Dear Compliance Professional,
The National Examination Program (NEP) of the SEC’s Office of Compliance Inspections and Examinations recently released its examination priorities for 2013. The NEP release addresses both market-wide priorities and priorities for each of the NEP’s four distinct program areas: (i) investment advisers and investment companies; (ii) broker-dealers; (iii) clearing and transfer agents; and (iv) market oversight.
There are several risk areas and examination priorities that apply to nearly all registrants and are as follows:
- Fraud Detection and Prevention – internal programs and controls will be scrutinized
- Corporate Governance and Enterprise Risk Management – how does the firm govern and manage legal, financial, compliance, operational and reputation risks
- Conflicts of Interest – risk governance frameworks will be looked at, including scrutiny over the firm’s affiliations
- Technology – the NEP may conduct examinations on the governance and supervision of IT systems for topics such as operational capability, market access, and information security (system outrages, data integrity) which may adversely affect investor confidence.
Priorities in each program area include:
- For investment advisers and investment companies — presence exams for newly registered private fund advisers, and payments by advisers and funds to entities that distribute mutual funds
- For broker-dealers — sales practices and fraud, and compliance with the new market access rule
- For market oversight — risk-based examinations of securities exchanges and FINRA, and order-type assessment
- For clearing and settlement — For transfer agent exams, timely turnaround of items and transfers, accurate recordkeeping, and safeguarding of assets. For clearing agencies designated as systemically important, conduct annual examinations as required by the Dodd-Frank Act.
Ongoing risks that are examination priorities in the investment adviser/investment company (IA/IC) area include:
- Safety of Assets
- Conflicts of Interest Related to Compensation Arrangements
- Fund Governance
New and Emerging Issues:
- Approximately 2,000 investment advisers have registered with the SEC for the first time as a result of Dodd-Frank. The NEP notes that the vast majority of new investment adviser registrants are advisers to hedge funds and private equity funds, and have never been subject to SEC regulation or examination. As such, the NEP will launch a two-year, coordinated national examination initiative;
- The continued convergence between investment advisers and broker-dealers (where the lines between the two types of registrants have blurred) and the practice of transacting advisory trades through broker-dealer firms for which they are registered representatives. The SEC stresses the dual registrant model is full of conflicts;
- The growing use of hedge fund strategies by mutual funds and the compliance issues involved with the use of these novel strategies; and
- The assessment of whether payments are being made to investment advisers by mutual fund companies in accordance with Investment Company Act Rule 12b-1
- Money Market Funds
- Compliance with Exemptive Orders
- Compliance with the Pay to Play Rule
Ongoing risks that are examination priorities in the Broker-Dealer (B-D) area include:
Sales Practices/Fraud. The B-D Program frequently finds fraud in connection with sales practices regarding retail investors, including: fraud targeting seniors, unsuitable recommendations of higher yield products, as well as activities and products on the periphery of certain registered entities, such as outside business activities.
Trading. The staff intends to address certain trading risk areas, with particular focus on high frequency trading, algorithmic trading, proper controls around the use of technology, alternative trading systems and order routing practices.
Capital. The B-D Program intends to conduct exams of clearing firms with multiple correspondents engaging in high frequency/high volume trading, focusing on the clearing firms’ internal controls for managing intraday liquidity risk, as well as assessing intraday net capital and other financial risks.
AML. The staff will identify clearing and introducing firms that appear to have weak anti-money laundering (“AML”) programs, especially customer identification programs (CIP), suspicious activity identification and reporting deficiencies, and weak due diligence procedures regarding certain accounts.
New and Emerging Trends for the B-D Program in 2013 will include:
- Exchange Act Rule 15c3-5, (the Market Access Rule) – i.e. Master/Sub-Accounts, Proprietary Trading, supervision of registrants’ technology system controls and governance, dual registrants/regulatory coordination
- Exchange-Traded Funds.
Policy Topics for the B-D Program in 2013 will include:
- JOBS Act
- Other Regulatory Requirements
The priority list is not exhaustive and priorities may be adjusted throughout the year in light of ongoing risk assessment activities. Senior exam staff, management from the SEC’s 12 regional offices and other SEC divisions and offices selected the examination priorities for 2013 in consultation with each of the commissioners, based on a variety of information and risk analytics. Click here to view the NEP’s complete list of examination priorities for 2013.