SEC Announces 2018 Examination Priorities

On February 7th, the Office of Compliance Inspections and Examinations (“OCIE“) of the Securities and Exchange Commission (the “SEC“) announced its 2018 examination priorities for registered investment advisers.[1] OCIE grouped the priorities into five general thematic areas: (1) protecting retail investors, concentrating on senior investors and retirement investments; (2) compliance and risks in critical market infrastructure; (3) the Financial Industry Regulatory Authority, Inc. (FINRA) and the Municipal Securities Rulemaking Board (MSRB); (4) cybersecurity; and (5) anti-money laundering programs. OCIE notes that the list of priorities is not exhaustive and priorities may be adjusted in light of market conditions, industry developments and ongoing risk assessment.

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, including private fund advisers that manage funds with a high concentration of investors investing for the benefit of retail clients, such as non-profit organizations and pension plans.

OCIE will carry on its Never-Before Examined Adviser initiative[2] to include focused, risk-based examinations of newly registered advisers as well as of selected advisers that have been registered for a longer period but have never been examined by OCIE.

As part of its emphasis on retirement investments, OCIE stated that it will examine investment adviser involvement in retirement vehicles that primarily serve state and local government employees and non-profit employees, including 403(b) and 457 plans.

OCIE intends to pay special attention to the sale of cryptocurrenies and other related products, and, when such products are securities, examine for regulatory compliance. Noted areas of focus will include whether financial professionals are providing investors with adequate disclosures about the risks associated with such investments, including the risk of investment losses, liquidity risks, price volatility and potential fraud.

OCIE indicated that it will continue to prioritize cybersecurity as part of its investment adviser examinations, which will concentrate on, among other things, governance and risk assessment, access rights and controls, data loss prevention, vendor management, training and incident response. In addition, OCIE is focused on working with firms to identify and manage cybersecurity risks and to encourage market participants to actively and effectively engage in this effort.

While OCIE’s published exam priorities apply to all investment advisers and are therefore general in nature, our experience in counseling clients through the SEC exam process as well as monitoring SEC enforcement proceedings and settlements 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: conflicts of interest, including disclosures related to allocating investment opportunities among clients, allocating expenses between fund managers and clients and among clients, and related party transactions; undisclosed proprietary interests in fund investments; adequacy and accuracy of disclosures pertaining to fees and expenses, as well as statements and disclosures in marketing materials; performance reporting and related disclosures; controls related to the prevention of misuse of material non-public information, including oversight of third party vendors, such as consultants or expert networks; and electronic communication both within the firm and with third parties.

Though this description of OCIE 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.
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[1] Examination Priorities for 2018, available here.
[2] See OCIE’s Letter to Never-Before Examined Investment Advisers, February 20, 2014, available here.