As the new year begins, Investment Advisors can expect an increase of compliance examinations. The SEC Office of Compliance Inspections and Examinations (“OCIE”) is aiming to target roughly 4,000 RIAs that have never been examined before. While there is some skepticism whether the SEC has enough resources to increase examinations, Reps Maxine Waters, D-Calif., and John Delaney, D-Md. are sponsoring a bill, the Investment Adviser Examination Improvement Act of 2013, that would authorize the SEC to collect annual user fees from RIAs to increase the frequency of their exams. Stay tuned for future updates about this bill’s progress.
So that Investment Advisers can better prepare for upcoming exams, the National Examination Program (“NEP”), a division of OICE, recently published its 2014 examination priorities to communicate with investors and registrants about areas perceived to have heightened risk. This article will discuss the NEP’s market-wide examination priorities as well as specific priorities for Investment Advisers/Investment Companies (“IA-IC’s”).
The most significant market-wide examination initiatives include the following areas:
- Fraud Detection and Prevention
- Corporate Governance, Conflicts of Interest, and Enterprise Risk Management
- Dual Registrants
- New Laws and Regulation (i.e. Rule 506(c) and crowdfunding)
- Retirement Vehicles and Rollovers
In addition to the market-wide issues listed above, the NEP intends to address specific concerns in its IA-IC Program. This Program has primary examination authority for approximately 11,000 registered investment advisers and 800 registered investment company complexes. Collectively, these entities manage nearly $55 trillion for investors. The program’s initiatives are divided into core risks, new and emerging risks, and policy topics.
The NEP has defined core risks as those “risk areas that are common to IA-IC’s and that have existed for a sustained period and are likely to continue for the foreseeable future.” New and emerging issues and initiatives are “issues and business practices that pose an increased risk due to changes and developments in the industry, including changes in financial conditions, products or investment strategies offered, technology, regulation, business combinations, and business practices.” Policy topics are “areas in which the SEC has an interest in gaining a better understanding of business practices in a particular area or learning the practical application of previously adopted rules and guidance.”
The IA-IC core risks include the following:
- Safety of Assets and Custody (particularly the “Custody Rule” under Rule 206(4)-2 of the Advisers Act)
- Conflicts of Interest Inherent in Certain Investment Adviser Business Models
- Marketing/Performance (i.e. marketing efforts from newly implemented JOBS Act rules)
IA-IC new and emerging risks include:
- Never-Before Examined Advisers (aimed at IA-IC’s registered for over three years but not yet examined by the NEP)
- Wrap Fee Programs
- Quantitative Trading Models
- Presence Exams
- Payments for Distribution in Guise
- Fixed Income Investment Companies
IA-IC policy topics are the following:
- Money Market Funds
- “Alternative” Investment Companies (particular focus on: (i) leverage, liquidity and valuation policies and practices; (ii) the staffing, funding, and empowerment of boards, compliance personnel, and back-offices; and (iii) the manner in which such funds are marketed to investors.)
- Securities Lending Arrangements
While the NEP plans to allocate substantial resources to the examinations of the issues outlined above, the list is not exhaustive and Investment Advisers should not limit their expectations to the topics discussed herein.