OCIE Directors Speaks About the SEC’s Exam Program

October 31, 2012

Carlo V. di Florio, the Director of OCIE, spoke at a NSCP conference in Washington, D.C. about OCIE’s exam program, including conflicts of interest. He began by explaining why conflicts of interest are important to OCIE. The SEC’s National Exam Program (NEP) is built around a risk-based strategy. The SEC has identified conflicts of interest as a key area for its risk analysis. This is based on the experience of its exam program that conflicts of interest, when not eliminated or properly mitigated, are a leading indicator of significant regulatory issues for individual firms, and sometimes even systemic risk for the entire financial system.

He stated that conflicts of interest are an integral part of its assessment of which firms to examine, what issues to focus on, and how closely to scrutinize. In addition, over the past two years, OCIE has conducted a sweep on conflicts of interest around confidential information received through investment banking and other business operations, and recently issued a report on that sweep.

He next identified the conflicts of interest that are currently a high priority for OCIE examinations include:

  • Compensation-Related Conflicts and Incentives:
    • Retail customers' interests potentially taking a back seat to various financial incentives of a broker-dealer or its representatives in recommendations and sales practices for new or risky products. This includes, for example, the retailization of complex instruments such as structured securities products. It also includes aggressive marketing of retirement products, and whether adequate due diligence is being performed on underlying investment vehicles;
    • Lack of oversight of outside business activities of representatives;
    • Incentives to place investors in accounts with fee structures that are high relative to the services provided, such as certain investment adviser or wrap fee accounts;
  • Portfolio Management-Related Conflicts:
    • Investment advisers that prefer one client over another when managing multiple accounts side-by-side, due to financial incentives or personal relationships;
    • Portfolio management activities by fund advisers that involve risks beyond the risk tolerance levels or stated objectives in the prospectus, such as overconcentration in a single issuer or sector, purchasing illiquid securities that appear to deliver higher returns, or a mismatch of fund liquidity to an expectation of fund redemptions;
  • Affiliations between investment advisers and broker-dealers:
    • Whether the client is put into an IA or BD account and the incentives associated with that decision;
    • Incentives of an investment adviser to use an affiliated broker-dealer for executing a client's trade even though the price or other terms of the execution are substandard;
  • Valuation:
    • Incentives of broker-dealers' and investment advisers to provide high marks in pricing relatively illiquid positions;
    • Inflating valuations to attract investors and charge more fees;
  • Transfer agent conflicts:
    • Conflicting incentives where a transfer agents' principals are owners of or affiliated with issuers, vendors, or others involved in the transfer agents' activities (e.g., attorneys, brokers, etc.);
  • Exchange Conflicts:
    • With regard to exchanges and self-regulatory organizations, blurred lines between SRO business and regulatory functions – for example, conflicts when an official with business-side responsibilities is also involved in regulatory oversight, where he or she may be in a position to affect the performance of competitors; and
    • The conflict between an exchange's responsibilities as an SRO and its business incentive to attract order flow from particular members.

He concluded his speech by discussing how firms can assess and mitigate conflicts.

Please click here for a copy of the speach.


Investment Advisers, Investment Companies