[ by Howard Haykin ]

The SEC Examination Priorities for 2013, released Thursday afternoon, details critical elements of the Agency's National Examination Program ("NEP").  The SEC's Office of Compliance Inspections and Examinations ("OCIE"), headed by Director Carlo di Florio, is responsible for the NEP. 

For a profile of Mr. di Florio's education and professional experience, go to:  [C-I's WHO'S News Story, "Carlo di Florio: Director of SEC OCIE", posted 2/22/13].

The SEC Examination Priorities for 2013 is presented in two sections. 

• NEP-Wide Initiatives, ... addressing several risk areas and exam priorities that apply to nearly all registrants.  These topics are described in general terms.    [C-I discusses these initiatives in this posting - see below.]

• Program Area Specific Initiatives, ... addressing risks faced by specific program areas - generally divided into ongoing risks, new and emerging risks, and policy topics.   The NEP covers these issues and topics separately for each of its Exam Programs, namely:  

1. Investment Adviser-Investment Company Exam Program.
2. Broker-Dealer Exam Program.
3. Market Oversight Exam Program.
4. Clearance and Settlement Exam Program. 

[C-I discusses the above programs in separate postings.]

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NEP-WIDE INITIATIVES

A number of risk areas and exam priorities apply to nearly all registrants - the 4 categories listed below are most significant.  Accordingly, the SEC has included relevant initiatives for each throughout the entire NEP.

1.  Fraud Detection and Prevention.      U.S. capital markets run, in large part, on trust.  That trust is irreparably damaged when investors lose capital to scams, theft, and other fraudulent conduct.  In response to such threats and risks, the NEP will utilize and enhance quantitative and qualitative tools, and analyses so as to identify market participants engaged in fraudulent or unethical behavior.  The NEP also encourages tips, complaints, and referrals from investors, registrants, and other parties to help identify potential frauds.

2.  Corporate Governance and Enterprise Risk Management.   The NEP  calls for SEC examiners to meet with senior management and boards of entities registered with the Commission and their affiliates.  The purpose is to discuss enterprise risk, and in particular, how a firm governs and manages financial, legal, compliance, operational, and reputational risks.   This initiative is designed to:

• understand firms’ approach to enterprise risk management;
• evaluate firms’ tone at the top;  and,
• initiate a dialogue on key risks and regulatory requirements.

The SEC believes it can better assess overall risk management at certain registrants through discussions with independent board members, senior management, internal audit, key risk and control functions, and leaders of business lines.  

The discussions also are intended to improve the effectiveness of SEC exams of such firms, as well as other registrants.  The staff further engages in “discovery” reviews that aid examination policy and rulemaking efforts, as well as joint monitoring efforts with other regulators.  

examples:   (i) the SEC joined with the Federal Reserve to monitor reform of tri-party repurchase agreements and practices.  (ii) last fall's Hurricane Sandy revealed certain gaps in some registrants’ business continuity plans.  By identifying the overall impact of the hurricane on certain entities’ operations, including the obstacles they confronted when implementing their business continuity plans, such information can be integrated into the NEP, improving its relevance and effectiveness.  Such information also can be shared with other registrants - on "what to do: and "what not to do."

3.  Conflicts of Interest ("COIs").     COIs, when not eliminated or properly mitigated and managed, are a leading indicator and cause of significant regulatory issues for individuals, firms, and sometimes the entire market.  In past years, the NEP has identified COIs as a key focus of its risk-based strategy, and an integral part of our assessment of which firms to examine, what issues to focus on, and how to examine those areas. 

Conflicts of interest are particularly challenging for large and complex financial institutions, given their extensive affiliations and the dynamic nature of their businesses.  COIs constantly arise and change.  Accordingly, the NEP  will focus on specific COIs, along with steps registrants have taken to mitigate conflicts, and the sufficiency of disclosures made to investors.  The staff also will look at the overall risk governance framework that firms have in place to manage conflicts on an ongoing basis.

4.  Technology.     Capital markets have experienced a revolution in technology that has spanned several decades.  Increasing complexity, interconnectedness, and speed fostered by technology is a continual challenge to both market participants and regulators.   Numerous market events over the past 2 years have underscored how important it is for the SEC and other regulators to track new trading technologies and understand their implications for maintaining transparent, stable markets that have the capability to create uneven playing fields or advantages for certain market participants over others.

In 2013, the NEP may conduct exams on governance and supervision of information technology systems to gauge aspects that can adversely affect investor confidence, such as:

• operational capability;
• market access; 
• information security;
• risks of system outages;
• data integrity compromises.

Among other things, the NEP is intended to help the industry and the SEC to better understand operational information technology risks and potential ways we may mitigate and effectively manage those risks.

Once again, this is the SEC Examination Priorities for 2013.  Next up Exam Programs for B/Ds, IAs and ICs, Clearing firms, and SROs/Exchanges.