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Regulation and Compliance > Federal Regulation > SEC

SEC Reveals Its 2014 Exam and Enforcement Priorities

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Officials at the Securities and Exchange Commission have ushered in an era of more transparency, parting the curtain for advisory firms on what they’ll be scrutinizing as well as which rulemakings are priorities this year.

SEC Chairwoman Mary Jo White and three of the agency’s division directors laid out over the past month where they will focus their energies in 2014.

Issues that are top of mind for the Office of Compliance Inspections and Examinations (OCIE), as well as for the enforcement and investment management divisions, include: the custody rule; insider trading; examining firms’ policies on cybersecurity; dually registered advisors’ or BDs’ shifting of client accounts from brokerage to advisory accounts; failure to correct compliance deficiencies; conflicts of interest; private funds; and cherry picking.

In a January speech titled “The SEC in 2014,” White also listed the technology initiatives being used by the agency’s exam team as well as the rules that the securities regulator hopes to finalize this year. The SEC chairwoman said that a “critical priority” to complete in the “relatively near term” is money market fund reform, as well as final implementation of crowdfunding rules.

As it stands now, the commission is considering two “significant proposals” for additional reform that were put out for comment last June: a floating net asset value for prime institutional money market funds—the type of fund that experienced problems during the financial crisis—and a proposal to require money market funds under certain circumstances to impose a liquidity fee and permit the imposition of redemption gates.

On the technology front, White highlighted the newly developed National Exam Analytics Tool (NEAT), which enables examiners to access and systematically analyze “massive amounts of trading data from firms in a fraction of the time it has taken in years past.”

White said that in one recent exam, an SEC team used NEAT to “analyze in 36 hours literally 17 million transactions executed by one investment advisor.”

In 2014, SEC examiners, White said, will be using the NEAT analytics to “identify signs of not only possible insider trading, but also front running, window dressing, improper allocations of investment opportunities and other kinds of misconduct.”

At the SEC’s Compliance Outreach Program National Seminar held at SEC headquarters in Washington in late January, Andrew Bowden, associate director of the National Investment Adviser/Investment Company Examination Program within OCIE, Norm Champ, director of the Division of Investment Management, and Andrew Ceresney, director of the SEC’s Enforcement Division, laid out for attendees—mainly compliance officers—their priorities for 2014, including some which are spillover issues from last year.

OCIE: Custody, IRA Rollovers, Alt Mutual Funds

Bowden noted that OCIE’s focus last year on making sure advisors comply with the custody rule will also be a focus this year. The “No. 1 [exam] item was custody and safekeeping of assets in 2013,” Bowden said. “I hope nobody missed this message coming out in 2013,” he said, because it will continue in 2014. “We’re going to closely assess your compliance with appropriate reporting of client assets.”

Bowden also mentioned OCIE scrutiny of qualified plan rollovers this year, as well as alternative mutual funds—which he said are the “largest growing” new fund sector.

Jane Jarcho, national associate director of OCIE’s National Exam Program, noted on a separate panel that OCIE’s exams will include assessing firms’ cybersecurity policies. Examiners will be looking at RIA resources going into information security, policies on cybersecurity risk, what policies are in place to prevent and respond to cyberattacks, lost information and identity theft. Jarcho said that examiners will also ask about internal and external cyberattacks that may have occurred at advisory firms, and will look at firms’ policies on IT training, vendor access and vendor due diligence, she said.

David Grim, deputy director of the Investment Management division, added, “Cybersecurity is a big issue that people are worried about—take a look at the policies and procedures you have around this issue and make sure they are current.”

Investment Management: Fiduciary Duty, Insider Trading

Champ noted the significant movement by dually registered advisors and broker-dealers of client accounts from brokerage to advisory accounts. “We get why this is going on … because with advisory accounts you get an [ongoing] advisory fee, and that is good for revenue.” However, Champ warned compliance officers to think about “where the advisor’s fiduciary duty occurs” when “recommending to move a client from a brokerage account that costs nothing to an advisory account that can cost 1% per year.”

With insider trading having “been a big deal” in the fund industry, Champ urged firms to make sure they have procedures to prevent the misuse of nonpublic information. “Think about what you are doing to prevent this,” he said, “and talk to us about a violation before we find it. If you detect a violation, it’s important that you talk to us.”

Champ also noted that guidance updates on various issues that began in 2013 will continue this year. Fourteen such updates “on areas where we’ve seen an issue” were issued last year, he said. The most recent one, released in January, looks at changes in the bond markets in which “dealers—the big wirehouses—are holding less inventory in bonds, 20% less,” Champ said, “so there are much fewer people out there making markets in bonds.” Look for more of these guidance updates this year, he said, as well as further guidance on Rule 506(c) private offerings.

Grim added the division is also looking at rulemakings this year around ETF registration and target-date funds.

Enforcement Division

Andrew Ceresney, who became sole director of the SEC’s Enforcement Division in January following the departure of co-director George Canellos, spoke of the cases the agency brought last year related to firms’ failure to correct deficiencies. “We had nine such cases last year, with more in the queue,” he said. “We worry that those [unaddressed] issues will lead to bigger issues.”

Noting the “critical” importance of the commission to enforce the custody rule, as the SEC “brought a number of cases” in this area last year, Ceresney noted “areas of unique development in 2013,” such as the portfolio manager who violated the rule that prohibits “obstructing or lying” to a CCO.

“I wasn’t even aware of the rule,” Rule 38a-1(c) of the Investment Company Act, which was enforced in that case, Ceresney admitted, but promised “we will be [enforcing] it extensively going forward.”

Yet another unique case was in the BD area, with the failure to disclose mark ups and mark downs, he said.

Not unique, however, will be the division’s continuing effort to enforce failures to supervise, he said.

Other issues of focus this year, he said, are conflicts of interest at funds, including side-by-side management of conflicts, which includes the related issue of principal transactions. “We brought a number of cases” on this last year, “and we will continue to bring cases here in 2014,” according to Ceresney.

Others focus areas include cherry picking, the practice of allocating more profitable trades to favored clients, as well as private equity and valuation in that realm, and disclosure of fees in this area.

In the private equity area, there will also be a focus on “zombie funds,” he said, which result when private equity holdings are not designed for quick liquidity, and “zombie managers” are unable to raise new capital.


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