The SEC’s Office of Compliance Inspections and Examinations (OCIE) publishes a yearly list of examination priorities. Although Registered Investment Advisers (RIAs) can expect examiners to focus on these priorities during an examination, OCIE uses a risk-based approach with each advisory firm. The scope of an RIA’s examination will depend upon the firm’s risk factors, such as the type of advisory services and products offered to clients.
Retail Investors, Including Seniors and Those Saving for Retirement
OCIE’s priorities reflect the SEC’s desire to protect retail investors, especially seniors and those saving for retirement. Examiners are particularly concerned about recommendations and advice given to seniors in retirement communities, as well as teachers and military personnel.
OCIE’s priorities recognize that certain securities products pose elevated risks when marketed to retail investors. Examiners will be scrutinizing higher-risk products, especially if they are complicated or non-transparent. Products with high fees and expenses are viewed as being riskier. Among the higher-risk products that concern OCIE are private placements and securities issued in new and emerging risk areas. In addition, examiners will be looking closely at RIAs that recommend affiliated or related issuers.
It is not surprising that OCIE’s examinations will address Regulation Best Interest, the Interpretation Regarding Standard of Conduct for Investment Advisers, and the Form CRS Relationship Summary, which were adopted in June, 2019 and have a compliance date of June 30, 2020. These standards of care are derived from well-established fiduciary principles and cannot be satisfied through disclosure alone. After the compliance date, examiners will begin evaluating the content and delivery requirements of Form CRS. The SEC’s interpretation of fiduciary duty is already an integral element of the investment adviser examination program.
Market Infrastructure and Information Security
OCIE’s priorities are intended to ensure that capital markets are secure and resilient. Therefore, OCIE will focus on critical services such as clearing agencies, national securities exchanges, alternative trading systems, and transfer agents.
Cybersecurity and data privacy will once again be a significant examination priority. Examiners will make certain that RIAs have implemented measures to protect clients’ financial information. Examiners also expect RIAs to oversee the information security of third parties and vendors. In addition, examinations will review registrants’ compliance with Regulations S-P (client privacy) and S-ID (identity theft) and their disposal of hardware, which may contain client and network information.
Because of the risks, OCIE will identify and examine registrants involved in the digital assets market, as well as those providing services through automated tools and platforms (i.e., “robo-advisers”).
Examinations will assess:
- Investment suitability;
- Portfolio management and trading practices;
- Safety of clients’ assets and funds;
- Pricing and valuation;
- Effectiveness of compliance programs and controls; and
- Supervision of employees’ outside business activities.
RIA Compliance Programs
Examinations will continue to assess RIAs’ compliance programs. Dually-registered advisers will be treated as a high priority. Examiners will be reviewing the risks associated with best execution, prohibited transactions, fiduciary advice, and disclosure of conflicts arising from these arrangements.
OCIE will also prioritize examinations of firms that utilize third-party asset managers. They will be reviewing RIAs’ due diligence practices, policies, and procedures. SEC examiners will be very interested in the accuracy and adequacy of disclosures of emerging investment strategies, such as a strategy focused on sustainable and responsible investing.
OCIE will continue to conduct risk-based examinations of RIAs that have never been examined. This priority includes new RIAs, as well as firms that have not been examined in recent years. Because older firms may have changed their business model or grown significantly, examiners want to determine if their compliance programs have been tailored to those changes.
Examiners will remain focused on advisers to private funds. OCIE’s priority in this area includes firms that provide management to separately managed accounts side-by-side with private funds.
Examiners will evaluate firms’ compliance risks, controls implemented to prevent the misuse of material, non-public information, and conflicts of interest.
RIAs will benefit greatly by carefully reviewing OCIE’s annual list of priorities. Following that review, firms should take steps to bolster their compliance programs to address OCIE’s concerns.
During Fiscal Year 2019, OCIE issued more than 2,000 deficiency letters. In response to those letters, many firms were compelled to take direct corrective actions, such as amending policies and procedures, enhancing their disclosures, or returning fees to investors. By being proactive, RIAs may be able to avoid compliance deficiencies.
OCIE’s 2020 examination priorities can be found at https://www.sec.gov/news/press-release/2020-4.
About RIA Compliance Group: RIA Compliance Group is an investment adviser compliance consulting firm based in Delray Beach, Florida. The firm’s mission is to provide affordable, timely, practical, and cost-effective compliance advice. We help investment advisers to comply with the myriad of state and SEC regulations and compliance obligations facing their firms. RIA Compliance Group takes pride in giving personal service and real world compliance advice, not theoretical concepts and legalese. The firm interacts on a daily basis with SEC and state securities regulators.