On February 20, the SEC’s Office of Compliance Inspections and Examinations (OCIE) launched a previously-announced initiative directed at investment advisers that have never been examined, focusing on those that have been registered with the SEC for three or more years. OCIE plans to conduct examinations of a “significant percentage” of advisers that have not been examined since they registered with the SEC. The examinations will focus on compliance programs, filings and disclosure, marketing, portfolio management, and safekeeping of client assets. The SEC plans to host regional meetings for investment advisers to learn more about the examination process.
On February 21, the SEC released an administrative order against a foreign financial institution that provided cross-border securities services to thousands of U.S. clients. The SEC asserted that the institution’s employees traveled to the U.S. to solicit clients, provide investment advice, and induce securities transactions despite not being registered to provide brokerage or advisory services. The order states that over a period of at least seven years, the institution served as many as 8,500 U.S. client accounts that contained an average total of $5.6 billion in securities assets. The institution admitted it was aware of federal broker-dealer and investment adviser registration requirements related to the provision of certain cross-border broker-dealer and investment adviser services to U.S. clients. After another foreign institution became subject to a federal investigation for similar activities, the institution began to exit the business, though the SEC order states it took years to do so. The order requires the company to disgorge more than $82 million, pay more than $64 million in prejudgment interest, and pay a $50 million civil penalty. In addition, the institution must retain an independent consultant to, among other things, confirm the institution has completed the termination of the business, and evaluate policies and procedures that could detect and prevent similar activity in the future.
On January 9, the SEC National Examination Program (NEP) published its examination priorities for 2014. The NEP’s market-wide priorities include (i) fraud detection and prevention; (ii) corporate governance and enterprise risk management; (iii) technology controls; (iv) issues posed by the convergence of broker-dealer and investment adviser businesses and by new rules and regulations; and (v) retirement investments and rollovers. The NEP also identifies priorities for specific program areas, including (i) investment advisers and investment companies; (ii) broker-dealers; (iii) clearing and transfer agents; (iv) market oversight program areas; and (v) clearance and settlement. For example, for the investment advisers and investment companies program area, the NEP plans to focus on certain emerging risks including (i) advisers who have never been previously examined, including new private fund advisers, (ii) wrap fee programs, (iii) quantitative trading models, and (iv) payments by advisers and funds to entities that distribute mutual funds.
On January 2, FINRA outlined certain specific areas of concern the independent regulator intends to focus on in 2014. The topics are largely consistent with FINRA’s 2013 priorities and are grouped in several categories: (i) business conduct; (ii) fraud; (iii) financial and operational; and (iv) market regulation. Under business conduct, for example, FINRA explains that it remains concerned about the suitability of recommendations to retail investors for complex products whose risk-return profiles may be difficult for investors to understand. FINRA lists numerous specific products it intends to scrutinize with regard to suitability. FINRA also intends to focus on, among other things, conflicts of interest, cybersecurity, anti-money laundering, and senior investors.
On October 28, the SEC announced enforcement actions against three investment advisory firms and certain executives for allegedly violating the “custody rule,” which was updated in 2010 and applies to SEC-registered investment advisory firms that have legal ownership or access to client assets or an arrangement permitting them to withdraw client assets. According to the SEC, in addition to other alleged securities violations, the firms allegedly failed to maintain client assets with a qualified custodian or engage an independent public accountant to conduct required surprise exams. To avoid further administrative proceedings, the firms and executives agreed to settle but did not admit the allegations. The firms and individuals collectively agreed to pay $535,000 in penalties, and one firm was required to disgorge nearly $350,000, inclusive of prejudgment interest. The firms also must submit to independent compliance reviews and implement certain specified compliance enhancements.
On October 23, the SEC announced penalties totaling $400,000 against three investment advisory firms and their executives for allegedly repeatedly ignoring problems with their compliance programs, which the SEC deemed inadequate to prevent misleading statements in marketing materials or inadvertent overbilling of clients. The penalties ranged from $25,000 for individuals to $100,000 for one of the firms. Among other things, the SEC highlighted the following deficiencies, which varied among the firms: (i) failing to complete annual compliance reviews, (ii) making misleading statements on company’s website and investor brochures by overstating the amount of assets under management while contradicting the amount the firm presented in its SEC filing, (iii) failing to adopt and implement written compliance policies and procedures, (iv) making false and misleading disclosures about historical performance, compensation, and conflicts of interest, (v) repeatedly over- and under-billing clients, (vi) failing to disclose known compliance deficiencies to potential clients in response due diligence questionnaires or requests for proposals, (vii) inflating the amounts of assets under management in SEC filings, and (viii) improperly removing and retaining nonpublic personal client information by an executive who left one of the firms. In addition to agreeing to the penalties, the firms agreed to hire compliance consultants and adopt specific compliance enhancements. The SEC took the actions as part of its Compliance Program Initiative, which targets firms that fail to effectively act upon SEC warnings about compliance deficiencies.
On October 23, the North American Securities Administrators Association (NASAA), a voluntary association whose membership consists of sixty-seven state, provincial, and territorial securities administrators in North America, published a report that indicates enforcement of state securities laws by U.S. state securities regulators is on the rise. The report reflects the results of a survey in which forty-eight U.S. NASAA members participated. According to the report, more than 2,600 administrative, civil and criminal enforcement actions involving nearly 3,700 respondents and defendants were reported by the states in 2011, including a near doubling of enforcement actions against investment adviser firms from the previous year. The report presents other summary findings and enforcement trends, including new risks related to crowdfunding and Internet offers.
On August 30, the SEC published a study of financial literacy. The Dodd-Frank Act required the SEC to examine (i) existing financial literacy among retail investors, (ii) methods to improve disclosures, (iii) information needed to make informed investment decisions, (iv) disclosure improvements related to expenses and conflicts of interest, (v) existing efforts to educate investors, and (vi) options for increasing investor financial literacy. The report’s findings reveal that currently investors lack knowledge of elementary financial concepts. The SEC staff reports that investors (i) prefer to receive disclosures before making a decision on whether to engage a financial intermediary, (ii) consider information about fees, conflicts of interest, and investment strategy essential, (iii) have mixed preferences on method of delivery for disclosures, but generally prefer that they be written in clear and concise language presented in summary and detailed form. The study concludes that transparency about conflicts of interest may be improved through the use of specific examples, among other things.
On July 3, the SEC announced that Ken C. Joseph will lead the Investment Adviser/Investment Company Examination Program for the New York Regional Office. Mr. Joseph previously served for 16 years as a Staff Attorney, Branch Chief, and Assistant Director in the SEC’s Division of Enforcement in Washington, DC and New York.
On July 2, the FDIC announced that Doreen R. Eberley will oversee all examination activities of the FDIC’s regional and field supervisory operations as Senior Deputy Director for Supervisory Examinations in the Division of Risk Management Supervision. Ms. Eberley currently serves as New York Regional Director and has been with the FDIC for 25 years. The FDIC also announced that Andrew Gray will serve as Deputy to the Chairman for Communications and Eric Spitler will serve as Director of the Office of Legislative Affairs.