On January 7, 2020, the U.S. Securities and Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) announced its examination priorities for 2020. The priorities continue to focus on protecting retail investors and assessing ongoing and emerging market-wide risks.
Advisers will note that OCIE continues to focus in 2020 on many of the critical investor protection and market integrity issues it did in the 2019 priorities. In addition, this year’s priorities have OCIE emphasizing the critical role that CCOs and compliance staff play at their firms, noting that “culture and tone from the top are key.” This year’s priorities also focus on new developments and issues, such as Regulation Best Interest (Reg BI), LIBOR transition, Environmental, Social and Governance (ESG) investing, and new AML beneficial ownership requirements. The priorities also put greater emphasis on operational resilience, including cybersecurity, privacy, information security and vendor risk management. Finally, the priorities explicitly focus on private funds.
2020 Priorities at a Glance
OCIE organized the 2020 examination priorities around the following themes:
- Retail investors, including seniors and people saving for retirement;
- Information security;
- Financial technology (FinTech) and innovation, including digital assets and electronic investment advice;
- Additional focus areas involving RIAs and Investment Companies;
- Additional focus areas involving Broker-Dealers and Municipal Advisors;
- Market infrastructure;
- Anti-money laundering programs; and
- Focus on Financial Industry Regulatory Authority (“FINRA”) and Municipal Securities Rulemaking Board (“MSRB”).
The priority areas outlined for 2020 are similar to OCIE’s priorities for 2019. The protection of “retail investors”, especially retirement plans and senior investors, have remained on the list for the last few years, along with Cybersecurity, and Market Infrastructure.
However, one of the newer and more interesting focus areas is that of financial technology and innovation, specifically in regard to systematic trading systems and the use of alternative data.
Advances in technology have given rise to an increasing number of investment advisers engaging in a “systematic” or “algorithmic” trading strategy. Via a collection of computer programs, these firms are capable of ingesting and processing large amounts of quantitative data in a very short period of time. In addition to the concerns regarding the data, outlined below, these firms are also frequently sending hundreds, if not thousands, of trades to the market per day. The SEC staff are exploring the controls in place to ensure that there is no potential for market abuse in the execution process, as well as identifying procedures surrounding the allocation of trades and trading strategies to client accounts, among others.
Along with the increase in the number of quantitative advisers, there is also an increasing demand for quantitative data. The result is a rapidly growing number of firms, from start-ups to established firms, who are sourcing, structuring and then selling data obtained through a variety of collection practices. OCIE is aiming to ensure that investment advisers engaged in the purchase and use of this data understand from where the data is being sourced and whether it is appropriate, or even legal, to use in their research process. The SEC staff will be asking whether there is due diligence being done on the source, including whether or not they have the right to be selling the data, and what collection practices were involved. They are also focusing on the data itself and how it is being used in the investment decision-making process. Of particular concern, are controls surrounding the potential receipt and use of material non-public information, or non-public personal information.
ACA advises firms to review their compliance programs in light of the priorities listed above. To get started, reach out to your ACA consultant or request a meeting here.
2020 Priorities in Detail
Protecting Retail Investors, Including Seniors and Those Saving for Retirement
OCIE will continue to pursue a variety of examination initiatives to assess potential risks to retail investors that arise in an increasingly complex investment landscape. Among other things, the SEC's National Exam Program ("NEP") will focus on the following:
Fraud, Sales Practices, and Conflicts
The SEC emphasized the importance of providing investors with disclosures relating to fees and expenses and conflicts of interest. OCIE will continue to review how firms oversee their interactions with senior investors, teachers, and military personnel, and how services and products are offered to these investors.
Examiners will also continue to review whether fees and expenses are calculated and charged in accordance with disclosures provided to investors. Of particular interest for 2020 will be practices or business models that create conflicts of interest and increased risks of inadequately disclosed fees, expenses, or other charges (e.g., advisory personnel who receive incentives to recommend certain mutual fund share classes that pay higher sales loads or distribution fees).
- Mutual Funds and Exchange Traded Funds (ETFs)
OCIE will continue to focus on mutual funds and ETFs and whether advisers are properly disclosing investment risks to investors and the oversight practices of their board of directors. OCIE also will review for mutual fund fee discounts that should be provided to investors as a result of policies.
- Municipal Securities and Other Fixed Income Securities
OCIE will examine broker-dealer trading activity in municipal and corporate bonds for compliance with best execution obligations; fairness of pricing, markups and mark-downs, and commissions; and confirmation disclosure requirements, including retail disclosures relating to mark-ups and mark-downs.
