Real World Insight From Current SEC and FINRA Exams

A big part of what we do here at Joot is help our clients with their regulatory examinations.  At any given time, we normally have at least a few clients that are undergoing a regulatory exam from either the Securities and Exchange Commission (the “SEC”) or the Financial Industry Regulatory Authority (“FINRA”).  This gives us a certain perspective on the current areas these regulators are focusing on during their exams and what appear to be the latest “hot button” topics.  We would like to share some of this information so you can take a look at your current compliance program and assess whether any of these focus areas apply to your firm. 

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SEC Areas of Focus

  • Best Execution: The concept of best execution of trades has traditionally applied to equity and other exchange traded securities (and bonds to some extent).  In recent examinations, we have noted the SEC has taken the approach that best execution should apply to the share class selection of mutual funds.  In other words, the SEC seems to indicate that the fiduciary duty of placing a client in the lowest share class available of a mutual fund, given the facts and circumstances, should be reviewed under the guise of best execution.  Factors to consider include: the custodian or broker used for the mutual fund trading and what share classes are offered; the long term costs associated with placing clients in share classes that have higher ongoing expenses versus share classes that have a commission charge; share class conversions and the effect on clients; and regular review (i.e. quarterly) of client accounts to ensure they are placed in the lowest share class available at that time.  When possible discrepancies have been found in exams, the SEC has asked the investment advisor to review the client accounts to determine if reimbursement of fees is appropriate.  In our experience, and is probably not surprising, the SEC has indicated that reimbursement should be done in most cases.     

  • Client Billing: Although not a new area of focus, the SEC continues to pay very close attention to billing of retail investors.  The first place that is reviewed is whether the ADV disclosure regarding billing matches with what is actually being conducted by the investment adviser.  When they dig into the process, they are taking a close look at how cash flows are being applied to the billing procedures and how the calculation methodologies are being applied to terminated accounts (such as pro-ration and refunds).  Consistency of billing is reviewed, and any exceptions to the billing process are scrutinized closely.  If you have billing exceptions, make sure they are documented thoroughly. 

  • Private Funds: For investment advisers who manage private funds, there appears to be a heavy focus on identifying conflicts of interest.  Agreements with vendors and trading information are reviewed and analyzed against private placement memorandums and subscription agreements.  The SEC is reviewing firm level advisory boards and any compensation arrangements that might conflict with fund disclosure as well as the access to non-public information the advisory boards may be privy to. 

  • Annual Compliance Review: Also, not a new area of focus, but the SEC continues to expect that investment advisers have a formal, documented annual compliance review process in place.  Risk assessments and compliance testing, both documented, are the expectation.  Verbal annual reviews are not adequate. 

  • Investment Adviser Employees Registered with Unaffiliated Broker-Dealers: The SEC focuses on the various compensation arrangements that present conflicts of interest between the fiduciary duty of the investment adviser and compensation received by employees acting as registered representatives of a broker-dealer.  Disclosure in the Form ADV 2 documents must disclose any and all conflicts (and perceived conflicts) and must be very descriptive.  The SEC is also focusing on the firm’s compliance program to ensure the various investment adviser compliance requirements are addressed appropriately.  If certain compliance responsibilities are completed by the broker-dealer, such as email archiving and review or code of ethics monitoring, the investment adviser must ensure it has the appropriate oversight of the broker-dealer to make sure things are being done properly and documented.  Remember, the investment adviser is ultimately responsible for the firm’s compliance program, not the broker-dealer.   

FINRA Areas of Focus

  • Regulation Best Interest (“Reg BI”) and Form CRS: This is, and will continue to be for some time, an area of focus.  FINRA will be checking for written policies and procedures and adequate training for sales representatives regarding Reg BI.  Broker-dealers will need to make sure its staff considers the express new elements of care, skill, and costs when making recommendations to retail customers. 

  • Communications with the Public (Rule 2210): We have seen a specific focus on private placement in retail communication and whether it is fair and balanced and all relevant information is communicated.  FINRA is also reviewing communications via digital channels, such as text and direct messaging and social media.  Email monitoring and customer complaints are also common areas of focus (no surprise).     

  • Trading Authorizations: Specific to discretionary trading, we have seen a deep dive on whether representatives are exercising discretion with the proper authorization.  FINRA has also been reviewing tickets to ensure they are marked correctly (solicited or unsolicited). 

  • Sale of Initial Public Offerings: Areas of focus here include review of allocation methodologies and adequate procedures to prevent flipping.    

These are current topics we see regulators focusing on during their examinations, but exams are always evolving.  If you need help, or would like more information, please contact us.  We are here to assist!

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