The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) announced its 2020 Examination Priorities. OCIE publishes its examination priorities annually to enhance the transparency of its examination program and to provide insights into its risk-based approach, including the areas it believes present potential risk to investors and the integrity of U.S. capital markets.

Exam Priorities

OCIE identified the following examination priorities for 2020, which are substantially similar to last year’s.

Retail Investors, Including Seniors and Individuals Saving for Retirement

OCIE will continue to emphasize the protection of retail investors, particularly seniors and those saving for retirement. OCIE will prioritize examinations i) of intermediaries that serve retail investors, namely SEC-registered investment advisers (“advisers”), broker-dealers, and dually registered firms; and ii) focused on investments marketed to, or designed for retail investors, such as mutual funds and exchange-traded funds (“ETFs”), municipal and other fixed income securities, and microcap securities. OCIE’s focus areas in this category are:

• • Fraud, sales practices, and conflicts. Examinations will focus on recommendations and advice given to retail investors, with a particular focus on seniors, teachers, and military personnel. Additionally, OCIE will focus on higher risk products, including private placements and securities of issuers in new and emerging risk areas;
  • Retail-targeted investments. OCIE will focus on mutual funds and ETFs, municipal securities and other fixed income securities, and microcap securities; and
  • Standards of care. OCIE will focus on Regulation Best Interest, the SEC’s Interpretation Regarding Standard of Conduct for Investment Advisers, and the Form CRS Relationship Summary.

Market Infrastructure

OCIE will continue its focus on entities that offer services critical to the proper functioning of capital markets, including clearing agencies, national securities exchanges, alternative trading systems, and transfer agents. Particular attention will be focused on the security and resiliency of entities’ systems.

Information Security

OCIE will continue to prioritize information security. Examinations will focus on, among other things, proper configuration of network storage devices, information security governance generally, and retail trading information security.

Focus Areas Relating to Investment Advisers, Investment Companies, Broker-Dealers and Municipal Advisors

• • OCIE will continue to focus on advisers that have never been examined, including new advisers and advisers previously registered that are yet to be examined.
  • OCIE will prioritize examining firms that utilize the services of third-party asset managers to advise clients’ investments to assess, among other things, the extent of these advisers’ due diligence practices, policies, and procedures.
  • OCIE has a particular interest in the accuracy and adequacy of disclosures provided by advisers 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.
  • Registered investment company examinations will focus on mutual funds and ETFs, the activities of their advisers, and the oversight practices of their boards of directors.
  • Broker-dealer examinations will focus on issues relating to the preparation for and implementation of recent rulemaking, along with trading practices.

Anti-Money Laundering Programs

OCIE will continue to prioritize examining broker-dealers and registered investment companies for compliance with their anti-money laundering (“AML”) obligations. The examinations will assess, among other things, whether these firms have established appropriate customer identification programs and whether they are satisfying their suspicious activity monitoring and reporting obligations, conducting due-diligence on customers, complying with beneficial ownership requirements, and conducting robust and timely independent tests of their AML programs.

Financial Technology (Fintech) and Innovation, Including Digital Assets and Electronic Investment Advice

Digital Assets. OCIE will continue to identify and examine SEC-registered market participants engaged in the digital asset market due to this space’s rapid growth and various risks. Examinations will assess: (i) investment suitability; (ii) portfolio management and trading practices; (iii) safety of client funds and assets; (iv) pricing and valuation; (v) effectiveness of compliance programs and controls; and (vi) supervision of employee outside business activities.

Electronic Investment Advice. OCIE will continue its focus on advisers that provide services to their clients through automated investment tools and platforms, often referred to as “robo-advisers.” Areas of focus include but are not limited to: (i) SEC registration eligibility; (ii) cybersecurity policies and procedures; (iii) marketing practices; (iv) adherence to fiduciary duty, including adequacy of disclosures; and (v) effectiveness of compliance programs.

FINRA and MSRB

OCIE will continue to conduct risk-based oversight examinations of the Financial Industry Regulatory Authority and examinations of Municipal Securities Rulemaking Board-registered firms.

Exam Statistics

In 2019, OCIE’s staff completed 3,089 examinations of advisers, investment companies, and broker-dealers, which is a 2.7% decrease from 2018. OCIE attributed this minor decrease to a month-long suspension of exam activity due to a government shutdown. Examinations of advisers fell slightly to approximately 2,180, covering 15% of this population as compared to 17% in 2018. Examinations of registered investment companies grew to over 150, increasing by approximately 12% from last year.

Exam Risk Factors

OCIE stated that the selection of firms for examination and the related areas of focus are determined through OCIE’s risk-based analysis, which varies depending on the type of firm and the nature of its business. OCIE considers dozens of factors in selecting advisers and broker-dealers for examination, including:

• Products and services offered, including certain products identified as higher risk;
• Compensation and funding arrangements;
• Prior examination observations and conduct;
• Disciplinary history of associated individuals and affiliates of a registered firm;
• Changes in firm leadership and other personnel; and
• Whether a firm has access to investor assets (i.e., custody).

Hallmarks of Effective Compliance

After conducting thousands of examinations on a variety of firms, OCIE noted several “hallmarks” of effective compliance that include:

• Compliance’s active management in most facets of firm operations and early involvement in important business decisions, including product innovation and new services;
• A knowledgeable and empowered chief compliance officer with full responsibility, authority, and resources to develop and enforce policies and procedures of the firm; and
• A commitment from C-level executives to set a tone from the top that compliance is integral to the organization’s success and that there is tangible support for compliance at all levels of an organization.

S&K Observations

In view of the continued frequency and scope of OCIE exams, advisers should regularly review the adequacy and effectiveness of their compliance program, policies and procedures.
Seward & Kissel Regulatory Compliance (“SKRC”) offers mock audits, compliance reviews and compliance trainings to help advisers prepare for OCIE exams.