Hot Topics for SEC Exams

Hot Topics for SEC Exams

As part of the SEC's new National Exam Program Overview, OCIE highlights six areas of focus for Investment Advisers:

"[T]he Program has identified specific strategic areas on which to focus when examining firms.... In FY2012, focus areas include the following priorities, among others:

Complex Entities. Staff will examine for the risks and practices associated with the SEC's rapidly growing complex registrant population. Review areas may include:

(i) Newly registered, private fund advisers that may be unfamiliar with the Federal securities laws.

(ii) Complex relationships in the private equity space.

(iii)Model risk of quantitative investment decision, order routing, and trade execution models utilized by various industry participants.

Sales Practice of New or Risky Products. The staff will review for the sale or recommendation of inappropriate investments by advisers. Among the areas of concern:

(i) The retailization of complex investments and smaller, niche-type products (e.g., structured products, reverse convertibles bonds, alternative mutual funds, leveraged ETFs).

(ii) Aggressive marketing of retirement/senior products and investments marketed as being "safe."

(iii)Portfolio management activities that may increase the risk of investor loss or harm.

(iv) Lack of due diligence performed on underlying investment vehicles/managers and any undisclosed conflicts and/or fee arrangements.

(v) Valuation practices and any conflicts that exist in the pricing process.

Fund Governance. The NEP will evaluate practices or oversight weaknesses that may increase the risk of shareholder loss or harm, such as:

(i) Mutual funds investing in a manner that is inconsistent with fund disclosures or engaging in activities that may pose higher risk.

(ii) Directors failing to satisfy fiduciary duties.

(iii) Systemic compliance breaches and processing issues that may have a significant impact on fund investors.

Compliance, Supervision, and Risk Management. The NEP will assess the appropriateness of compliance programs and risk management processes relative to business operations to identify potential weaknesses that raise investor protection concerns, such as:

(i) Effects of cost-cutting, mergers and acquisitions, and aggressive business strategies to make up for losses and revenue cuts.

(ii) Lack of oversight of outside business activities and weak compliance of remote locations, branch offices, and independent contractor representatives.

(iii)Dual and affiliated registrants transitioning broker-dealer customers into advisory clients.

(iv) Ineffective compliance and risk management with respect to complex investments and/or investment strategies.

Fraudulent Activities/Safety of Assets. The NEP continues its initiative to identify fraudulent, abusive, and manipulative activities surrounding the safety of client assets. Areas of focus include:

(i) Custody arrangements that increase the potential for misappropriation of assets.

(ii) Ponzi schemes or ponzi-like schemes.

(iii)Manipulative activity, such as front-running and insider trading.

(iv) Cyber security risks associated with malicious hacking and fraudulent schemes.

 Performance and Advertising. The NEP will assess performance characteristics and marketing practices that have been associated with an increased risk of misrepresentations and investor harm. For example:

(i) Aberrational performance that may be indicative of abusive valuation.

(ii) The use of solicitors to attract new clients, particularly when non-cash compensation is used by advisers.

For additional commentary on developments in compliance and ethics, visit Compliance Building, a blog hosted by Doug Cornelius.

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