OCIE Gives Advisers a Heads-Up About Its Latest Sweep Examination Initiative

Last week, OCIE published a National Exam Program Risk Alert highlighting the staff’s focus on advisers’ responsibility to act consistently with their clients’ best interests. According to OCIE, its latest sweep examination, the “Share Class Initiative,” will “address the risk that registered advisers may be making certain conflicted investment recommendations to their clients.”

Like other Risk Alerts published by OCIE, this notice highlights issues and risks that OCIE staff have identified in the course of its examination program.

The Risk Alert reminds advisers that, as fiduciaries, they have an obligation to act in their clients’ best interests and must disclose material conflicts of interest, “such as the receipt of compensation for selecting or recommending mutual fund share classes.” Accordingly, the Share Class Initiative will focus on advisers’ practices related to share class recommendations and compliance oversight of that process.

The Share Class Initiative will be risk-based and focus on the following high-risk areas:

  • Fiduciary Duty and Best Execution. Examiners will review advisers’ investment practices to confirm that they are acting in their clients’ best interests and seeking best execution in connection with recommending investments in mutual funds.
  • Disclosures. Examiners will evaluate advisers’ disclosures to clients (including, without limitation, Part 2 of an adviser’s Form ADV) to ensure that they adequately disclose whether the adviser (or its supervised persons) accepts compensation for the sale of investment products, including asset-based sales charges or service fees from the sale of mutual funds. This disclosure should adequately explain any conflict of interest inherent in the receipt of such compensation.
  • Compliance Program. Examiners will review an adviser’s Rule 206(4)-7 compliance program to determine if it adequately addresses the selection of mutual fund share classes.

Our take

OCIE’s published 2016 examination priorities include a focus on investor protections and adequately addressing conflicts of interest, and the SEC has brought several enforcement actions related to advisers’ causing clients to purchase more expensive share classes of mutual funds. Over the last couple of years, FINRA has brought similar actions for failures of broker-dealers to apply eligible sales charge waivers. It is therefore not surprising that OCIE would focus on this issue. Advisers should take the opportunity to review their compliance policies, and the implementation of such policies, to ensure that they adequately address the matters identified in the Risk Alert. Doing so quickly — and promptly making any necessary changes or improvements identified in such review — could mitigate any issues identified by the staff.

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