Repeat After Me: 12b-1s, Succession Planning, Third-Party Audits

In case you missed it, the Securities and Exchange Commission's annual investment advisor compliance outreach summit, held in mid-April at the agency's Washington headquarters, was chock full of vital information about what the securities regulator will be zeroing in on this year — particularly 12b-1 fees, succession planning and third-party advisor audits.

By year-end, the agency plans to launch a "Share Class Initiative" to examine advisors' commissions in connection with recommending share classes that charge investors 12b-1 fees, and the agency is knee-deep in assessing the "scope" of potential third-party advisor audits, agency executives said.

Jane Jarcho, national director of investment advisor exams, who was also recently named deputy director of the agency's Office of Compliance Inspections and Examinations, noted at the compliance summit the recent actions the agency took in this area. One was against three AIG affiliates — which agreed to pay $9.5 million to the SEC — for placing clients in share classes that charged fees for marketing and distribution even though the clients were eligible to buy shares in an institutional share class that did not charge 12b-1 fees.

"We will continue to look at this; this is a really important area," Jarcho said.

Diane Blizzard, associate director of the SEC's Division of Investment Management, said that the IM division is "still developing" a third-party advisor audit proposal, which would be designed to provide "additional touches" alongside SEC exams.

Such additional information about advisors' businesses collected by third-party exams would help inform OCIE's "risk-based" exam approach, she said, adding that IM is still assessing the "scope" of such exams, which "will drive the questions about cost, standards and SEC oversight" of the third-party audit process.

"There's an awful lot to work out when it comes to this proposal," Blizzard said.

Jarcho agreed that "a lot of thinking [about] getting the scope [of such audits] right is being put into this proposal; There's a lot of discussion on what the scope should be."

Jarcho added that while SEC Chairwoman Mary Jo White has stated that using third-party audits to boost the number of advisor exams is not her "first choice," developing such a proposal is "a priority of White's and a lot of effort is being placed on this" at the agency.

The Chairwoman Speaks

White noted in her remarks that while the agency has become "smarter" about exams by using "risk-based analytics and employing tools like targeted or limited-scope exams," more is still needed.

The advisor population, White said, "continues to grow at a rapid rate and our objective is to expand our coverage to protect investors across the spectrum."

She reiterated the recent decision by the agency to transition some staff examiners from the broker-dealer examination program to the investment advisor/investment company exam program, "with a goal of increasing overall staffing levels in the IA/IC examination program — between transitioning staff and new hires — by 20%."

While "that will help," White said, it "is not nearly enough."

Marc Wyatt, head of OCIE, noted that the agency is trying to keep pace with the onslaught on new advisor registrants: 1,000 new advisors registered over the past two years.

Blizzard also noted the agency's continued work on a rule to require that advisors "create and maintain" transition plans. "In the middle of a crisis is not the time to start the planning process," she said, noting that the SEC is looking at the requirements fund companies adhere to when developing their business continuity plans as it develops the rule for advisors.

She noted that the IM division is tailoring the proposal to accommodate the unique business models of the "different types of advisors out there."

As to advisor exams, Jarcho told summit attendees that just because OCIE decides to examine an advisory firm doesn't mean "you've done something wrong."

OCIE, she said, is "very risk-based" when it comes to performing exams, and "you may have a product that we think poses a risk and we are coming to look at that product." A lot of exams occur because "we are interested in something you're playing a role in — like a business line, product."

Jarcho noted the agency's Fixed Income Liquidity Risk Initiative, for instance, which was launched in 2015 and will likely conclude this year. She said OCIE has conducted exams of about 30 investment companies as well as 38 associated advisors and sub-advisors under the initiative.

And a Focus on Retirement

More than 200 exams have also been conducted under OCIE's Retirement-Targeted Industry Reviews and Examinations (ReTIRE) Initiative, which was announced last summer and zeros in on "higher-risk areas" of registrants' sales, investment and oversight processes, with particular emphasis on select areas where retail investors saving for retirement "may be harmed."

The initiative looks at such areas as fee and account selection, suitability, marketing and branch offices, Jarcho said, with a particular focus on branch offices in the IA space.

"We anticipate this to be a multi-year initiative; it's an enormous area to tackle," Jarcho said. The first year's exams looked at three types of platforms: captive sales forces, non-captive sale forces, and direct sales and solicitations, she said.

She added that 80% of the ReTIRE exams have been in the IA space and 20% on broker-dealers. Results of the exams "will help us determine industry practices and what risks we need to focus on."

What about robo-advisors? Where does the agency stand here?

Jarcho noted that the agency's "preliminary review" of robo-advisors is that "we're neutral on the business model — it's not good or bad." However, she noted that the SEC is "interested in ensuring that they are complying with the [Investment] Advisers Act."

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