SEC Targets Conflicts of Interest, Cybersecurity
The U.S. Securities and Exchange Commission is focusing on conflicts of interest and cybersecurity as part of its enforcement and examination priorities for hedge funds and private equity firms.
In its 2015 examination priorities, the SEC said it will assess whether firms are prioritizing trading venues based on payments or credits for order flow in conflict with their best execution duties.
In a Feb. 26 speech, Julie Riewe, co-chief of the SEC’s Asset Management Unit, said that the agency anticipates bringing enforcement actions against funds on matters involving best execution failures in the share class context, undisclosed outside business activities, related-party transactions, fee and expense misallocation issues in the private fund context, and undisclosed bias toward proprietary products and investments.
The SEC views conflicts of interest that are not eliminated or properly mitigated as a leading indicator of significant regulatory issues for individual firms. The SEC’s Office of Compliance Inspections and National Exam Program has routinely focused on conflicts of interest in their risk analysis of which advisers to examine and in their determination of which issues to focus on and how closely to scrutinize them in their examinations of investment advisers.
The Presence Exam Initiative and the Never Before Examined Adviser Initiative both included conflicts of interest.
“We have seen entire presence exams just focused on one conflict and the manner in which the advisor approaches and addresses the conflict to assure they’re meeting their fiduciary duties,” Jillian Timmermans, vice president and partner at Cordium, which provides compliance advisory services, told Markets Media. “In the past, some really key ones that we’ve seen fixated on have been things like valuation, gift and entertainment, trade allocations, and personal trading.”
Conflict of interest was mentioned as both an examination priority and an enforcement priority by the SEC for 2015. “A conflict is anything that would cause an investment advisor to put their own interests ahead of the interests of clients and investors, so it definitely covers quite a few areas,” Timmermans said. “Just about anything could be a conflict.”
Fees and expenses are going to continue to be a focal point of examinations. “The SEC mentioned that specifically, as part of the 2015 examination priority letter, they’re going to be drilling down on fees and expenses, what they’re charging for the different fund vehicles, what disclosure is out there with respect to the fees that are being charged.,” Timmermans said. “That’s both with respect to the offering documents for the fund vehicles as well as what’s in the Form ADV.”
Cybersecurity is another examination priority this year with the SEC. “It began last year when they conducted an initial sweep of investment advisors and broker-dealers, and really delved down into what they had in place from a cybersecurity perspective,” said Timmermans.
The SEC’s Office of Compliance Inspections and Examinations released a risk alert in February that detailed the results of the initial sweep. The examinations focused on how firms identify cybersecurity risks, establish cybersecurity policies, procedures, and oversight processes, and protect their networks and information.
“They noted just recently that they’re going to be doing a second sweep,” said Timmermans. “They’re looking to expand the information that they have in terms of what firms are currently doing to ensure that they are protected from a cybersecurity perspective. They actually anticipate that either in the summer or early fall, they’ll be going out with phase two of the cybersecurity sweep. That one will most likely include on-site visits and a lot deeper digging.”
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