Resources for How to Address the SEC’s 2019 Focus Areas

Resources for How to Address the SEC’s 2019 Focus Areas

21 February 2019

Each year, the SEC publishes their exam priorities.  This provides advisers with transparency in OCIE’s examination program and highlights areas that the SEC believes are of heightened risk.

Unlike last year (when OCIE announced a focus on cryptocurrencies) there is nothing brand new this year that we haven’t seen in previous years.  It’s kind of the same ‘ol, same ‘ol.

However, if you…

  • Are new to the industry,
  • Haven’t stayed on top of the SEC’s focus areas in the past, and/or
  • Want to be prepared for an exam…

 

…understanding exactly what is on their radar is a good practice.

2019 Focus Areas

While there are six areas of focus for 2019, this article discusses only the three areas that directly impact registered investment advisers:

  1. Retail investors, including seniors and those saving for retirement
  2. Digital assets, which include cryptocurrencies, coins, and tokens
  3. Cybersecurity

For each focus area, we provide a summary from the SEC’s 2019 Examination Priorities publication, suggestions for how to address the SEC’s concerns, and wherever possible, links to resources for additional information and guidance.

Let’s get started.

Retail Investors

OCIE announced it will focus on the following categories, as they relate to the retail investor:

  1. Fees and Expenses
  2. Conflicts of Interest
  3. Senior Investors and Retirement Accounts and Products
  4. Portfolio Management and Trading
  5. Never-Before or Not-Recently-Examined Investment Advisers
  6. Mutual Funds and Exchange Traded Funds
  7. Municipal Advisers

Let’s break it down, one by one.

1.  Fees and Expenses

It is important that investors are provided with full and complete disclosures on the fees and expenses they will be paying and how those fees are being calculated.

SCS Suggests

  • As part of your annual compliance review, periodically conduct a review to compare client agreements, invoices, and the ADV to ensure the fees disclosed and billed are consistent. Also, compare the assets for proper valuation, and confirm proper calculation.
  • If you have any additional conflicts that create financial incentives (e., recommending securities in which persons receive commission or have ownership, referral arrangements), make sure the conflicts and financial arrangements are fully disclosed to the clients in your ADV Part 2A.
  • If you charge a consulting or financial planning fee (whether hourly or fixed), make sure you have evidence to support the services rendered and that the fee is earned.

 

2.  Conflicts of Interest

Examiners will review the adviser’s policies for:

  • use of affiliated service providers and products,
  • security-based, non-purpose loans and lines of credit, and
  • borrowing funds from clients.

 

These all present additional conflicts that need to either be avoided or fully disclosed and mitigated to adhere to your fiduciary responsibility.

SCS Suggests

Again…

  • If you have any additional conflicts that create financial incentives (e., recommending securities in which persons receive commission or have ownership, referral arrangements), make sure the conflicts and financial arrangements are fully disclosed to the clients in your ADV Part 2A.
  • If borrowing money from a client, review the firm’s financial condition to make sure full payment is highly probable and disclose this practice fully in your ADV part 2A. Interview staff to confirm loans are fully disclosed.

 

3.  Senior Investors and Retirement Accounts and Products

The SEC continues to focus on the compliance program, appropriateness of certain investment recommendations made to seniors, and the supervision of employees and independent representatives working with senior investors.

SCS Suggests

If you haven’t already, we encourage you to read our blog post about Senior Investors.   We go into a lot of detail about:

  • who is considered a senior investor,
  • what your responsibility is to them,
  • the types of senior-investor-related questions we have seen in SEC examinations,
  • how to address the SEC’s concerns with your policies and procedures,
  • processes for obtaining a trusted contact,
  • how to train your staff to look for signs of diminished capacity and elder abuse, and
  • how to address diminished capacity and elder abuse, if it is suspected.

 

It’s a helpful read.

4.  Portfolio Management and Trading

This is a critical component to an investment adviser’s business.  The SEC will focus on allocation, consistency with objectives, suitability, monitoring of accounts, and if making more risky investments, the adequacy of those disclosures.

SCS Suggests

  • As part of your annual review, periodically obtain client investment policy statements, confirm objectives are in line with your clients’ risk tolerances, and compare against appraisal reports for adherence to objectives and restrictions. Interview the portfolio managers and confirm their process is consistent with your firm’s written policies and disclosures in the ADV Part 2A, and make any adjustments as needed.
  • As part of your annual review, periodically review the firms trading activity for its clients, and analyze to see if there are any patterns of accounts being systematically favored or disfavored. Confirm adherence to the firm’s allocations and rotation policies.  Again, make adjustments as needed.

