Yesterday, the Securities and Exchange Commission (SEC) Office of Compliance Inspections and Examinations ("OCIE") released its annual top exam priorities for the 2018 calendar year. The OCIE is the SEC division which conducts examinations of registered investment adviser ("RIA") firms and this priority list can help investment advisers be better properly prepared for a regulatory examination. In general, the list of priorities for 2018 closely mirrors the agency's past 2017 and 2016 examination priority lists as well as recently issued risk alerts. For 2018 the OCIE is focused on five categories: matters of importance to retail investors, including seniors and those saving for retirement, compliance and risks in critical market infrastructure, Financial Industry Regulatory Authority (FINRA) and municipal Securities Rule Making Board (MSRB), cybersecurity and anti-Money laundering programs.
This year's top examination priorities are also likely to received increased focus from the investment adviser community as the SEC also shared two key examination statistics as part of this release:
- In the 2017 fiscal year, the National Exam Program ("NEP") completed more than 2,100 exams of RIA firms, which is an increase of ~46% over the 2016 fiscal year.
- In the 2017 fiscal year, the SEC achieved examination coverage of ~15% of all investment adviser firms, compared to 8% five years ago.
The OCIE states that within the areas of emphasis, the agency will be particularly focused on these common RIA regulatory compliance issues:
- Disclosure of the cost of investing: The staff notes, "it is important for financial professionals to inform investors of any conflicts of interest that might provide incentives for financial professionals to recommend certain types of products or services to investors, including any higher cost or riskier products." Examiners will focus on whether fees and expenses are calculated and charged in accordance with the disclosures provided to investors." In addition they will also "review fees charged to advisory accounts, particularly where the fee is dependent on the value of the account, to assess whether assets are valued in accordance with investor agreements, disclosures, and the firm's policies and procedures."
- Electronic Investment Advice: "Robo-advisers" will continue to be a focus in 2018. In addition to "robo-advice", the staff notes they will also focus on investment advisers that "primarily interact with clients online." Similar to last year, there will be a particular emphasis on the "registrants’ compliance programs, including the oversight of computer program algorithms that generate recommendations, marketing materials, investor data protection, and disclosures of conflicts of interest."
- Wrap Fee Programs: This continues to be a long-standing regulatory focus area and 2018 is no different. In particular, the staff states they "will likely review whether investment advisers are acting in a manner consistent with their fiduciary duty and whether they are meeting their contractual obligations to clients." In addition, auditors will explore recommendations to invest in a wrap fee program, disclosures, and conflicts of interest.
- Never-Before Examined Investment Advisers: Similar to the past couple of years, the staff remains focused on its Never-Before Examined Adviser initiative. They will "continue to make risk-based assessments and select those investment advisers for examination that have elevated risk profiles."
- Senior Investor and Retirement Accounts and Products: Given the fact that seniors and those individuals saving for retirement are heavily reliant on their investment returns, the staff noted they will "review how broker-dealers oversee their interactions with senior investors, including the ability of firms to identify financial exploitation of seniors." This year examiners "will continue to conduct examinations of investment advisers and broker-dealers that offer services and products to investors with retirement accounts." The examiners will focus on "investment recommendations, sales of variable insurances products, and sales and management of target date funds."
- Cryptocurrency, Initial Coin Offerings (ICOs), Secondary Market Trading and Blockchain: Given the rapid rise of cryptocurrencies, it is no surprise to see them added to the list of exam priorities for 2018. "Along with the growth of these products and markets, the number of broker-dealers and investment advisers engaged in this space continues to grow as well." The staff notes, examiners "will continue to monitor the sale of these products, and where the products are securities, examine for regulatory compliance." Focus areas will include, but are not limited to maintaining adequate controls and safe guards to protect against from "theft and misappropriation," and whether investors are being provided with the appropriate disclosures about all risks associated with investing in cryptocurrencies.
- Cybersecurity: Similar to the past couple of years, the staff continues to focus on cyber threats noting they have "increased dramatically" and a successful cyber attack can not only impact the firm, but "other market participants and retail investors." The staff notes, "we are focused on working with firms to identify and manage cybersecurity risks and to encourage market participants to actively and effectively engage in this effort." They will continue to be focused on reviewing cybersecurity compliance procedures, controls, and testing.
As RIA compliance consultants, we strongly recommend that the principals and Chief Compliance Officer of all investment advisory firms registered with the SEC, regardless if the firm has been examined before or not, review the contents of the SEC 2018 exam priority document. Furthermore, past exam priority lists released in prior years should also be reviewed. Links to these past investment adviser audit priority lists are here:
- 2017 SEC RIA Examination and Audit Priorities
- 2016 SEC RIA Examination and Audit Priorities
- 2015 SEC RIA Examination and Audit Priorities
- 2014 SEC RIA Examination and Audit Priorities
- 2013 SEC RIA Examination and Audit Priorities
Lexington Compliance and RIA in a Box LLC are not law firms, investment advisory firms, or CPA firms. Lexington Compliance and RIA in a Box LLC do not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.