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SEC (Securities and Exchange Commission) Announces 2014 Examination Priorities

The SEC’s National Examination Program (NEP) published its 2014 examination priorities for investment advisers and investment companies.

Safety of Assets and Custody. The NEP continues to observe non-compliance with the custody rule. As we discussed in our April update, the SEC published a Risk Alert in March 2013 sharing observations regarding the most common issues of non-compliance. The safety of assets and custody was an exam priority last year and resulted in several enforcement actions in 2013. Given the importance of this requirement for a fiduciary, the staff will continue to test compliance with the custody rule and confirm the existence of assets through a risk-based asset verification process. Examiners will pay particular attention to those instances where advisers fail to realize they have custody and therefore fail to comply with requirements of the custody rule.

Conflicts of Interest. The staff has observed instances of non-compliance with the federal securities laws very often arise in situations where there are undisclosed conflicts of interest. The staff will therefore conduct examinations focused on conflicts of interest, including:

  • compensation arrangements for the adviser, with a particular focus on undisclosed compensation arrangements and their effect on recommendations made to clients; 
  • the allocation of investment opportunities;
  • controls and disclosure associated with side-by-side management of performance-based and strictly asset-based fee accounts;
  • risk controls and disclosure, particularly for illiquid investments and leveraged investment products and strategies; and 
  • higher risk products or strategies targeted to retail (and especially retired or elderly) investors.

Marketing/Performance. The staff will review the accuracy and completeness of advisers’ claims about their investment objectives and performance. For example, the staff will review and test hypothetical and back-tested performance, the use and disclosure of composite performance figures, performance record keeping and compliance oversight of marketing. The staff also expects to review marketing efforts arising out of newly effective rules adopted under the JOBS Act.

Payments for Distribution in Guise. The staff will continue its review of the variety of payments made by advisers and funds to distributors and intermediaries, the adequacy of disclosure made to fund boards about these payments, and boards’ oversight of the same. The staff will assess whether such payments are, in fact, payments for distribution and preferential treatment.

Fixed Income Mutual Funds. The staff will monitor the risks associated with a changing interest rate environment and the impact this environment may have on bond funds and related disclosures of risks to investors.

Money Market Funds. The staff will continue targeting some examinations at money market funds, focusing particularly on how they have managed any potential stress events and working with Division of Investment Management staff to examine particular money market funds that exhibit outlier behavior in some respect. Cases brought in 2013 involving money-market fund operations include Ambassador Capital Management, LLC (discussed in this update).

Alternative Investment Companies. The staff will continue its assessment of funds offering alternative investment strategies, with a particular focus on: (i) leverage, liquidity and valuation policies and practices; (ii) the staffing, funding, and empowerment of boards, compliance personnel, and back-offices; and (iii) the manner in which such funds are marketed to investors. The staff will additionally review the representations and recommendations made regarding the suitability of such investments.

Securities Lending Arrangements. The staff will examine securities lending arrangements to determine whether they comply with exemptive orders and evaluate consistency with relevant no-action letters.

Wrap Fee Programs. The staff will assess whether advisers are fulfilling their fiduciary and contractual obligations to clients and will review the processes in place for monitoring wrap fee programs recommended to advisory clients, related conflicts of interest, best execution, trading away from the sponsor and disclosures.

Quantitative Trading Models. The staff will examine advisers with substantial reliance on quantitative portfolio management and trading strategies and assess, among other things, whether these firms have adopted and implemented compliance policies and procedures tailored to the performance and maintenance of their proprietary models, including such procedures as: (i) evaluating if any models are used to manipulate the markets; (ii) reasonably reviewing or testing the models and their output over time; (iii) maintaining proper documentation within required books and records; and (iv) maintaining a current inventory of all firm-wide proprietary models.

Never-Before Examined Advisers. This initiative will address advisers that have never been examined and are not part of the Presence Exam initiative (referenced below). The staff will utilize a number of strategies to conduct focused, risk-based examinations of the adviser population that has been registered for more than three years but has not yet been examined by the NEP.

Presence Exams. The staff will continue its 2012 initiative to examine a significant percentage of the advisers registered since the effective date of the Dodd-Frank Act. The vast majority of these new registrants are advisers to hedge funds and private equity funds that were not registered or regulated by the SEC prior to the Dodd-Frank Act and have never been examined by the SEC. The staff will continue to prioritize examinations of private fund advisers where the staff’s analytics indicate higher risks to investors, or where there are indicia of fraud, broker-dealer status concerns or other serious wrongdoing. The five key focus areas of these examinations are marketing, portfolio management, conflicts of interest, safety of client assets and valuation.

Source: Examination Priorities for 2014, Office of Compliance Inspections and Examinations, January 9, 2014, available at:

Copyright © 2020 Godfrey & Kahn S.C.National Law Review, Volume IV, Number 42


About this Author

Susan Hoaglund, Investment Management Attorney, Godfrey Kahn law firm

Susan Hoaglund is a member of the Investment Management Practice Group. Susan provides advice to investment advisers, investment companies, broker-dealers and banks regarding legal, regulatory and compliance matters.

Chris Cahlamer Investment Management Attorney

Chris Cahlamer is the team leader of the firm’s Investment Management Practice Group, where he practices in investment management and securities law, focusing on investment companies, investment advisers, regulatory examinations, new product development, SEC compliance and reporting obligations, CCO support, private fund formation and operation, investment company reorganizations, investment advisor mergers and acquisitions, and general corporate and board fiduciary issues.

Chris earned his law degree, summa cum laude, at Marquette University Law School. While there, he received the Corporate Practice Institute Award and served as senior articles editor on the Marquette Law Review. He completed his undergraduate education at St. Norbert College, graduating as a member of the honors program and earning his bachelor’s degree, summa cum laude, in international economics and political science.

Chris is a member of the State Bar of Wisconsin and the American Bar Association.

Carol A. Gehl, Securities Law Attorney, Godfrey and Kahn law firm

Carol Gehl is a shareholder and the team leader of the Securities Practice Group in the Milwaukee office.

Carol’s practice is focused on investment management entities, including mutual funds, hedge funds, investment advisers and broker-dealers throughout the nation. During the last number of years, Carol has facilitated the organization of numerous mutual funds, hedge funds and investment advisers; assisted in SEC and FINRA examinations of regulated entities; provided ongoing advice to mutual fund Boards of Directors; and assisted with several mergers of investment advisers and...