- Microcap Securities
OCIE will continue to examine broker-dealers involved in selling stocks of companies with a market capitalization of under $250 million and review for manipulative schemes, compliance with Regulation SHO, and compliance with Exchange Act Rule 15c2-11.
Standards of Care
Firms will need to prepare for compliance with the Commission’s June 2019 adoption of Regulation Best Interest, the Interpretation Regarding Standard of Conduct for Investment Advisers, and the Form CRS Relationship Summary. Following the June 30, 2020 compliance date for Regulation Best Interest and Form CRS, OCIE intends to assess implementation of the requirements, including policies and procedures regarding conflicts disclosures, and for both broker-dealers and RIAs. OCIE has already integrated the Interpretation Regarding Standard of Conduct for Investment Advisers into the IAIC examination program.
Cybersecurity has been a focal point for the NEP for the past few years, however, this year the topic has been broadened to acknowledge that a breach in information security, including a successful cyber-attack, may have consequences extending beyond the firm compromised. Focus areas will include proper configuration of network storage devices, information security governance, and policies and procedures related to retail trading information security, among others.
In connection to third-party and vendor risk management, OCIE will also focus on oversight practices related to certain service providers and network solutions, including those leveraging cloud-based storage.
Financial Technology (FinTech) and Innovation, including Digital Assets and Electronic Investment Advice
FinTech continues to develop rapidly. OCIE remains focused on staying on top of new and evolving technologies to assess the effectiveness of related compliance and controls related to firms’ usage of alternative data and technologies.
There has been significant growth in this market, which means increased risk. The OCIE will continue to monitor the offer and sale, trading, and management of digital assets, and for firms actively engaged in the digital asset market, examinations will focus on, among other things, investment suitability, portfolio management, trading, safety of client funds and assets, pricing, compliance programs and internal controls, and supervision of employee outside business activities.
Electronic Investment Advice or Robo-Advisors
Areas of focus will include, among others, SEC registration eligibility, cybersecurity policies and procedures, marketing practices, adherence to fiduciary duty, including adequacy of disclosures, and effectiveness of compliance programs.
Additional Focus Areas Involving RIAs and Investment Companies
OCIE will continue to review the compliance programs of RIAs. For 2020, there will be a particular interest in the accuracy and adequacy of disclosures provided by RIAs offering clients new types or emerging investment strategies, such as strategies focused on sustainable and responsible investing, which incorporate environmental, social, and governance (ESG) criteria.
Additionally, OCIE will prioritize examinations of:
- newly registered advisers, as well as advisers that have been registered for some time but have never been examined;
- mutual funds and ETFs, the activities of their RIAs, and oversight practices of their boards of directors; and
- RIAs to private funds, such as firms that provide management to separately managed accounts side-by-side with private funds.
Additional focus areas involving Broker-Dealers and Municipal Advisors
In addition to focusing on their sales practices to retail investors, broker-dealer examinations will also focus on the safety of customer cash and securities, risk management, certain types of trading activity, the effects of evolving commissions and other cost structures, best execution, and payment for order flow arrangements.
Anti-Money Laundering Programs
Examiners will continue to review whether firms are in compliance with applicable anti-money laundering requirements, with a focus on the compliance and testing of these firms’ AML programs.
OCIE will continue to examine firms that provide services that directly impact the functioning of critical markets with a focus on those firms’ operations and compliance with recently effective rules.
OCIE will continue to conduct examinations of clearing agencies that the Financial Stability Oversight Council has deemed systemically important and risk-based examinations of other registered clearing agencies.
National Securities Exchanges
OCIE will examine internal audit and surveillance programs and funding for regulatory programs.
Regulation Systems Compliance and Integrity (SCI) Entities
Examiners will continue to review SCI entities and assess the effectiveness of their written policies and procedures as relates to Regulation SCI.
Examiners will focus on transfer agent operations, including transfers, recordkeeping, and the safeguarding of funds and securities.
Focus on FINRA and MSRB
OCIE will continue to oversee FINRA and MSRB.
OCIE examinations of FINRA will focus on FINRA’s operations and regulatory programs, including the quality of their examinations of broker-dealers and municipal advisors that are also registered as broker-dealers.
OCIE examinations of MSRB will focus on the effectiveness of MSRB’s operational and internal policies, procedures, and controls.
Attend our Upcoming Webcast
Join us Wednesday, January 22 at 11am ET for a live webcast discussion about the SEC’s 2020 examination priorities.
For More Information
To learn more about how ACA can help enhance or strengthen your compliance program, please reach out to your ACA consultant or request a call here.