investment objectives and presentations of performance information, including hypothetical and back-tested performance information. The SEC Letter also expressed concern about marketing efforts arising out of the newly adopted rules under the Jumpstart Our Business Startups (JOBS) Act.

New and Emerging Issues for Investment Advisers

  • Never-before examined advisers, i.e., advisers that have been registered for more than three years but have not yet been examined by the SEC.
  • Hedge fund and private equity fund advisers that were not registered or regulated by the SEC prior to the Dodd-Frank Act.4
  • Wrap fee programs recommended to advisory clients, and the accompanying fiduciary and contractual obligations for investment advisers, as well as best execution, trading away, and disclosures related to wrap fee programs.
  • Use of quantitative trading models and advisers’ policies and procedures for these trading models.
  • Payments to intermediaries and distributors by investment advisers and the funds to intermediaries and distributors, the adequacy of disclosures regarding these payments, and board oversight.
  • Risks for fixed income investment companies associated with a changing interest rate environment for fixed income investments.5

Policy Topics for Investment Advisers

  • Money Market Funds, focusing particularly on how the funds have managed any potential stress events.
  • “Alternative” Investment Companies, i.e., funds offering “alternative” investment strategies, focusing on the manner in which such funds are marketed to investors, and the representations and recommendations made regarding the suitability of such investments, as well as the leverage, liquidity, and valuation of such funds.
  • Securities Lending Arrangements, focusing on their compliance with all relevant exemptive orders and no-action letters.

Investment advisers may want to consider these priorities when designing and conducting their internal compliance programs.                                        

1 The SEC Letter is available at http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2014.pdf.
2 Significant Deficiencies Involving Adviser Custody and Safety of Client Assets (March 4, 2013), available at http://www.sec.gov/about/offices/ocie/custody-risk-alert.pdf.
3  Rule 206(4)-2 under the Investment Advisers Act of 1940.
4 Notably, the SEC Letter also makes reference to David Blass’ speech cautioning private fund advisers on broker-dealer registration issues, since that was an important regulatory finding arising from the SEC’s examination of investment advisers that were newly registered with the SEC as a result of the Dodd-Frank Act.  Blass’ speech is available at http://www.sec.gov/News/Speech/Detail/Speech/1365171515178#.UtQcNJ5dWPk.
5 The SEC recently released guidance concerning risk management in the fixed income market, which is susceptible to volatile swings due to growing interest rate uncertainty.  The guidance is available at http://www.sec.gov/divisions/investment/guidance/im-guidance-2014-1.pdf.