The Commission’s Office of Compliance Inspections and Examinations or OCIE announced its 2019 Examination Priorities just before Christmas and the current Government partial-shutdown (here). While the inspection program is currently at a stand-still, at some point in the near future it is reasonable to assume that OCIE will begin inspections.
The focus of the 2019 Program differs from that of 2018, although its risk-based essence and key points are similar. As the glossy brochure discussing the program makes clear, the Office “measures performance in multiple ways . . .” that are tied to four key points or “pillars:” Promoting compliance; preventing fraud; identifying and monitoring risk; and informing policy. While not identical to the five key principles or building blocks of last year’s program of risk, data, transparency, resources and technology, they inform and drive the program in a similar manner (last year’s program is discussed here):
Promoting Compliance is a critical goal of the entire OCIE program. The goal is built on transparency, identifying weaknesses and education. To that end, over the last year the Office has issued five Alerts discussing best execution, fee and expense compliance issues, exams and registered investment companies, adviser compliance issues tied to the cash solicitation rule and observations related to electronic messaging.
Preventing fraud is another key goal of the overall inspection program. Indeed, the point of promoting compliance, educating those examined as well as the public with Alerts and, when necessary, referring matters to the Division of Enforcement for further action is to safeguard investors and prevent fraud. Fortunately, only a small fraction of the over 3,000 exams conducted last year resulted in an actual Enforcement referral – not every examination where infractions are uncovered results in an Enforcement action just as not every rule infraction means the compliance systems and efforts have failed.
Identifying and monitoring risk is the underlying predicate for all of the inspections. As the Brochure makes clear “OCIE will continue to stay abreast of changes in the SEC’s registrant base, the markets, and investor needs and preferences, and will adjust its risk-based program in response to these changes.” This translates to a focus on matters such as Regulation SCI, fixed income best execution obligations and advisers recommending digital assets.
Informed policy is an outgrowth of the inspection program since it enables the Office to provide “further insight to other SEC Divisions and Offices regarding how registered entities have implemented the SEC’s rules, the practical difficulties and challenges faced . . .” and common areas of noncompliance thus complementing the overall compliance focus.
The five 2019 pillars of the National Exam inspection program translate into six focal points for the National Exam Program:
1) Retail Investors: This includes “seniors and those saving for retirement.” This focus mirrors that of the Enforcement Division which formed a special task force to foster the protection of retail investors. Indeed, SEC Chairman Jay Clayton has repeatedly emphasized the protection of retail investors and seniors since the beginning of his tenure. To implement this goal the OCIE program will thus concentrate on:
a. Fees and expenses and, in particular, business models which have or create a risk of inadequate disclosure;
b. Conflicts of interest, including those from the use of affiliated service providers, securities-backed non-purpose loans and borrowings from clients and products directed at seniors;
c. Portfolio management and trading;
d. Securities professionals such as municipal advisers and broker-dealers holding customer assets; and
e. Microcap securities.
2) Registrants responsible for critical market infrastructure: This includes clearing agencies, transfer agents and national securities exchanges.
3) FINRA and MSRB: Each organization serves as a regulator, monitoring and assessing critical market infrastructure and market professionals.
4) Digital assets: These assets have grown rapidly and are frequently volatile as recent market action reflects. Chairman Clayton has repeatedly addressed the risks associated in these assets. Congress has held hearings. And, the Division of Enforcement has initiated a series of fraud and registration violation actions.
5) Cybersecurity: The protection of the financial markets and participants is crucial. The Office intends to prioritize this area in each of its exam programs. The threat to, and impact on, market participants is well illustrated by recent breaches at public companies.
6) Anti-Money Laundering: OCIE intends to continue prioritizing AML programs at broker- dealers, assuring compliance with the Bank Secrecy Act while scrutinizing policies and procedures governing the filing of suspicious activity reports with FinCEN which are critical in detecting and combating terrorist financing and corruption.
Collectively these points represent not just the focus of OCIE in its 2019 inspection program, but more importantly the Commission’s efforts in its overall administration of the federal securities laws. For a discussion of key issues for exam preparation see Dorsey Federal Enforcement Forum here.