Priorities for the 2018 SEC Examination

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Written by: Brian Young

Each year, the Office of Compliance Inspections and Examinations (“OCIE”) of the U.S. Securities and Exchange Commission (“SEC”) communicates its examination priorities for the upcoming year. The SEC has narrowed their focus on the following common themes:(1) Retail Investors (2) Compliance and risks in critical market infrastructure (3) Cybersecurity. Based on these themes, the SEC has pinpointed several key areas of concern that will be focus areas for 2018. Some of which are similar to years past, however, continue to be a priority for the SEC. We have provided an overview below of the key topics that RIAs need to be mindful of in 2018.

Disclosure of the Costs of Investing

The SEC will focus on the calculation of fees and expenses paid to the Advisor as well as any compensation that is paid to affiliates of the Advisor.

Focus areas include:

  • Consistency of the advisory fee calculations and the advisory fee methodology disclosures.
  • If charging an asset-based fee, the consistency of the valuation of client securities and the valuation methodology disclosures.
  • Advisors that receive financial incentives to recommend mutual fund share classes (ie. high sales loads or distribution fees).
  • Client accounts that are not re-assigned to a new IAR when an employee leaves the firm.
  • Advisors that transition from commission based accounts to fee based accounts.

    • Electronic Investment Advice

    As in prior years, the SEC will continue to focus on advisors that offer investment advice through automated programs (ie. robo-advisors).

    Focus areas include:

  • Oversight of the algorithms used to generate general investment advice.
  • Marketing materials.
  • Policies and procedures related to client data protection.

    • Wrap Fee Programs

    For advisors that charge a wrap fee (ie. fee that includes both advisory fees and execution costs), they will need to demonstrate that the wrap fee is in the best interest of the client.

    Focus areas include:

  • Any conflicts of interest are disclosed.
  • Review for best execution.
  • Disclosure of execution costs with broker-dealers.

    • Never Before Examined Investment Advisors

    Due to the large volume of newly registered advisors and the limited resources of the SEC, the SEC will continue to prioritize advisors that have “elevated risk profiles”. This likely includes advisors that fall under the scenarios outlined by the 2018 exam priorities.

    Senior Investors and Retirement Accounts and Products

    Advisors that provide investment advisory services to seniors and/or retirement accounts will continue to be a focus for the SEC. Advisors will need to have internal controls in place to identify and mitigate financial exploitation of seniors.

    Focus areas include:

  • Investment product recommendations.
  • Sales of variable insurance products.
  • Usage of target date funds.
  • Advisors that serve state and local government employees and non-profit employees (ie. 403(b) and 457 plans).

    • Mutual Funds and ETFs

    As the primary investment products for retail clients, the SEC will focus on the types of mutual funds and ETFs recommended to clients.

    Focus areas include:

  • Funds that experienced poor performance or liquidity.
  • Funds that are managed by advisors with little experience managing a fund.
  • Funds that hold securities that are difficult to value due to market stress (ie. securitized loans or mortgage backed securities).
  • Ensure that risk disclosures are provided to investors.

    • Cryptocurrency, Initial Coin Offerings (ICOs), Secondary Market Trading, and Blockchain

    Cryptocurrency has wildly risen in popularity over the past year. The SEC will monitor this space as advisors engaged in this market continues to grow.

    Focus areas include:

  • If advisors maintain controls and safeguards to protect assets from theft.
  • If advisors are providing adequate disclosures associated with the risks of these type of investments including: investment losses, trading liquidity, price volatility, and potential fraud.

    • Cybersecurity

    Cybersecurity continues to be a priority for the SEC as we have witnessed large scale cyber attacks over the past year.

    Focus areas include:

  • Governance and risk assessment.
  • Access rights and controls.
  • Data loss prevention.
  • Vendor management.
  • Training.
  • Incident response.

    • Please remember that OCIE and the SEC communicate these as PRIORITIES, and not an all-inclusive list of all focus areas. To read the full report, click here: "2018 National Exam Program Examination Priorities"

    Contributors: Conor Anderson