In addition to its broker-dealers priorities list, the SEC released its 2014 examination priorities as pertains to the investment adviser/investment company program, which has primary authority for approximately 11,000 registered advisers and 800 companies, which collectively manage $55 trillion for investors.
As was the case with the broker-dealers list, the SEC separated its investment adviser/company priorities into three areas: core risks, new and emerging issues and initiatives & policy topics.
Core Risks
The SEC identified safety of assets and custody as a priority area for investment advisers and companies in 2014 because the agency has continued seeing non-compliance concerning the issue of fund security and fiduciary requirements. For instance, the SEC expressed concern at misconduct that arises when advisers fail to realize they have custody and therefore fail to comply with the Custody Rule.
Non-compliance too emerges from conflicts of interest situations. The SEC specifically is concerned with conflicts of interest that arise from certain investment adviser business models. For instance, a business structure that repeatedly places an adviser's interests ahead of a client's is unhealthy and unnecessarily risky for investors. Examples of potential areas for misconduct include:
> Compensation (or commission) arrangements or schemes in which investment advisers receive payment in exchange for certain recommendations made to clients;
> Deficient disclosure or risk control requirements or policies, notably those for illiquid and leveraged investment products and strategies;
> Side-by-side management of performance-based and asset-based fee accounts;
> Higher risk products or strategies specifically targeted to retail—namely retired or elderly—investors.
Accuracy of marketing/performance for recommended products is also of concern as recommendations should be tied to and rooted in facts and proven performance. This priority area includes accurate composite performance figures, record keeping and firm-based compliance oversight of marketing.
New and Emerging Issues and Initiatives
In an effort to provide more thorough oversight of its registered persons, the SEC will address never-before examined advisers, notably those who have been registered for longer than three years but have not yet been examined. On a related note, the SEC will step up presence exams, bolstering five key focus areas: (1) marketing, (2) portfolio management, (3) conflicts of interest, (4) safety of client assets and (5) valuation.
Fiduciary and contractual obligations are a priority area in 2014 and the SEC specifically will review processes in place for monitoring wrap fee programs recommended to clients. Amongst potential misconduct items to be reviewed are conflicts of interest, best execution, trading away from sponsors and issues of disclosure.
Disclosures will also play a key role with review of payments for distribution in guise when the staff determines whether payments made by advisers and funds to distributors and intermediaries are adequately disclosed and/or whether they are instead payments for distribution and preferential treatment. Payments in guise are indicative of a conflict of interest situation, which can be harmful to investors because their interests are passed over in favor of the advisers'.
Investment advisers with "substantial reliance" on quantitative trading models in portfolio management will be a growing area of review in 2014. For instance, the SEC will review quantitative trading policies and procedures for possible market manipulation, the effect on outputs over time, questions of proper documentation and keeping required books and records and maintaining a current inventory of firm-wide models. Market manipulation can likewise hurt investors when their investments artificially deflate.
Policy Topics
The SEC will further assess "alternative" investment companies and alternative investment strategies, particularly as relates to issues of leverage, liquidity, valuation policies, marketing and suitability.
If you have invested with an investment adviser or firm who has exposed you to undue risks, including Custody Rule noncompliance, a conflict of interest, inaccurate marketing or unsuitable recommendations, and such misconduct has proven harmful to your investments or interests, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for investigation and consultation.