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Heads Up! Slew of SEC Risk Alerts on Their Way, Exam Chief Warns

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The Securities and Exchange Commission’s exam division plans to release soon — likely in March — risk alerts indicating how it will conduct exams on Regulation Best Interest and Form CRS and is zeroing in on the “race to zero commissions” by brokerage firms, Pete Driscoll, head of the Office of Compliance Inspections and Examinations, said Friday.

Speaking at the Investment Adviser Association’s annual compliance conference in Washington, Driscoll told attendees to brace for eight upcoming risk alerts this year on: fixed income cross-trading (very close to release); Reg BI and Form CRS (coming very soon); cryptocurrency/digital assets; Libor; alternative data gathered from outside sources; top findings in the compliance space; and top findings on private funds.

Driscoll said OCIE will continue to focus on “fees and expenses,” a mainstay for the SEC, and is continuing exams of private funds and robo-advisors.

Driscoll says he sees two groups of robos: those that provide “another style of offering investment advice by firms that have robust compliance, legal and risk programs” and those run by tech-based startups that are typically “not terribly familiar” with securities laws.

“We see risks there,” he said.

As to environmental, social and governance focused funds, “We’re worried about, if someone claims they’re ESG, are they really ESG?” Driscoll said.

As to Reg BI exams, the risk alert will include a sample list of what the SEC will ask for: “We’ll be looking at implementation beginning in July; going forward, we won’t be looking at trading likely until the winter of 2021; by that time there’ll be a healthy enough amount of trading at firms to start ingesting that into our analytic tools,” Driscoll said.

Reg BI exams, “will take longer, too,” he added.

Data Drilldown

Alternative data is “not just in the private funds space,” Driscoll said. “It’s something we’re focused on; I’m hearing more and more from CCOs of large fund complexes that they’re getting requests to purchase alternative data. … The use of alternative data can be good; if firms want to spend additional resources to get further information to make a more informed investment decision for their clients … that’s inherently good.”

The challenges, however, are “is it material nonpublic information? Was it obtained reasonably?”

The use of alternative data is “exploding,” Driscoll continued. “It’s supposed to double this year, and is becoming more and more mainstream in the investment management world. We are spending some time doing exams in that space.”

Nick Morgan, a partner at the global defense firm Paul Hastings in Los Angeles, who sat on the panel with Driscoll, asked what the SEC sees as trouble spots in acquisition of alt data — for instance, website scraping and communicating with insiders.

“Those exams are early on,” Driscoll responded. The goal is to assess if the data is “publicly available or is it coming from a firm that’s getting it in a reasonable and legitimate way.”

Another OCIE focus: how firms sell their clients’ data. Are clients aware firms do this? “That’s a fear that we have — that firms are misusing the data and making money off their clients’ information without telling their clients.”

Race to Zero

As for the race to zero commissions, Driscoll said OCIE is probing “is it free?”

Said Driscoll: “I’m waiting for the first firm to come out with the slogan: ‘You get what you pay for.’”

OCIE is looking at how firms are compensating for the loss of commission revenue — for example, cash management, exchange rebates, odd lots (in the broker-dealer program). “As the price of securities goes up and there are fewer splits, is there pricing issues, manipulation in odd lots?”

Enforcement Trends

One trend that has emerged over the last year and closely relates to the share class selection disclosure initiative is “the conflict of interest disclosure around fees; that’s a space where we’re looking not just at mutual funds space but at UITs [unit investment trusts],” said SEC co-enforcement chief Steven Peikin, who also sat on the panel. “Over the next year or so I expect to see enforcement recommendations in all those spaces.”

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