Virtual Asset Management Roundtable Series: SEC Examination Trends for Investment Advisers

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1 Virtual Asset Management Roundtable Series: SEC Examination Trends for Investment Advisers April 10, 2014 Jennifer L. Klass Daniel R. Kleinman Richard F. Morris Christine M. Lombardo

2 Our Team Jennifer L. Klass Richard F. Morris com Daniel R. Kleinman Christine M. Lombardo Morgan, Lewis & Bockius LLP 1

3 Agenda Recent Developments Expanding oversight of investment advisers Asset manager risk oversight program Uniform standard of care ERISA fiduciary definition 2014 SEC Examination Priorities Market-wide initiatives Core risks New and emerging g risks Policy topics Morgan, Lewis & Bockius LLP 3

4 Recent Developments Expanding Oversight of Advisers SEC Funding for FY 2015 There is an immediate and pressing need for significant additional resources to permit the SEC to increase its examination coverage of registered investment advisers so as to better protect investors and our markets. During FY 2013, the SEC examined 9% of advisers comprising approximately 25% of AUM A top ppriority is to add 316 additional OCIE staff to examine more registered firms in the investment management industry and private fund advisers, among other things. April 1, 2014 Congressional testimony by Chair Mary Jo White regarding the SEC s proposed FY 2015 budget. Morgan, Lewis & Bockius LLP 3

5 Recent Developments Expanding Oversight of Advisers Pi Private Fund dunit According to recent press reports, the SEC has developed a private fund unit co-chaired by Igor Rozenblit and Marc Wyatt. Initially, the unit will be comprised of 12 to 15 staff in the Boston, New York, Chicago and San Francisco regional offices. Asset Manager Risk Oversight Program Chair White has asked the IM staff for an action plan designed to enhance the program Expanded stress testing More robust data reporting Increased oversight of the largest asset management firms Morgan, Lewis & Bockius LLP 4

6 Recent Developments Uniform Standard d of Care Dodd-Frank Act ( 913) Calls for study and rulemaking regarding obligations of brokers, dealers and advisers when providing personalized investment advice and recommendations to retail customers Recent Developments Chair White indicates that SEC will intensify consideration of role and duties of investment advisers and broker-dealers primary immediate focus for this year Chair White directs the SEC staff to to evaluate all of the potential options available to the commission, including a uniform fiduciary standard for broker-dealers and investment advisers when dealing with retail customers, and other measures that may be more targeted and achievable in the shorter term. Proposed rules under 913 of the Dodd-Frank Act listed as pending action Morgan, Lewis & Bockius LLP 5

7 Recent Developments ERISA Fiduciary i Re-definition iti Anticipated DOL changes 2010 proposal to broaden the definition of an investment t advice fiduciary i under ERISA Effect would revise the five-factor test into a two-pronged test, effectively eliminating the regular basis and mutual understanding factors Status expecting reproposal, with changes, in summer 2014 Morgan, Lewis & Bockius LLP 6

8 2014 Examination Priorities Market-Wide Initiatives Fraud Detection and Prevention Increased reliance on risk monitoring and data analytics (quantitative and qualitative tools) to identify fraudulent or unethical behavior Corporate Governance, Conflicts of Interest and Enterprise Risk Management Technology Governance and supervision of information technology systems, operational capability, market access, information security and preparedness to respond to sudden malfunctions and system outages OCIE Risk Alert: SEC Examinations of Business Continuity Plans of Certain Advisers (Aug. 27, 2013) Morgan, Lewis & Bockius LLP 7

9 2014 Examination Priorities Market-Wide Initiatives Technology (cont.) FINRA Targeted Examination Letter on Cyber- security (January 2014) SEC Cyber-Security Request Identification of Risks/Cyber-security Governance Protection of Firm Networks and Information Risks Associated with Remote Customer Access and Funds Transfer Requests Risks Associated with Vendors and Other Third Parties Detection of Unauthorized Activity Morgan, Lewis & Bockius LLP 8

10 Dual Registrants 2014 Examination Priorities Market-Wide Initiatives Selection of brokerage or advisory accounts Different supervisory structures and legal standards of conduct for the provision of brokerage and advisory services Best execution enforcement actions New Laws and Regulation Rule 506(c) review of general solicitation practices and verification of accredited investor status Due diligence on private offerings OCIE Risk Alert: Investment Adviser Due Diligence Processes for Selecting Alternative Investments (Jan. 28, 2014) Municipal advisors Morgan, Lewis & Bockius LLP 9

11 2014 Examination Priorities Market-Wide Initiatives Retirement Vehicles and IRA Rollovers Percentage of IRA assets expected to continue to increase and exceed those held in employersponsored plans ($9 trillion expected by 2018) SEC focus on sales practices and improper or misleading marketing and advertising, conflicts, suitability and churning when recommending the movement of assets from a retirement plan to an IRA Follows FINRA Notice Morgan, Lewis & Bockius LLP 10

12 2014 Examination Priorities Core Risks Safety of Assets and Custody OCIE Risk Alert: Significant Deficiencies Involving Adviser Custody and Safety of Client Assets (Mar. 4, 2013) Custody rule enforcement actions (Oct. 28, 2013) Conflicts of Interest Marketing and Performance Focus on accuracy and completeness of claims about investment objectives and performance Morgan, Lewis & Bockius LLP 11

13 2014 Examination Priorities New and Emerging Issues Never-before Examined Advisers Advisers that have been registered for 3 years or more, excluding private fund advisers Risk-assessment or focused review on one or more higher-risk areas (e.g., compliance program, filings and disclosure, marketing, portfolio management and safety of client assets) ) Presence Exams Continuation of 2012 initiative to examine private fund advisers registered since Dodd-Frank Five key areas of focus are marketing, portfolio management, conflicts of interest, safety of client assets and valuation Morgan, Lewis & Bockius LLP 12

14 2014 Examination Priorities New and Emerging Issues Wrap fee programs Assessment of whether advisers are fulfilling their fiduciary and contractual obligations to clients Review of processes for monitoring program recommendations, conflicts, best execution, trading away and disclosures Quantitative trading models Payments for distribution in guise Fixed income investment companies Impact of changing interest rate environment on bond funds and related risk disclosures Morgan, Lewis & Bockius LLP 13

15 2014 Examination Priorities Policy Topics Money market funds Focus on how funds manage stress events and examining funds that exhibit outlier behavior Alternative investment companies Leverage, liquidity and valuation policies and practices Staffing, funding and empowerment of boards, compliance personnel and back-offices Manner in which funds are marketed to investors Securities lending arrangements Compliance with exemptive orders and consistency with relevant no-action letters Morgan, Lewis & Bockius LLP 14

16 Conclusion Morgan, Lewis & Bockius LLP 15

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