SEC Releases 2019 Examination Priorities

The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) has released its 2019 examination priorities. OCIE publishes its exam priorities annually to promote transparency of its examination program and provide insights into the areas it believes present potentially heightened risk to investors or the integrity of the U.S. capital markets.  This year, particular emphasis will be on digital assets, cybersecurity, advisory issues and matters of importance to retail investors, including fees, expenses, and conflicts of interest.

“OCIE continues to thoughtfully approach its examination program, leveraging technology and the SEC staff’s industry expertise,” said SEC Chairman Jay Clayton. “As these examination priorities show, OCIE will maintain its focus on critical market infrastructure and Main Street investors in 2019.”

This year, OCIE’s examination priorities are broken down into six categories:

  • Compliance and Risks in Critical Market Infrastructure.

OCIE will continue to examine entities that provide services critical to the proper functioning of capital markets. OCIE will conduct examinations of these firms which include, among others, clearing agencies, national securities exchanges, and transfer agents, focusing on certain aspects of their operations and compliance with recently effective rules.

  • Retail Investors, Including Seniors and Those Saving for Retirement.

OCIE will continue to prioritizes the protection of retail investors, particularly seniors and those saving for retirement in 2019.  To this end, OCIE will focus examinations on:

Senior Investors.  OCIE will conduct examinations that review how broker-dealers oversee their interactions with senior investors, including their ability to identify financial exploitation of seniors. In examinations of investment advisers, OCIE will continue to review the services and products offered to seniors and those saving for retirement. These examinations will focus on, among other things, compliance programs of investment advisers, the appropriateness of certain investment recommendations to seniors, and the supervision by firms of their employees and independent representatives.

Broker-Dealers Entrusted with Customer Assets.  Broker-dealers that hold customer cash and securities must abide by certain rules, including the Customer Protection Rule (Exchange Act Rule 15c3-3), and have a significant responsibility to ensure that those assets are safeguarded and accurately reported.  The Customer Protection Rule restricts the use of customer assets and prevents the broker-dealer from using customer assets as working capital. Examinations of select broker-dealers will focus on compliance with this rule, as well as procedures and controls to promote compliance.

Advisory Issues.  With respect to disclosures regarding the costs of investing, OCIE will continue to review fees charged to advisory accounts, ensuring that the fees are assessed in accordance with client agreements and firm disclosures. For these examinations, OCIE will select firms with practices or business models that may create increased risks of inadequately disclosed fees, expenses, or other charges. With respect to mutual fund share classes, OCIE will continue to evaluate financial incentives for financial professionals that may influence their selection of particular share classes. In addition, OCIE remains focused on investment advisers participating in wrap fee programs, which charge investors a single bundled fee for both advisory and brokerage services.

Additionally, OCIE will continue to exam investment advisers to ensure that those advisers are acting in a manner consistent with their fiduciary duty and adequately disclosing conflicts of interests.  Since conflicts of interest provide incentives for financial professionals to recommend certain types of products and services, OCIE examinations will additionally focus on the policies and procedures addressing the use of affiliated service providers and products, securities-backed non-purpose loans and line of credits, and borrowing funds from clients.

OCIE will also continue to conduct risk-based examinations of certain investment advisers that have never been examined, including newly-registered investment advisers, as well as those registered for several years but that have yet to be examined. OCIE will also prioritize examinations of certain investment advisers that have not been examined for a number of years and may have substantially grown or changed business models.

 Finally, OCIE will review advisory firms’ practices related to portfolio management and trading of advisory client account.  To this end, OCIE will examine investment transactions executed on behalf of advisory clients to determine that they fairly allocate investment opportunities among clients, ensuring consistency of investments with the objectives obtained from clients, disclosing critical information to clients, and complying with other legal restrictions and that the investment or trading strategies of advisers are suitable for and in the best interests of investors based on their investment objectives and risk tolerance. 

  • FINRA and MSRB

OCIE will continue its oversight of FINRA by focusing examinations on FINRA’s operations and regulatory programs, including market regulation by contract for a majority of national securities exchanges, reviews of broker-dealer advertisements, administration of the testing and licensing of registered persons, and operation of industry utilities such as Trade Reporting Facilities.  Additionally, examinations of FINRA will continue to focus on the quality of FINRA’s examinations of broker-dealers and municipal advisors that are also registered as broker-dealers.

MSRB regulates the activities of broker-dealers that buy, sell, and underwrite municipal securities, and municipal advisors. MSRB establishes rules for municipal securities dealers and municipal advisors, supports market transparency by making municipal securities trade data and disclosure documents available, and conducts education and outreach regarding the municipal securities market. OCIE, in coordination with FINRA, conducts examinations of MSRB members to ensure compliance with MSRB rules. Given MSRB’s broad responsibility to regulate municipal securities transactions, OCIE will continue to conduct inspections of MSRB to evaluate the effectiveness of MSRB’s policies, procedures, and controls.

  • Digital Assets.

The digital asset market has grown rapidly and may present risks to retail investors. The number of digital asset market participants, including broker-dealers, trading platforms, and investment advisers, also continues to increase. Given the significant growth and risks presented in this market, OCIE will continue to monitor the offer and sale, trading, and management of digital assets, and where the products are securities, examine for regulatory compliance. In particular, through high level inquiries, OCIE will take steps to identify market participants offering, selling, trading, and managing these products or considering or actively seeking to offer these products and then assess the extent of their activities. For firms actively engaged in the digital asset market, OCIE will conduct examinations focused on, among other things, portfolio management of digital assets, trading, safety of client funds and assets, pricing of client portfolios, compliance, and internal controls.

  • Cybersecurity.

Cybersecurity protection is critical to the operation of the financial markets. The impact of a successful cyber-attack may have consequences that extend beyond the firm compromised to other market participants and retail investors, who may not be well informed of these risks and consequences.  OCIE is working with firms to identify and manage cybersecurity risks, and to encourage market participants to actively and effectively engage in this effort.

OCIE will continue to prioritize cybersecurity in each of its five examination programs. Examinations will focus on, among other things, proper configuration of network storage devices, information security governance generally, and policies and procedures related to retail trading information security. Specific to investment advisers, OCIE will emphasize cybersecurity practices at investment advisers with multiple branch offices, including those that have recently merged with other investment advisers, and continue to focus on, among other areas, governance and risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response.

  • Anti-Money Laundering Programs.

The Bank Secrecy Act requires broker-dealers to establish anti-money laundering (AML) programs. These programs must, among other things, include policies and procedures reasonably designed to identify customers, perform customer due diligence, monitor for suspicious activity, and where appropriate, file suspicious activity reports (SARs) with the Financial Crimes Enforcement Network.  The use of SARs include the detection and combating terrorist financing, public corruption, market manipulation, and a variety of other fraudulent behavior.

In 2019, OCIE will continue to prioritize examining broker-dealers for compliance with their AML obligations, including whether they are meeting their SAR filing obligations, implementing all elements of their AML program, and robustly and timely conducting independent tests of their AML program.

The 2019 examination priorities published reflect OCIE’s assessment of certain risks, issues, and policy matters arising from market and regulatory developments, information gathered from examinations, and other sources, including tips, complaints, and referrals, and coordination with other regulators.  Finally, it is important to note that the priorities for 2019 are not exhaustive, and OCIE will also address other issues in its examinations.