SEC Releases 2021 Examination Priorities
On March 3, 2021, the SEC’s Division of Examinations (“Division”) released their examination priorities (“Release”) for 2021. The Release represents the ninth year of the Division publishing their priorities. In the Release’s introduction, the Division leadership notes that investment advisers and market participants effectively delivered services as designed and adapted to remote work in the face of challenges presented during the COVID-19 pandemic. In fiscal year 2020, the Division conducted 2,952 examinations, issued over 2,000 deficiency letters and referred over 130 cases to the Division of Enforcement.
This post focuses on the general examination priorities contained in the Release. My colleague EJ Yerzak addresses the cybersecurity related priorities in a separate post.
Protection of Retail Investors
As in prior years, the Division prioritizes the protection of retail investors, including seniors, teachers, military personnel and those saving for retirement. Examinations will focus on how RIAs and broker-dealers meet their respective standards of conduct. Examinations of RIAs will assess, among other things, whether an RIA provides advice, including with respect to account and program types, that is in the best interest of its clients. For a broker-dealer, examinations will consider a firm’s compliance with Reg BI, including the effectiveness of written supervisory procedures. In December 2020, the Division issued a release outlining its examination focus with respect to Reg BI. The Division will also assess a firm’s compliance with Form CRS. In examinations of Form CRS filings during 2020, the Division noted that some filings lacked readability, contained inadequate disclosure of disciplinary requirements and even identified hundreds of firms that failed to timely file a Form CRS.
Examinations of RIAs and broker-dealers will focus on key themes related to protecting retail investors, including sales practices and the adequacy of disclosures. In considering sales practices, examinations will focus on the appropriateness of recommendations including the selection of account types, conversions and rollovers, and products, especially higher risk products such as structured products, leveraged/inverse ETFs, private placements and microcap securities.
The importance of disclosure is stressed throughout entire Release. Examinations will focus on the adequacy of disclosures with respect to conflicts of interest, including fees, expenses, revenue sharing, compensation for execution, fees related to turnkey asset management providers (“TAMPs”). In addition, the adequacy of disclosure regarding product risks, including disclosures related to new or enhanced risks resulting from the pandemic, such as increased risks of municipal securities in light of pandemic impacts upon such issuers.
Financial Technology, Innovation and Digital Assets
The Division will prioritize examinations of new technology providers, including Robo-Advisers, automatic asset allocation and fractional share purchases. Examinations will focus on whether firms are operating consistently with their representations and handling customer orders in accordance with customer instructions. In light of the run in certain securities in January 2021 and the market stresses created, this issue is timely for the SEC and likely to draw extensive scrutiny. A new priority this year is examining controls around alternative data, including compliance around the creation, receipt and use of such data.
With respect to recommendations or advice with respect to digital assets, examinations will focus on acting in the client’s best interest, portfolio management and trading practices, safety of client funds and assets, pricing and valuation, effectiveness of compliance programs and controls and supervision of a representatives outside business activities.
Environmental, Social and Governance (“ESG”) Factors
With the rise in client demand for ESG sensitive products, examinations will focus on how firms promote the use of ESG factors in the management of client portfolios. Specifically, examinations will consider the consistency and adequacy of disclosures, reviewing to determine that practices match the disclosures, including reviewing advertising for false or misleading statements and considering whether proxy voting is aligned with ESG strategies.
Other Themes
Anti-Money Laundering (“AML”) Programs. Examinations of broker-dealer and mutual fund AML programs will consider whether programs are tailored to the Firm, the effectiveness of policies and procedures, customer due diligence and robust and timely independent testing.
LIBOR Transition. With the pending discontinuation of LIBOR as a reference rate, Firms should consider their exposure to LIBOR, preparations to transition a new reference rate and client disclosures.
Compliance Programs. Examinations will consider the strength of a RIA’s compliance program, including account selection, portfolio management practices, custody, best execution, business continuity and valuation. In addition, examinations will evaluate a firm’s compliance culture, tone at the top and the sufficiency of compliance resources.
Mutual Funds and ETFs. Examinations of mutual funds and ETFs will review the adequacy of disclosures, valuation, filings, personal trading, liquidity, security lending and money market fund stress testing and board oversight.
Private Fund Advisers. Private fund examinations will consider preferential treatment of clients in funds with liquidity issues, including the use of gates and suspensions of withdrawals. In addition, fees and expenses, funds with high concentration of structured products and the impact of economic conditions on private fund portfolio companies will be high priorities.
Conclusion
As in prior years, the Division of Examinations has set forth an aggressive agenda and stays attuned to key market risks.