With the best intentions, on January 7th, the Securities and Exchange Commission’s (“Commission”) Office of Compliance Inspections and Examinations (“OCIE”) shared the National Exam Program priorities for 2020 (the “2020 Priorities”). OCIE appears to have intentionally broadened the scope of this year’s document to not only provide guidance concerning certain risks areas, but also to remind the industry to also focus on all other compliance areas, even if not specifically discussed.
The 2020 Priorities is almost double last year’s length at 28 pages. While there are more specific risk areas discussed, the introduction is more robust. In addition to providing the regular summary of FY 2019 examination results, it also provides insight into how OCIE determines its risk-based focus areas for specific advisers. Most notably, the 2020 Priorities has a catch-all section, “Additional Focus Areas Involving RIAS and Investment Companies.” While this new section includes past exam targets such as “Never-Before and Not Recently-Examined RIAs,” “Mutual Funds and ETFs”, and “RIAS to Private Funds,” the section also quickly casts a wide net by referencing “core [RIA compliance] areas”. For example, the 2020 Priorities reference the appropriateness of account selection, portfolio management practices, custody and safekeeping of client assets, best execution, fees and expenses, and valuation of client assets for consistency and appropriateness of methodology.” The section is explicit that “OCIE will continue to review the compliance programs of RIAs, including whether those programs and their policies and procedures are reasonably designed, implemented, and maintained.” Finally, we are reminded that “OCIE will [continue to] assess the adequacy of disclosures and governance practices in the core areas reviewed. OCIE could have saved themselves some time drafting the document and simply said, “This year we will prioritize Rule 206(4)-7(a) and your fiduciary duty.”
As we’ve said in past years, every CCO should read the NEP Priorities and use them to prioritize testing areas as applicable to the business. Many of the items discussed are repeats from prior years, as their relevance or routine appearance as issues in examinations call for continued focus. This year we advise CCO’s to review the SEC’s June 2019 Interpretation Regarding Standard of Conduct for Investment Advisers (the “Interpretation”), in conjunction with the 2020 Priorities. The Interpretation is far more than a refresher on fiduciary duty, clarifying the dual duties of loyalty and care. In addition, the Interpretation re-emphasizes the fact that informed consent is a component of fiduciary duty. It also makes clear that the Commission will continue to apply a broad, “principle-based” lens during examinations, providing examples and discussing the flexibility afforded investment advisers in satisfying these duties.
2020’s exam focus areas include:
- Retail Investors, Including Seniors and Individuals Saving for Retirement has been a longstanding area of focus, and illustrates the Commissions emphasis on protecting the Main Street investor. Its focus on firms that serve retail investors and investments marketed to retail investors covers three subtopics:
- Fraud, Sales Practices, and Conflicts with an emphasis on complex products and advisers fulfilling their fiduciary duties to clients. This area can include recommending affiliated offerings, also a feature of the 2019 program.
- Retail-Targeted Investments such as mutual funds and ETFs, fixed income products, and microcap securities.
- Standards of Care likely will focus on the implementation by firms of Regulation Best Interest and the adoption by June 2020 of the Form CRS client relationship summary but, as with these other topics, has broad applicability.
- Information Security has been on the NEP in one form or another since 2012, shifting in focus over the years from infrastructure concerns to cybersecurity. It was a priority item in each of its five examination programs in 2019, a practice slated to continue in 2020.
- FinTech and Innovation, Including Digital Assets and Electronic Investment Advice focuses on areas of innovation and advancement, including digital assets (cryptocurrency, blockchain) as introduced in 2016, and electronic investment advice, or “robo-advisers”, which make their return from their 2017-18 introduction to the NEP.
- RIAs and Investment Companies with an emphasis on mutual funds and ETFs marking their fifth consecutive appearance and private fund advisers making an explicit return from 2017. Not-yet or not-recently examined advisers also continued their run from 2014. More broadly, examinations are expected to review programs in terms of tailoring to business practices, such as oversight of third party managers, supervisory procedures for dual registrants, and cybersecurity for highly technical or on-line business models.
- Broker-Dealer Financial Responsibility appears this year as a return of the broad category of ‘safety of client assets’ which has appeared as distinct items intermittently. This year’s NEP will continue to focus on broker-dealers that hold customer assets and compliance with the Customer Protection Rule and Net Capital Rule. Trading and Broker-Dealer Risk Management was added this year, reflecting an emphasis on supervision of trading algorithms as well as oversight of the handling of odd lot trades, which tend to reflect retail investor activities. Municipal Advisers continue to be an area of focus this year, and have been an element of the NEP since 2015.
- Any-Money Laundering continues as a focal area in 2020 and has been an element of the NEP since 2015.
- Market Infrastructure elements such as national securities exchanges, clearing agencies, and transfer agents have been highlighted consistently over the past few years and includes specific mention of compliance with Regulation Systems Compliance and Integrity (Reg SCI).
- An emphasis on the fundamental aspects of the markets brought an emphasis to FINRA oversight in 2017 and MSRB oversight in 2018, which continued in 2019 and remains in the 2020 Program.
- Fees & Expenses: Disclosure of the Costs of Investing continues as an area of focus from the 2018 Program.
A few items dropped off of the NEP as explicit mentions this year. As with previous years, we expect that this means merely that those areas have been incorporated into the broader exam Program and will continue to receive thorough coverage. Cybersecurity is expected to remain a key focus area, despite now falling under the broader umbrella of Information Security.
While there is not a lot new here, advisers should take note. The consistency of the National Exam Program and SEC Risk Alerts is indicative of either new developments or ongoing deficiencies across the industry, and thus merit careful consideration.
For advice on compliance and testing programs, please reach out to your consultant or contact us at firstname.lastname@example.org.