Client Alerts

SEC Announces 2019 Examination Priorities

Client Alerts | January 8, 2019

On December 20, 2018, the Office of Compliance Inspections and Examinations (“OCIE“) of the Securities and Exchange Commission (the “SEC“) announced its 2019 examination priorities for registered investment advisers.[1] OCIE grouped the priorities into six general thematic areas: (1) matters of importance to retail investors, including seniors and those saving for retirement; (2) compliance and risk in registrants responsible for critical market infrastructure; (3) select areas and programs of the Financial Industry Regulatory Authority, Inc. and the Municipal Securities Rulemaking Board; (4) digital assets; (5) cybersecurity; and (6) anti-money laundering.

This Legal Update focuses on identified priorities particularly relevant to private fund managers that are SEC-registered investment advisers.

In the context of assessing risks to retail investors, OCIE identified certain initiatives that are relevant for private fund managers:

• For example, OCIE indicated that it will focus on firms that have practices or business models that may create increased risks that investors will pay inadequately disclosed fees, expenses or other charges, and will continue to examine whether fees are charged in accordance with client agreements and firm disclosures. OCIE will also review policies and procedures addressing the use of affiliated service providers and products, focusing on the impact to investors and the related disclosures of conflicts of interest that may be present.
• OCIE specified that it will review adviser practices for executing client investment transactions, fairly allocating investment opportunities among clients, ensuring consistency of portfolio investments with stated investment objectives, disclosing critical information to investors and complying with other legal restrictions. OCIE will also review adviser portfolio recommendations to evaluate, among other things, whether investment strategies have drifted from disclosures to investors and are accompanied by adequate disclosure concerning, and monitored for, relevant risks.
• As part of its emphasis on retirement investments, OCIE stated that it will continue to review products offered by investment advisers to seniors and those saving for retirement, which may include private funds with a high concentration of investors investing for the benefit of pension plans.
• OCIE will continue to conduct risk-based examinations of certain investment advisers that have never been examined, including newly-registered investment advisers and those registered for several years but that have yet to be examined. In addition, OCIE will prioritize examinations of certain advisers that have not been examined for a number of years and may have substantially grown or changed business models.

Given the significant growth and risks presented in the digital asset (i.e., cryptocurrencies, coins and tokens) market, OCIE will continue to monitor the offer and sale, trading and management of digital assets, and when such products are securities, examine for regulatory compliance. In particular, OCIE indicated that it will take steps to identify market participants involved with digital assets and then assess the extent of their activities. For firms that are actively engaged in that market, OCIE will conduct examinations focused on, among other things, portfolio management of digital assets, trading, safety of client funds and assets, pricing of client portfolios, compliance and internal controls.

OCIE expressed that it will continue to prioritize cybersecurity as part of its investment adviser examinations, which will concentrate on, among other things, proper configuration of network storage devices, information security governance generally, policies and procedures related to retail trading information security, cybersecurity practices at advisers with multiple branch offices, governance and risk assessment, access rights and controls, data loss prevention, vendor management, training and incident response. In addition, although OCIE emphasized compliance with anti-money laundering (“AML“) requirements applicable to broker-dealers, private fund managers should ensure that all elements of their AML policies and procedures have been implemented and that compliance with those procedures is tested as part of the manager’s annual compliance review.

While OCIE’s published exam priorities apply to all investment advisers and are therefore general in nature, our experience in counseling clients through the OCIE exam process as well as monitoring SEC enforcement proceedings, settlements and risk alerts indicates that that the SEC is focused on several other areas in their examination of private fund managers. In particular, OCIE has been focusing on: compliance with best execution obligations and the SEC’s pay-to-play[2] and cash solicitation[3] rules under the Investment Advisers Act of 1940, as amended; electronic communications both within the firm and with third parties; undisclosed proprietary interests in fund investments; performance reporting and related disclosures; and controls related to the prevention of misuse of material non-public information, including oversight of third party vendors, such as consultants or expert networks.

Though this description of OCIE examination priorities is not exhaustive, private fund managers that are registered investment advisers should take note of these stated priorities and review their businesses and operations to determine if any enhancements or changes are necessary.
[1] OCIE’s 2019 Examination Priorities are available here.
[2] See our Legal Update entitled “SEC Regulatory Roundup: Best Execution, Pay-to-Play and Advertising Red Flags for Private Fund Managers” dated August 2018, available here.
[3] See our Legal Update entitled “Investment Adviser Compliance Issues Related to the Cash Solicitation Rule” dated December 2018, available here.

This Legal Update provides general information only and is not intended as legal advice.