SEC Issues Guidance on its 2014 Examination Priorities

by Baker Donelson
Contact

Each year, the SEC Office of Compliance Inspections and Examination's National Exam Program (NEP) issues a letter communicating to investors and registrants the areas that the staff perceives to present heightened risks. This year, the NEP published its Examination Priorities for 2014 on January 9, 2014. 1

The NEP's examination priorities address issues that span the entire market, as well as issues that relate specifically to particular business models and organizations. This Alert will address examination priorities identified by the NEP in the following areas:

  1. Market-wide;
  2. Investment Advisors and Investment Companies;
  3. Broker-Dealers;
  4. Exchanges and Self-Regulatory Organizations; and
  5. Clearing and Transfer Agents.

The NEP's Examination Priorities Letter reminds investors and registrants that while it intends to allocate significant resources in 2014 to these areas, the NEP will conduct additional examinations focused on risks, issues and policy matters that are not discussed in its guidance.

Market-Wide Examination Priorities

The NEP identified the following, among others, as its most significant initiatives for 2014.

  • Fraud Detection and Prevention – Because scams, theft, unfair advantage and other fraudulent activities erode the trust in the nation's capital markets and adversely affect investors and the efficient functioning of the markets, the NEP indicated it will continue to use a risk-based approach to targeting registrants and business practices. As part of this effort, the NEP advised that it will continue to utilize and enhance its quantitative and qualitative tools and techniques to seek to identify market participants engaged in fraudulent or unethical behavior. The NEP reminded registrants that it has rolled out both a Quantitative Analytics Unit and a Risk Analyses Examination Initiative to assist in these efforts.
  • Technology – Given the increasing complexity, interconnectedness and speed fostered by technology utilized in the capital markets, the NEP intends to continue focusing on examining the governance and supervision of information technology systems, operational capability, market access, information security and preparedness to respond to sudden malfunctions and system outages.
  • Dual Registrants – The NEP considers the convergence among broker-dealers and investment advisory representatives to be a significant risk. Therefore, the NEP will continue to examine the risks inherent in this business model. Moreover, the NEP will continue to assess the impact to investors of the different supervisory structures and legal standards of conduct that govern the provision of brokerage and investment advisory services.
  • New Laws and Regulation – The NEP provided that it will review general solicitation practices and verification of accredited investor status under newly adopted Rule 506(c) of the Securities Act of 1933.  Moreover, the NEP intends to review, monitor and analyze the use of Rule 506(c) generally, as well as evaluating the due diligence conducted by broker-dealers and investment advisors for such offerings. The NEP also intends to examine industry developments and compliance with crowdfunding offerings and the recently-adopted rules governing municipal advisors.

Investment Advisor and Investment Company Priorities

The NEP identified as "core risks" in this area the safety of assets and custody, conflicts of interest inherent in certain investment advisor business models, and marketing/performance. Specifically, in these areas, the NEP indicate that it would continue to test compliance with Rule 206(4)-2 under the Advisors Act (the "Custody Rule"), as examiners have continued to find that registrants have been out of compliance with its requirements. Additionally, the NEP has observed that non-compliance with the federal securities laws is frequently the result of unaddressed conflicts of interest.  The staff noted that conflicts of interest are often found in compensation arrangements, the allocation of investment opportunities, controls and disclosures related to the side-by-side management of performance-based and asset-based fee accounts, disclosures related to illiquid or leveraged investments, and higher-risk products or strategies targeted to retail (particular retired or elderly) investors. Finally, the NEP provided that it will review the accuracy and completeness of advisers' claims about their investment objectives and performance.

The NEP also explained that its 2014 examinations will focus on the following "New and Emerging Issues and Initiatives":

  • Never-Before Examined Advisors;
  • Wrap Fee Programs;
  • Quantitative Portfolio Management and Trading Strategies;
  • Presence Exams (focusing on marketing, portfolio management, conflicts of interest, safety of client assets and valuation);
  • Payments Made by Advisors and Funds to Distributors and Intermediaries (payments "in guise"); and
  • Fixed Income Investment Companies.

