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CFTC Announces 2019 Examination Priorities

The Compliance Branch of the Division of Market Oversight (DMO) of the Commodity Futures Trading Commission (CFTC) for the first time announced its annual examination priorities for contract markets and swap execution facilities.  The DMO will prioritize the following areas in 2019: cryptocurrency, disruptive trading, trading practices, block trades, markets, market makers and trading incentive programs, and relationships with service providers.  The DMO expects that most of its regulated entities will undergo at least one examination in 2019.  The CFTC expects that the DMO will announce examination priorities every year in order to enhance industry communication, prioritize risk-based areas of concern, pursue continuous improvement, and create efficiencies.

Expect the NFA to follow the DMO’s lead with respect to the announced priorities as well as the areas required in the Self-Examination Questionnaire.

FINRA Examination Priorities Letter Focuses on RegTech and Digital Assets

FINRA released its 2019 Examination Priorities Letter, spotlighting new areas including online distribution platforms and fintech, regulatory technology, digital assets, and fundraising for outside business activities.  FINRA will closely scrutinize member firms’ participation with online securities distribution platforms and whether firms are aiding the unlawful distribution of unregistered securities by handling customer accounts and/or receiving transaction-based compensation.  When using regulatory technology tools, firms will be asked how they supervise third party vendors and how they protect customer information.  FINRA will work with the SEC to ensure that member firms implement adequate controls and supervision when engaging with digital asset offerings through marketing, clearing, and recordkeeping activities.  FINRA continues its focus on outside business activities with a special emphasis on fundraising for personal benefit.  FINRA also makes clear that it will continue to review firms for compliance with longstanding priorities including suitability, fund share classes, private placements, communications, AML, cybersecurity, senior investors, best execution, and supervision. 

Compli-pros should read this Examination Priorities Letter together with the recently released Examinations Findings to create an inventory of compliance risks that the firm should immediately address through gap analysis and enhanced procedures.  Our experience is that the FINRA examiners hew closely to the announced priorities. 

The Friday List: Top 10 OCIE Priorities for 2019

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

Christmas came early this year as the SEC’s Office of Compliance Inspections and Examinations (OCIE) released its 2019 priorities, which in prior years came out in January or February.  OCIE has expanded its activities under the new Administration, boasting that it completed over 3,150 exams during the past year.  OCIE increased investment company exams by 45% and reviewed 17% of investment advisers, making good on its prior commitment to double adviser exams.  The Exam Priorities letter is long (12 single space pages) and covers many topics.  To help synthesize the data, we offer the Top 10 OCIE Priorities for 2019:

 

Top 10 OCIE Priorities for 2019

  1. Fees and Expenses:  OCIE will review disclosure and calculation of fees charged to clients.
  2. Portfolio Management: The staff will scrutinize how firms allocate investment opportunities and whether assets are managed according to stated investment objectives.
  3. New Advisers: OCIE continues to focus on never-before examined advisers and advisers that have not been examined in many years.
  4. Mutual Fund Share Classes:  The SEC will focus on which mutual fund share classes are recommended and whether reps have a financial incentive.
  5. Wrap Fee Programs: Firms must monitor wrap programs to make certain that the bundled fee is the best deal for clients.
  6. Affiliated Products/Services:  OCIE will examine the use of affiliated services or products for undisclosed conflicts of interest.
  7. Senior Investors:  The regulators are concerned about unsuitable recommendations to senior investors and supervision of reps.
  8. ETFs: The staff has prioritized ETFs with custom indexes, limited secondary market trading, and risky assets.
  9. Digital Assets: Concerned about the volatile cryptocurrency markets, the SEC remains vigilant about the sale, trading, and management of digital assets.
  10. Cybersecurity: OCIE wants firms to identify and manage cybersecurity risks including devices, governance, and policies and procedures.

FINRA Releases 2018 Examination Results

FINRA has released its 2018 Examinations Findings as a “resource for firms to strengthen their compliance programs and supervisory controls.” FINRA says the report selected certain observations because of “their potential significance, frequency, and impact on investors and the markets.” The report highlights widespread deficiencies in suitability policies and procedures including “quantitative suitability” (i.e. series of transactions), overconcentrations, excessive trading, and variable annuities. FINRA also cites widespread failures to ensure fulsome disclosure of fixed income mark-ups, reasonable private placement due diligence, and abuse of discretionary authority. The broker-dealer regulator summarizes other concerns including anti-money laundering, net capital and customer protection calculations, best execution and outside business activities.

This extensive list (15 pages) covers many of FINRA’s greatest regulatory hits. It’s a great document for new compliance officers because it covers a wide range of broker-dealer compliance requirements. Rather than helping compli-pros focus resources, it works better as a checklist to verify that the firm has addressed the most serious regulatory requirements.

