On February 21, 2013, the SEC announced its 2013 exam priorities. The SEC outlined its market-wide priorities followed by priorities in four distinct examination programs:
- Investment Advisers and Investment Companies
- Broker-Dealers
- Clearing and Transfer Agents
- Market Oversight
In each of the above programs, the SEC will examine (a) ongoing risks (b) new and emerging risks and (c) policy issues.
With respect to investment advisers, the SEC emphasized its intent to examine a significant number of newly-registered advisers within the next two years. Most of these advisers are private fund managers. The SEC also reiterated its Presence Exam initiative. In addition to newly-registered private fund managers, the SEC will focus on dually registered investment advisers/broker-dealers.
As on-going risks in the investment adviser/investment company area, the SEC identified:
- Safety of assets: the staff will focus on whether advisers appropriately recognize situations in which they have custody as defined in the Custody Rule; comply with the Custody Rule’s “surprise exam” requirement; satisfy the “qualified custodian” provision; and satisfy the requirement of the audit exception used by pooled investment vehicles;
- Conflicts of interest related to undisclosed compensation arrangements: these activities may include undisclosed fee or solicitation arrangements; referral arrangements and receipt of payments for services allegedly provided to third parties;
- Marketing and accurate performance advertising: this is, according to the SEC, an inherently high-risk area due to the highly competitive nature of the investment management industry. The staff will focus on the accuracy of advertised performance including hypothetical and back-tested performance; the assumptions of the methodology used; appropriate disclosures and compliance with record-keeping requirements;
- Conflicts of interests related to allocation of investment opportunities: these conflicts stem in particular from the side-by-side management of accounts where fees differ (e.g. mutual funds without performance fees vs. accounts that pay performance fees);
- Fund governance of investment companies: SEC staff will assess whether there is “tone at the top” and will confirm full and accurate disclosures by the investment adviser to fund directors regarding fund compliance matters. SEC staff will also assess whether fund directors conduct appropriate reviews of fund service providers (which include investment advisers and sub-advisers) in connection with contract renewals, valuation of fund assets and assessment of expenses.
As new and emerging issues, related to investment advisers, the SEC mentions:
- The examination of the 2,000 new registrants (mostly advisers of private investment funds);
- The continued convergence between investment advisers and broker-dealers (where the lines between the two types of registrants have blurred) and the practice of transacting advisory trades through broker-dealer firms for which they are registered representatives. The SEC stresses the dual registrant model is full of conflicts;
- The growing use of hedge fund strategies by mutual funds and the compliance issues involved with the use of these novel strategies; and
- The assessment of whether payments are being made to investment advisers by mutual fund companies in accordance with Investment Company Act Rule 12b-1 or whether they are instead payments for preferential treatment which the SEC currently sees are being made under many different names and purportedly for a variety of services, such as revenue sharing, sub-TA, shareholder servicing, and conference support.
The SEC examination priorities can be found here: http://www.sec.gov/news/press/2013/2013-26.htm.
