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by Laura Anthony, Esq.

SEC Announces Examination Priorities For 2015; Focus On Transfer Agents, Investment Advisers and Broker Dealers

ABA Journal’s 10th Annual Blawg 100

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On January 13, 2015, the SEC published its Office of Compliance Inspections and Examinations (OCIE) priorities for 2015.  The OCIE examines and reviews a wide variety of financial institutions, including investment advisers, investment companies, broker-dealers, transfer agents, clearing agencies and national securities exchanges. 

The priorities this year have a primary focus on (i) protecting retail investors, especially those saving for retirement; (ii) assessing market-wide risks; and (iii) using data analytics to identify signs of potential illegal activity.  In addition, the SEC will examine municipal advisers, proxy services, never-before-examined investment companies, fees and expenses in private equity and transfer agents. 

Transfer agents and broker-dealers will be scrutinized for potential claims of engaging in or aiding and abetting pump-and-dump or market manipulation schemes.

The SEC shares its annual examination priorities as a heads-up and to encourage industry participants to conduct independent reviews and make efforts for increased compliance, prior to an SEC examination, investigation or potential enforcement proceeding.  Moreover, the SEC chooses its priority list in conjunction with discussions with all divisions of the SEC and other market regulators and identifies what it believes are the areas that present heightened risk to investors and market integrity. 

The SEC will focus its examinations on issues involving investment advisers, broker-dealers and transfer agents and, in particular, related to retail investors planning for retirement; market-wide risks and data analytics. 

A.  Retail Investors

Retail investors are being offered products and services that were formally only available to institutional investors.  A wide range of products that have traditionally been alternative or institutional products, such as private funds, illiquid investments and structured products, are now available to the retail investor.  In addition, as investors are more dependent than ever on their own investments for retirement, financial services firms have increased their services in the area of planning for retirement and the SEC intends to examine this area of service. The SEC will examine whether information, advice, products and services are being offered consistent with laws, rules and regulations. 

The focus of examinations in this area will be on:

               Fee Selection and Reverse Churning – Financial professionals are increasingly acting as investment advisers and maintaining dual licenses as broker-dealer and adviser.  Unlike broker-dealers which typically only charge a commission or markup on purchases and sales of securities, advisers charge a variety of fee structures including fees based on assets under management, hourly fees, performance-based fees, wrap and unified fees.  The SEC will examine advisers’ recommendations of account types and setups to ensure that it is in the best interest of the client and not merely designed to generate the maximum fees.  Moreover, the SEC will review actual performance of services and fees charged in relation thereto. 

               Sales Practices – The SEC will examine whether broker-dealers and advisers are using improper or misleading sales practices when recommending the movement of retirement assets, especially when the move results in increased risks or higher fees.

               Suitability – The SEC will evaluate investment recommendations and especially those involving complex or structured products and higher-yield securities.  The SEC will review whether proper due diligence is being conducted prior to the recommendations, the disclosures being made and the suitability of the recommendations for the particular investors. 

               Branch Offices – The SEC will examine supervision policies and practices over branch offices and will use data analytics to identify branches that are deviating from compliance practices and rules and regulations.

               Alternative Investment Companies – There has been a rapid and significant growth in funds offering alternative investments or returns not correlated with the stock market.  The SEC will examine these funds with a focus on: (i) leverage, liquidity, and valuation policies and practices; (ii) factors relevant to the adequacy of the funds’ internal controls, including staffing, funding, and empowerment of boards, compliance personnel and back offices; and (iii) the marketing of the funds to investors.

               Fixed-Income Investment Companies – The SEC will review whether mutual funds that have significant exposure to increased interest rates are prepared for such increases and have properly disclosed the risks to its investments. 

B.  Assessing Market-Wide Risks

The OCIE will examine structural risks and trends across the industry, including compliance with Dodd-Frank, cybersecurity controls and broker-dealers’ compliance with best execution duties in routing order flow.

               Large Firm Monitoring – The OCIE will work with the Division of Trading and Markets and the Division of Investment Management to monitor the largest U.S. broker-dealers and asset managers to assess risks.

               Clearing Agencies – The OCIE will conduct an annual examination of all clearing agencies.

               Cybersecurity – The OCIE will examine transfer agents’, broker-dealers’ and investment advisers’ cybersecurity compliance and controls.

               Potential Equity Order Routing Conflicts – The OCIE will examine whether firms are prioritizing trading venues based on payments or credits for order flow in conflict with best execution requirements.

C.  Data Analytics

The OCIE intends to use data analytics capabilities to focus on registrants and registered representative that are potentially engaged in illegal activity such as excessive trading and penny stock pump-and-dump schemes. 

               Recidivist Representatives – The OCIE will use data analytics to identify individuals with a track record of misconduct and examine the firms that employ them.  This is a major focus for the regulators this year.  In an upcoming blog, I will write about newly enacted Rule 3110(e), which requires FINRA member firms to review the backgrounds of its employees and to verify information on representatives Form U4.  Broker-dealers that hire “high-risk and recidivist brokers” will face increased scrutiny. 

               Microcap Fraud – The SEC will examine the operations of broker-dealers and transfer agents for activities that indicate they are engaged in or aiding and abetting pump-and-dump schemes or market manipulation.

               Excessive Trading – The SEC will use data analytics to identify firms and representatives engaged in excessive trading.

               Anti-Money Laundering (“AML”) – The SEC will examine clearing and introducing firms AML programs and specifically firms that have not filed suspicious activity reports or have filed such reports late.  The SEC will also examine programs that allow customers to deposit and withdraw cash and/or provide non-U.S. customers with direct access to the markets.

D. Other Areas of Examination

In addition to the primary focus discussed above, the SEC will prioritize the following additional areas for examination:

               Transfer Agents – The SEC views transfer agents as an important gatekeeper to prevent Section 5 and other violations as well as preventing fraud.  The SEC intends to allocate more resources to examine transfer agents and particularly those involved with microcap securities and private offerings. 

               Municipal Advisors – The SEC will conduct examinations of newly registered municipal advisors.

               Proxy Services – The SEC will examine proxy advisory service firms including how they make recommendations on proxy voting and how they disclose and mitigate potential conflicts of interest.  In addition, the SEC will examine compliance with fiduciary duties on behalf of investors.

               Never-Before-Examined Investment Companies – The SEC will examine never-before-examined investment companies.

               Fees and Expenses in Private Equity – The SEC has observed a high rate of deficiencies among advisers to private equity funds in connection with fees and expenses and will continue to examine this area.

The Author
Attorney Laura Anthony
LAnthony@LegalAndCompliance.com
Founding Partner, Legal & Compliance, LLC
Corporate, Securities and Business Transaction Attorneys

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile.

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