Finally, the NEP indicated that in 2014 it will continue to target "policy topics" including money market funds, "alternative" investment companies and securities lending arrangements.

Broker-Dealer Priorities

The NEP identified the following "core risks" in this area.

  • Sales Practices/Fraud – The NEP highlighted its broker-dealer program's efforts to conduct examinations focused on detecting and preventing fraud and other sales practice violations to retail investors with respect to affinity fraud targeting seniors and other groups; micro-cap fraud; "pump and dump" schemes; unsuitable recommendations of higher yield and/or complex products; the adequacy of due diligence efforts; and unregistered entities engaged in the sale or promotion of unregistered offerings or other unusual capital raising activities.
  • Supervision – The NEP indicated its efforts to prevent securities laws violations will focus on broker-dealer's supervision of: independent contractors and financial advisors in "remote" locations and large branch offices; registered representatives with significant disciplinary histories; and private securities transactions.

In addition, the NEP indicated it would focus on examining market access controls related to, among other things, erroneous orders; the use of technology with a focus on algorithmic trading and high frequency trading; information leakage and cyber security; and market manipulation practices involving practices such as marketing the close, parking, fraudulent stimulation of demand (spoofing), and excessive markups and markdowns.  The NEP also provided that it would continue its efforts to focus on examining internal controls, compliance with customer protection and net capital rules, and the adequacy of anti-money laundering (AML) programs.

The NEP noted that it would also focus its 2014 examinations on the following "new and emerging issues and initiatives":

  • Exchange Act Rule 15c3-5 (the "Market Access Rule");
  • Suitability of Variable Annuity Buybacks; and
  • the Fixed Income Market.

Exchanges and Self-Regulatory Organization Priorities

The OCIE's Office of Market Oversight, and its Market Oversight Program, are responsible for examining certain SROs and exchanges to evaluate their compliance with applicable securities laws and rules, as well as the SROs' own rules. In this area, the NEP identified the following 2014 priorities:

  • Oversight of FINRA;
  • Exchange examinations, including risk targeted exams focused on areas of perceived control weaknesses at the exchanges;
  • Pre-launch reviews of new exchange applicants to determine whether each applicant is organized and has the capacity to carry out its responsibilities as an SRO by enforcing its members' compliance with the federal securities laws; and
  • Section 31 fee examinations.

Clearing and Transfer Agent Priorities

The Clearance and Settlement Program identified the following areas as priorities in 2014:

  • Annual Exams Mandated by the Dodd-Frank Act, including risk-based exams of the Depository Trust Company (DTC), the National Securities Clearing Corporation (NSCC), the Fixed Income Clearing Corporation (FICC) and the Options Clearing Corporation (OCC);
  • Other Examinations, including utilizing a risk-based approach to examine clearing agencies; and
  • Pre-launch review of new clearing firm applicants.

Additionally, in 2014, the Transfer Agent Program intends to focus on examining the following areas:

  • Compliance and controls with respect to the "core activities" of transfer agents: the timely turnaround of items and transfers; accurate recordkeeping and associated retention; and safeguarding funds and securities;
  • Transfer agents that service microcap securities and private offerings;
  • Policies and procedures adopted by transfer agents;
  • Transfer agents that provide "third-party" administration;
  • Policies and procedures related to order taking, recordkeeping and clearing relationships, particularly with respect to the Direct Registration System; and
  • Business continuity and disaster recovery plans.

Conclusion

The NEP's 2014 Examination Priorities Letter provides a blueprint of areas the SEC deems to be "high risk" going into 2014. In light of this guidance, firms should assess their compliance and supervisory programs in the context of these key risk areas. Firms must also evaluate their sales practices, as well as their policies and procedures with respect to these areas, in order to ensure they are in compliance with all applicable rules and securities laws.

1 On January 2, 2014, the Financial Industry Regulatory Authority (FINRA) issued its 2014 Regulatory and Examination Priorities Letter, which identifies several areas that overlap the SEC's concerns. See Baker Donelson's alert on this topic here.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Baker Donelson | Attorney Advertising

Written by:

Baker Donelson
Contact
more
less

Baker Donelson on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.