U.S. SEC releases 2014 exam priorities; exchanges, retirement in focus

January 15, 2014

By Nick Paraskeva, for Compliance Complete

NEW YORK, Jan. 15 (Thomson Reuters Accelus) – The U.S. Securities and Exchange Commission on Thursday published the 2014 priorities for its national examination program (NEP). Prominent among the priorities were scrutiny of “perceived control weakness” at financial exchanges and oversight of retirement investments.

The NEP’s examination priorities address issues that span the entire market, such as fraud, retirement rollovers and older investors, corporate governance, enterprise risk-management and technology. In addition, each of the NEP’s four program areas: investment advisers and investment companies, broker-dealers, exchanges and self-regulatory
organizations, and clearing and transfer agents, have individual focus areas.


For broker-dealers, it is the second list of exam topics this year, after those of FINRA, and it expands areas being tested for compliance. Issues include the convergence of brokers and advisers and related risks of investors receiving unsuitable advice.
“We are publishing priorities to highlight areas we perceive have heightened risk,” said Andrew Bowden, Director of the SEC’s Office of Compliance Inspections and Examinations (OCIE). “This document, along with our Risk Alerts and other public statements, helps to increase transparency, strengthen compliance, and inform the public and the financial industry about key risks that we are monitoring and examining.”

Market-wide issues

When a broker-dealer is dually registered as an investment advisor, the SEC stated it may “create a risk that customers are placed in an inappropriate account type that may increase revenue to the firm but may not provide a corresponding benefit to the customer”. Use by representatives of misleading qualifications such as financial adviser may confuse investors to view recommendations as being in their best interests.

Retirement rollovers are a concern as advisers and broker-dealers have incentives to recommend that employer-sponsored 401(k) plans be moved into higher cost investments such as IRAs issued by their firm. The SEC will review sales practices, suitability and conflicts, including supervision of such sales to ensure they are meet customer needs. Marketing and advertising that fairly discloses the risks is also key.

To review conflicts and risk, the SEC will meet management and boards of entities, and if needed their affiliates. They will discuss how a firm identifies and mitigates conflicts of interest and legal, compliance, financial, and operational risks. The aim is to evaluate firms’ control environment and tone at the top, and their approach to conflict and risk management, They are also used as dialogue regulatory requirements.

Technology supervision and governance is now a higher SEC priority after recent system outages shook confidence in markets. The review of information technology systems includes their operational capability, change management process, and how access to markets is managed. Information security controls are particularly important for customer data, and preparedness to respond to sudden systems malfunctions.

Sectoral issues

Broker-dealer sales practice reviews cover fraud involving seniors and micro-cap stocks, and unsuitable recommendations in higher yield and complex products, e.g., leveraged ETFs to ensure due diligence. An assessment of supervision of independent representatives in branches and with a disciplinary history will be conducted. The existence of such factors challenges firms’ ability to supervise or monitor compliance.

In markets, controls on access, erroneous orders, technology, algorithmic and high-frequency trading are highlighted as well as overall scrutiny of controls at financial exchanges after a string of recent problems. Also tested are information leakage, IT security, and market manipulation involving practices such as marking-the-close and excessive markups. Other issues include abuses of the market making exception for Reg SHO short sales, and the relationships between broker-dealers and Alternative Trading Systems (ATSs).

A new exam area for investment advisers is wrap fee programs, where advisory and brokerage services are offered to a client for a single “wrapped” fee, which is not dependent on the transactions in the client’s account. The SEC will review that advisers meet their fiduciary obligations to clients, and have processes to monitor recommendations made, conflicts of interest, best execution and make disclosures to clients.

Another emerging issue is advisers who rely on quantitative trading models. Staff will assess if a firm has compliance policies tailored to the performance and maintenance of their proprietary models. These need to review any use of models to manipulate markets, and review or test models and their output over time. Documentation of the models and a current inventory of all firm-wide proprietary models should be kept.

List of SEC exam topics

Market-wide issues

  • Fraud;
  • Governance, conflicts and enterprise-wide risk;
  • Technology oversight;
  • Dual registrant broker-dealer and investment adviser businesses;
  • New rule changes and developments;
  • Retirement rollovers.

Investment advisors, investment companies, hedge funds

Existing core risks

  • Safety of assets and custody;
  • Conflicts of interest;
  • Marketing/performance.

New emerging issues

  • Firms examined for the first time, e.g. hedge fund advisers;
  • Wrap fee programs;
  • Quantitative trading models;
  • Presence exams for newly registered firms;
  • Payment by advisers and funds to distributors of mutual funds;
  • Fixed income investment companies, risk from a shift in rates.

Policy topics

  • Money market funds, how they managed stress events;
  • Alternative investment companies, e.g. liquidity, leverage;
  • Securities lending arrangements.


Existing core risks

  • Sales practices and fraud e.g. seniors, microcap, registration;
  • Supervision, e.g. of representatives with a disciplinary history;
  • Trading, high frequency, manipulation, short sales, ATS;
  • Internal controls, e.g, over liquidity, credit, and market risk;
  • Financial responsibility, customer assets, capital, collateral;
  • AML, clearing and introducing firms, for access to markets.

New emerging issues

  • Market access rule, compliance with controls, recordkeeping;
  • Suitability of variable annuity buybacks by insurers on poor terms;
  • Fixed-income market, execution, market structure, use of ATS.

Markets, exchanges, self-regulatory organizations

  • Oversight of FINRA, for Dodd-Frank implementation;
  • Risk exams of exchanges, for perceived control weaknesses;
  • Review of new exchange applicants for compliance capability;
  • Section 31 fee exams, for accurate reporting, payments.

Clearing agencies, designated as systemically important

  • Conduct annual exams of DTC, NSCC, FICC and OCC;
  • Pre-launch reviews of new clearing agency applicants.

Transfer agents

Existing core risks

  • Timely turnaround of items and transfers;
  • Accurate recordkeeping;
  • Safeguarding of assets.

New emerging issues

  • Agents for microcap securities and for private offerings;
  • Transferring certificates damaged by Hurricane Sandy;
  • Direct registration system for transfers;
  • Business continuity and disaster recovery plans.

(Nick Paraskeva is principal of Reg-Room LLC (www.reg-room.com), which provides regulatory information and consultancy. He covers various facets of the banking and securities industry and delivers exclusive analysis through Thomson Reuters. He can be contacted at (212) 217-0403 and nparaskeva@nyc.rr.com. Follow Nick on Twitter@regroom.)

 (This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)

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