 

5.  Never-Before or Not-Recently-Examined Investment Advisers

The SEC will continue to focus their attention on advisers that have either never been seen or have not been examined in many years.

SCS Suggests

For New Advisers

You can fill out the form at the bottom of our website to pick up our free step-by-step guide for CCOs, “How to Master the Annual Review and Promote a Culture of Compliance.”  It is a 3-part series in which you learn how to develop an annual review to work for you instead of against you, how to make it realistic to implement and manage, and how to make it support the operations and ever-changing needs of your firm, as opposed to being just another thing you have to do to meet regulatory requirements.  But the beauty of it is, by going through this process, you WILL meet the SEC’s requirements.

For Never-Before and Not-Recently-Examined Investment Advisers

If you have never been examined or it has been a few years, review a recent SEC exam letter and confirm you are able to address the request.  (Reach out to us, if you would like a copy of a recent SEC exam letter.)  In our experience, the SEC generally provides an adviser two weeks to gather the required records.

Also, continue reading this article and review recent Risk Alerts to stay on top of the SEC’s hot topics.

6.  Mutual Funds and Exchange Traded Funds

These are the primary investment vehicles for retail investors.  The SEC issued a risk alert of the types of Mutual Funds and ETFs they are going to focus their exams on.

SCS Suggests

If you haven’t already, read our discussion about the ETF and Mutual Fund Risk Alert.  We provide suggestions for each of the categories of ETFs and Mutual Funds that the SEC is concerned about:

  • Index funds that track custom-built indexes
  • Smaller ETFs
  • ETFs with little secondary market trading volume
  • Funds with higher allocations to certain securitized assets
  • Funds that underperform significantly relative to peer groups
  • Newer mutual funds or ETFs
  • Mutual funds and private funds that have similar strategies and/or are managed by the same portfolio manager(s)

 

If your firm manages any of those mutual funds or ETFs that fall into any of those categories, read our blog post.

7.  Municipal Advisers

The SEC will select municipal advisers that have never been examined to confirm their restriction requirements, professional qualifications, and continuing education requirements have been met. They will also address the MSRB rules for adherence and appropriate disclosures regarding conflicts.

SCS Suggests

If you’re a municipal adviser, make sure you fully understand the requirements and can support your adherence.

Digital Assets

The availability of digital assets continues to grow.  The SEC will monitor the offer, sale, trading, and management of digital assets.  The SEC will confirm proper registration if digital assets are in fact determined to be a security.  They will identify the market participants that are offering, selling, trading, and managing these types of assets.  For advisers that offer digital assets, during the examination, they will focus on: portfolio management, trading, safety of client funds and assets, pricing, compliance and internal controls.  Which—let’s face it—generally covers everything.

SCS Suggests

It seems this is an area that the SEC is still unfolding.  When we attended a conference with regulators, they didn’t have answers.  If you are an adviser that offers cryptocurrency, you need to be able to fully address the following:

  • The existence of the assets. If they cannot be validated, then full disclosure on this limitation should be made.
  • Document the process for how the assets are valued, and apply that consistently.  If there are any limitations, consider making disclosures.

 

Cybersecurity

The SEC will focus on the following:

  1. proper configuration of network storage devices,
  2. information security governance,
  3. policies and procedures,
  4. risk assessment,
  5. access rights and controls,
  6. data loss prevention,
  7. vendor management, and
  8. training and incident response.

SCS Suggests

We are at a time and age, when it’s not so much a matter of IF you will have a cybersecurity threat, but WHEN.  It is imminent that you, if you haven’t already, take this seriously, and have (a) a plan in place to protect your firm against cybersecurity threats and (b) an incident response plan for WHEN you firm has an attack.

For practical guidance on cybersecurity compliance, watch or listen to our recent webinar.  You can also download a copy of the slides.

In Closing

Some of the SEC’s focus areas were not covered in this article because they do not specifically pertain to registered investment advisers.  To read the SEC’s discussion on their priorities not covered in this article or to read, in full, the ones that are, you can view or download a pdf of the 2019 Examination Priorities.

It’s important to keep abreast of changes in the regulatory environment because as an RIA, you are subject to the SEC’s rules and regulations and are expected to be in compliance with them, even if you’re unaware of what they are. The risk of not being in compliance is increased for registered advisers unfamiliar with regulatory requirements.

As part of your annual review, we recommend you put a practice in place to review and test the areas of higher risk to your firm that are on the SEC’s priority list.