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News July 13, 2015 Issue

New Exams Will Focus on Retail Investments for Retirement

The SEC’s Office of Compliance Inspections and Examinations is putting flesh on the bones of one of its stated 2015 examination promises: It will begin examining advisers and broker-dealers that sell to retail investors saving for retirement.

The Retirement-Targeted Industry Reviews and Examinations Initiative, shortened to the somewhat clunky acronym of ReTIRE, was announced June 22 by OCIE in a risk alert.

The ReTIRE Initiative will focus on what the risk alert referred to as "certain higher-risk areas of registrants’ sales, investment and oversight processes, with particular emphasis on select areas where retail investors saving for retirement may be harmed." This would be in keeping with OCIE’s 2015 exam priority of "examining matters of importance to retail investors and investors saving for retirement, including whether the information, advice, products, and services being offered is consistent with applicable laws, rules, and regulations."

Advisers and broker-dealers will be chosen for the exams based on SEC staff use of data analytics, information from prior examinations, and "examiner-driven due diligence to identify registrants to examine," the alert said.

"Many retail investors, including advisory clients and brokerage customers, are more dependent than ever on their own investments for retirement," OCIE said in explaining why examinations focused on this area are necessary. Recognizing that investors today face a "complex and evolving set of factors" when making investment decisions, it identified some of these factors as including "the broad and changing array of investments available and services offered and the changing market environment."

Interpreting the exam

That said, is the initiative really new? The only thing really new about this exam initiative is that "it puts all of the SEC’s concerns about retail investments for retirement in one place," said Mayer Brown attorney Adam Kanter. "Otherwise, the issues they’re looking at aren’t all that new. Examiners have been looking for these types of issues in the past, and they’ve specifically been named in past examination priorities releases. Maybe now, with this initiative, they will be drilling down a bit more and doing it in a more concentrated fashion."

"There appears to be a unique focus on retail client level interactions and activities," said Stradley Ronon partner Lawrence Stadulis. "Rather than concentrating on firm-level compliance obligations, such as personal securities reports and written compliance policies, it looks like these exams will target the adviser/retail customer relationship. Thus, they will approach the exam process from a slightly different vantage point – that of the client. Sort of like eating an ice cream sundae starting at the bottom rather than with the cherry on top."

What this may mean, Stadulis said, is that examiners are looking at, among other things, documentation establishing the customer relationship and the basis for any advice that has been rendered. Also, that the advice is suitable under the client’s unique circumstances. This may be a new experience for those advisers who previously have been examined primarily at the firm level."

Specific areas of focus

OCIE said that examiners working on the ReTIRE Initiative will focus on:

  • Reasonable basis for recommendations. Examiners will want to know that advisers are consistently meeting their fiduciary duty obligations and broker-dealers are meeting their SRO obligations when making recommendations or providing investment advice. In that regard, expect examiners to see how advisers and broker-dealers are selecting account types, performing due diligence on investment options, making initial investment recommendations, and providing ongoing account management, according to the alert.
  • Conflicts of interest. "Registrants may be expected, as applicable, to identify material conflicts of interest, to design compliance programs to address the risks caused by these conflicts, and/or to disclose material conflicts of interest," OCIE said. To that end, examiners will review advisers’ and broker-dealers’ sales and account selection practices in light of the fees charged, the services provided to investors and the expenses of such services.
  • Supervision and compliance controls. "The staff will review registrants’ controls, oversight and supervisory policies and procedures, as appropriate, and for compliance with any applicable specific requirements discussed therein," OCIE said. Examiners may also focus on registrants with operations in multiple and/or distant branch offices, and broker-dealer representatives with outside business activities.
  • Marketing and disclosure. OCIE’s goal here is to ensure that any materials distributed to investors are not deceptive or misleading. To this end, expect examiners to review brochures, sales and marketing materials, and disclosures to retail investors. They will want to validate that the content is "true and accurate" and does not omit material information that should be disclosed, that disclosures regarding fees are complete and accurate, and that credentials and endorsements "are valid and meet any stipulated standards," the alert said.

Examiners may go beyond these areas and select additional topics based on what they identify during examinations, OCIE said.

OCIE’s exam priority for retail investments used for retirement may provide a further indication of what examiners will look for. The priority list, issued in January 2015, identified the following among its areas of concern:

  • Fee selection and reverse churning. "Financial professionals serving retail investors are increasingly choosing to operate as an investment adviser or as a dually registered investment adviser/broker-dealer, rather than solely as a broker-dealer," OCIE said. While broker-dealers receive commissions for each trade they make (raising the issue of churning, meaning making a lot of trades just to get the commissions), advisers get paid a fee regardless of how many trades are made. This creates the possibility that former broker-dealers will have a disincentive to trade, and simply charge fees to clients without much work to back it up (reverse churning).
  • Sales practices. OCIE said it will assess whether registrants are using improper or misleading practices when recommending the movement of retirement assets from employer-sponsored defined contribution plans into other investments and accounts.
  • Alternative investment companies. The SEC is studying retail alternative investments that lure investors with returns similar to private funds, but within traditional vehicles, like mutual funds. "We will continue to assess funds offering alternative investments and using alternative investment strategies," OCIE said, "with a particular 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 manner in which such funds are marketed to investors."
  • Fixed income investment companies. OCIE said it would review whether mutual funds with significant exposure to interest rate increases have implemented compliance policies and procedures, as well as investment and trading controls.