On February 7, 2018, the SEC's Office of Compliance Inspections and Examinations ("OCIE") published its 2018 National Exam Program Examination Priorities (the "2018 Exam Priorities").1 When compared to those of the prior five years, on the whole, OCIE's priorities have not shifted dramatically. Perhaps the most noticeable difference in the 2018 Exam Priorities versus those in prior years is the lack of a specific mention of private fund advisers, which were explicitly highlighted in OCIE's 2016 and 2017 exam priorities. While this is certainly a shift from previous years, private fund advisers should not assume that OCIE is completely deprioritizing the examination of private fund advisers. As OCIE specifically outlined in the core principals section of the 2018 Exam Priorities, the SEC is using a risk-based approach in conjunction with technology and data to do more with less.
As innovation in financial markets continue and with the ever-increasing risks in the cyber arena, it is not surprising that the 2018 Exam Priorities focused on many of the issues being covered by the mainstream financial media (i.e., retirees, cybersecurity, crypto assets, and anti-money laundering). Investment advisers should expect that in addition to more typical issues covered in OCIE's exams (e.g., conflicts of interest), OCIE exams will focus on the following key areas:
- Never-Before-Examined Advisers. Using their risk-based assessment tools, OCIE will continue to review advisers that have never been examined.
- Cybersecurity. Unsurprisingly, OCIE continues to emphasize cybersecurity. Many of the focus areas come out of OCIE's learning from their 2014 and 2017 cybersecurity sweep exams. See Lowenstein Sandler's Client Alert "Cybersecurity 2: Insights from OCIE's Recent Round of Cybersecurity Exams."2 Private fund managers and other investment advisers should continue to focus on effective training for staff, vendor management, cyber governance, and regular risk assessments as they implement, manage, and modify their cybersecurity programs.
- Crypto Assets. OCIE will examine firms for compliance with regulations in respect of crypto assets that are considered securities. Private fund advisers trading crypto assets will need to consider, among other things, compliance with SEC Rule 206(4)-2 (the "custody rule") for these types of assets. In addition, registered investment advisers will need to carefully consider the impact on their code of ethics as it relates to personal trading in crypto assets. See Lowenstein Sandler's Client Alert "Digital Tokens: Should SEC Registered Investment Advisers Update Their Code of Ethics?"3
- Anti-Money Laundering. OCIE will continue to focus on anti-money laundering ("AML") programs. Advisers should continue to advance their AML programs and work closely with their funds' administrators to ensure compliance with AML rules and regulations, both in the United States and abroad.
In addition to issues applicable to private fund advisors, OCIE is keenly focused on advisers that provide electronic investment advice (so called "robo-advisers"). The 2018 Exam Priorities note that OCIE will continue to concentrate on the processes and compliance policies and procedures of robo-advisers and investment advice offered through automated or digital platforms to retail investors. Firms that utilize these technologies should concentrate on maintaining robust compliance and data protection programs in addition to providing appropriate disclosures to clients and prospective clients.
Observations and Recommendations
Private fund managers should not expect a significant drop-off in either the number or scope of examinations in 2018. In fact, given the increase in both the efficacy of the technology utilized by OCIE and the sophistication of its staff, we expect the "do more with less" mantra will have a minimal impact on OCIE's focus on private advisers. While we expect additional emphasis on the areas highlighted by OCIE in the 2018 Exam Priorities during examinations, we do not anticipate that OCIE will cease to focus on core compliance areas that they have highlighted in prior years.
Please contact Benjamin Kozinn, Scott H. Moss, or your regular Lowenstein Sandler contact if you have any questions regarding OCIE's examination priorities or areas of improvement or change at your firm in consideration of OCIE's concerns.