SEC OCIE exams to rise despite lower budget

More SEC examinations will target advisers as the agency shifts its projected lower funding toward RIAs and away from broker-dealers, according to the SEC’s 2018 budget request.

The Office of Compliance Inspections and Examinations, which probes more than 12,000 RIAs and 4,000 broker-dealers, is seeking $340.8 million from Congress for the next fiscal year. The division’s request would cut its budget by $5.4 million, or 1.5%, from this year’s continuing resolution.

Former SEC Chairwoman Mary Jo White led a shift in the division’s resources in her final year, according to the agency’s 2016 annual report. The division increased staff overseeing investment firms and RIAs by 20% through hiring and reassignment after 2,000 new advisers registered in the past two years.

The SEC also moved some OCIE staff to FINRA’s new Securities Industry Oversight office, which is “focused on assessing FINRA’s fulfillment of its core mission to regulate member broker-dealers,” according to the annual report.

The budget request, which current Chairman Jay Clayton presented last week in testimony before a Senate panel, reflects the change. The number of SEC exams of BDs will drop 43% this year to 310 from 543 in 2016, the document shows.

OCIE predicts the number of BDs who will face exams in 2018 to tick up to 320, despite the lower funding request. The division also forecasts the number of advisers examined to grow to 1,850, a 6% increase from this year and a 28% jump from last year.

Representatives for the agency didn’t respond to a request for an explanation on how the lower funding would yield more adviser exams.

OCIE will manage the higher workload with a lower budget through “the introduction of efficiencies” and 100 reassigned staff members, Clayton told lawmakers last week. Assets managed by RIAs have more than tripled to $70 trillion since 2001, he noted.

“I expect that for at least the next several years we will need to do more each year to increase the agency’s examination coverage of investment advisers in light of continuing changes in the markets,” Clayton said.

Compliance experts, however, expect both SEC and FINRA examinations to decline under President Trump, with a greater focus on enforcement in each case. Both agencies set records for enforcement actions in 2016.

Click through the slideshow for a full analysis of the budget request and its impact on advisers. Unless otherwise noted, data for 2017 is based on SEC’s continuing resolution and data for 2018 is based on the agency’s requests or estimates.
OCIE projects the share of RIAs who will receive exams to rise to a seven-year high this year and maintain that level next year, according to its budget request. Some 13% of firms will face exams, compared to 11% in 2016 and only 9% in 2010.

“The staff continued to enhance its risk assessment and surveillance capabilities to ensure that the program is spending its limited time and resources on those firms presenting the highest risk,” according to the budget request.

White, the former chairwoman, had noted the growth of staff examining RIAs in testimony before Congress last November. On the other hand, she also reported that OCIE was “only able” to push the rate of RIAs examined up by one percentage point from 2015.

“This level of coverage cannot be allowed to persist,” White said in remarks before the House Financial Services Committee. “Significantly more resources are needed to fulfill our responsibility to investors.”
OCIE found firms in compliance at a higher rate last year. The percentage of firms where examiners identified deficiencies dropped 6.5 percentage points to 72%, while those with significant findings and ones referred to the Division of Enforcement also fell. All three figures reflected four-year lows.

The division did not provide any projections for this year or next year in the budgetary document. OCIE officials did explain the nature of exam findings during exams, though.

“Examiners find a wide range of deficiencies during examinations,” according to the document.

“Some of the deficiencies are more technical in nature, such as failing to include all information that is required to be in a record. However, other deficiencies may cause harm to customers or clients of a firm, have a high potential to cause harm, or reflect recidivist misconduct.”
Tipsters prompted more exams in 2016 than either of the previous two years, according to OCIE. Outreach led to more referrals, complaints and other tips, though the division received 31 more overall in 2013, its first year tracking the figure.
OCIE carried out 2,400 exams overall in 2016, a 20% jump over 2015 and a higher number than any of the previous seven years, according to the SEC’s annual report. RIAs received the bulk of them, and regulators predicted that RIAs will see more exams in both 2017 and 2018.

All types of exams led to voluntary refunds of $60 million to investors in 2016, the annual report shows.
OCIE will pursue some exams of BDs even after ceding some of the responsibility to FINRA in a change that took effect in October, according to the SEC’s annual report.

While FINRA will boost its enforcement and exams, OCIE merged its oversight of BDs and advisers registered with both regulators into the Broker-Dealer and Exchange office.

Examiners from the unit “will maintain a significant presence nationwide, including in market centers such as New York and Chicago,” according to the annual report.
RIAs form a growing majority share of exams undertaken by OCIE, the division’s budget request shows. Some 71% of exams in 2017 are expected to probe RIAs, an increase of 11 percentage points from 2016. The agency requested a similarly high proportion for 2018.
OCIE may perform exams of any of the 26,000 market participants overseen by the SEC. The division had received increased funding for four straight years between 2012 and 2016.

Yet OCIE officials are seeking some $5 million less for the next fiscal year, along with $35 million less for the SEC overall. At the same time, however, the agency plans to conduct more probes of firms.

Examiners are on pace to carry out 2,449 exams overall this year, and OCIE forecasts the number to grow 6.5% to 2,609 in 2018, according to the SEC’s budget request.
Full-time OCIE staff at SEC headquarters and its regional offices would fall by 25 employees in 2018 under the division’s budget request. SEC officials predict that OCIE’s ranks will rise by 46 full-time staffers to 1,069 by the end of the year from 1,023 in 2016.

By the end of 2018, however, the division would lose 19 employees from regional offices and six from headquarters, if lawmakers approve OCIE’s budget ask. Officials project the trimmed-down workforce to conduct even more exams.
OCIE’s funding has trailed its request in each of the past five years. The division saw the largest disparity between its actual funding and its request to Congress in 2014, when the actual budget was more than $78 million below the request.

Last year, though, the division’s funding fell short by only 0.1% of its proposed budget.
The average cost of a single exam, as measured through dividing OCIE’s budget by the number of exams, would reach a low of around $130,000 by 2018 under the division’s budgetary proposal. The average stood at about $166,000 only four years ago.

The SEC will “accelerate and expand our ongoing efforts to find efficiencies throughout our operations,” officials wrote in the agency’s requested budget.