SEC Is Examining Registered Funds and ETFs for Oversight, Policies, and Conflicts

 

The SEC’s Office of Compliance Inspections and Examinations has announced a sweep of certain mutual funds and ETFs. The OCIE staff will target smaller ETFs and funds/ETFs that use custom indexes, allocate to securitized assets, exhibit aberrational underperformance, or employ inexperienced managers or private fund sponsors that manage a similar mutual fund.  The SEC will assess compliance policies and procedures and fund oversight of risks and conflicts, disclosures to shareholders and the Board, and oversight processes.  Among some of the issues of concern to the OCIE staff include bid/ask spreads for secondary market trading of smaller ETFs, portfolio management for underperforming funds, the effect of unexpected market stresses on securitized assets, and side-by-side allocations for private and public funds.  OCIE is encouraging fund sponsors and boards “to consider improvements in their supervisory, oversight, and compliance programs.”

Compli-pros and fund lawyers should mobilize to review policies and procedures for affected advisers and boards, consult about changes, and implement enhanced oversight and processes.  We recommend taking action before the OCIE staff arrives for its examination. 

OCIE Releases 2018 Exam Priorities

The SEC’s Office of Compliance Inspections and Examinations released its 2018 examination priorities, focusing on retail investors, market infrastructure, FINRA, cybersecurity, and anti-money laundering.  As part of its mission to protect retail investors, OCIE will focus on (i) disclosure and receipt of compensation that could suggest a conflict of interest, (ii) robo-advisers, (iii) wrap fee programs, (iv) poor-performing mutual funds and ETFs, and (v) cryptocurrency offerings.  OCIE also plans to supervise FINRA’s “operations and regulatory programs” including the quality of its examinations.  OCIE also intends to scrutinize cybersecurity and anti-money laundering practices including risk assessment and customer due diligence.  OCIE makes clear that its priorities list is “not exhaustive” and could be expanded as a result of regulatory developments, examination information, complaints and tips, and other regulators.

OUR TAKE: OCIE is fairly transparent.  Now that the staff has identified these issues, compli-pros should expect a heavy focus during examinations.  Compliance departments should review policies and procedures and testing to get ready.

 

FINRA Releases Annual Exam Priorities Letter

FINRA released its annual Regulatory and Examination Priorities Letter identifying areas of FINRA focus for 2018.  FINRA announced a focus on fraud including insider trading, microcap pump-and-dump, Ponzi schemes and the resulting referrals to the SEC, even if the wrongdoing is outside of FINRA’s jurisdiction.  FINRA will also target supervision practices including the hiring and review of high-risk brokers, branch offices, and outside business activities.  New this year is a focus on cryptocurrency offerings and the role registered reps play in effecting transactions.  FINRA also highlights best execution, cybersecurity, anti-money laundering, and business continuity.  Consistent with prior years, FINRA will devote resources to customer protection and net capital, suitability, and liquidity risk.

OUR TAKE: Compli-pros should use the Priorities Letter as a checklist to review the Written Supervisory Procedures.  FINRA generally means what it says and addresses these topics during exams.

 

FINRA Issues Examinations Findings Report

FINRA has issued a report summarizing its observations on the compliance and supervision issues arising from recent examinations.  Highlighted concerns include cybersecurity, outside business activities, anti-money laundering, product suitability, best execution, and alternatives in IRA accounts.  FINRA found weaknesses in cybersecurity programs including failure to control access to data, insufficient risk assessments, and inadequate vendor supervision.  FINRA expressed concerns about failures to report OBAs and failures to execute adequate reviews or retain documentation.  AML programs fell behind as firms changed and grew but failed to properly resource growing AML volume.  FINRA raised suitability concerns over recommendations of UITs, fund share classes, and complex products.  FINRA hopes that firms will use the report as a “resource in tailoring their compliance and supervisory programs to their business.”

OUR TAKE:  It’s always good to get more transparency into the examination program.   What’s less clear is how firms should react to this information especially since FINRA generally issues its examination priorities letter in January.  Regardless, expect FINRA to focus on these issues during cycle exams.

SEC Chairman Re-Commits to Examinations and Enforcement

In recent testimony about the SEC’s proposed 2018 budget, Chairman Jay Clayton emphasized enforcement and examination activities.  Mr. Clayton noted that 50% of requested budget resources will go to enforcement and examinations.  He said that the SEC is on track to deliver a 20% increase in adviser examinations and plans a further 5% increase.  He noted that the staff will put a special focus on cybersecurity efforts.  Mr. Clayton also committed to continue the SEC’s “vigorous enforcement efforts to investigate and bring civil charges” including critical areas such as “investment professional misconduct.”

OUR TAKE:  It appears that the Clayton SEC will continue the examinations and enforcement focus of the Mary Jo White SEC.  The more things change, the more they stay the same.