Compliance Alert – SEC Exam Priorities

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Dear Compliance Professional,


The National Examination Program (NEP) of the SEC’s Office of Compliance Inspections and Examinations recently released its examination priorities for 2013. The NEP release addresses both market-wide priorities and priorities for each of the NEP’s four distinct program areas: (i) investment advisers and investment companies; (ii) broker-dealers; (iii) clearing and transfer agents; and (iv) market oversight.

This Compliance Alert newsletter includes a synopsis of the investment adviser examination priorities portion of the NEP release. For those of you who want to view the full text of the release (recommended) you can click on the following link:

Examination Priorities for 2013

In addition, please visit the U.S. Compliance Consultants blog for additional commentary on these important issues.

The NEP release looks at ongoing risks, new and emerging issues and policy topics.

Ongoing Risks

The SEC anticipates that the ongoing risks selected as focus areas for investment advisers in 2013 will include:

Safety of Assets

The SEC will continue to utilize a risk-based verification process to confirm the safety of client assets and compliance with custody requirements. The SEC will review the measures taken by registrants to protect client assets from loss or theft, the adequacy of audits of private funds and the effectiveness of policies and procedures in this area. The SEC will focus on whether advisers are:

  • Appropriately recognizing situations in which they have custody as defined in the Custody Rule;
  • Complying with the Custody Rule’s surprise exam requirement;
  • Satisfying the Custody Rule’s qualified custodian provision; and
  • Following the terms of the exception to the independent verification requirements for pooled investment vehicles.

Conflicts of Interest Related to Compensation Arrangements

The SEC will review financial and other records to identify undisclosed compensation arrangements and the conflicts of interest that they present. These activities may include undisclosed fee or solicitation arrangements, referral arrangements and receipt of payment for services allegedly provided to third parties.


The SEC will focus on the accuracy of advertised performance, including hypothetical and back-tested performance, the assumptions or methodology utilized and related disclosures and compliance with record keeping requirements.

Conflicts of Interest Related to Allocation of Investment Opportunities

Advisers managing accounts that do not pay performance fees side-by-side with accounts that pay performance-based fees face unique conflicts of interest. While reviewing portfolio management practices, the SEC will confirm that the registrant has controls in place to monitor the side-by-side management of its performance-based fee accounts, such as certain private investment vehicles, and registered investment companies, or other non-incentive fee-based accounts, with similar investment objectives, especially if the same portfolio manager is responsible for making investment decisions for both kinds of client accounts or funds.

New and Emerging Issues

The SEC anticipates that the new and emerging risks for investment advisers in 2013 will include:

New Registrants

The SEC intends to launch a coordinated national examination initiative designed to establish a meaningful presence with newly registered advisers. The initiative consists of four phases: (i) engage with the new registrants; (ii) examine a substantial percentage of the new registrants; (iii) analyze examination findings; and (iv) report to the industry with observations.

Dually Registered IA/BD

It is not uncommon for a financial professional to conduct brokerage business through a registered broker-dealer that she does not own or control and to conduct investment advisory business through a registered investment adviser that she owns and controls, but that is not overseen by the broker-dealer. This business model presents multiple conflicts. Among other things, the SEC will review how financial professionals and firms satisfy their suitability obligations when determining whether to recommend brokerage or advisory accounts, the financial incentives for making such recommendations, and whether all conflicts of interest are fully and accurately disclosed. In addition, the staff will review dually registered firms’ policies and procedures to understand if such policies and procedures provide guidelines for when a financial professional makes a securities recommendation to a customer with a broker-dealer account versus an investment adviser account.

New and Emerging Issues

The SEC anticipates that the policy topics for investment advisers in 2013 will include:

Compliance with the Pay to Play Rule

To prevent advisers from obtaining business from government entities in return for political “contributions” (i.e., engaging in pay to play practices), the SEC recently adopted and subsequently amended, the Pay to Play rule. The SEC will review for compliance in this area, as well as assess the practical application of the rule.