In compliance, the moment of truth is the regulatory exam. During the exam, advisers and compliance officers have the opportunity to work closely with regulators to evaluate their firm’s policies and procedures. Although determinations made by regulators can often seem ambiguous, there is a fair amount of consistency and process in place for regulatory examinations. To assist firms with regulatory exam preparation, the SEC publishes its exam priorities to provide a glimpse into the areas of focus that may arise during the review process. Here are a few key highlights from the SEC’s 2021 Examination Priorities
One key point mentioned was a “name change” for the examination division. The Office of Compliance Inspections and Examinations (OCIE) has been renamed the “Division of Examinations (EXAMS).” While the purpose of the Division remains the same, the name change is notable for recognition and communicating with examiners.
EXAMS will continue to prioritize examinations of new RIAs, RIAs that have not been examined for several years, never before examined RIAS, and dually registered or affiliated RIAs. The Division will continue to focus on RIA compliance programs, including whether those programs and their policies and procedures are reasonably designed, implemented, and maintained. Core areas include account selection, portfolio management, custody, best execution, fees and expenses, business continuity plans, valuation, and whether RIAs have sufficient resources to perform core compliance responsibilities.
New RIAs are often occupied with simply launching their firms, and compliance matters may not rank high on their priorities list. Existing firms may fall into the trap of compliance complacency, believing that all is well and no news is good news. But this guidance tells us that your friendly neighborhood Regulator may soon be knocking on your door for what may be a comprehensive exam. Now is the time to get your compliance ducks in a row by reviewing your program top to bottom.
The Division will focus on ESG products that are widely available to investors, such as open-end funds and ETFs, and those offered to accredited investors such as qualified opportunity funds. Additionally, The Division will review the consistency and adequacy of the disclosures RIAs provide to clients regarding these strategies. The goal here is to determine whether the firms’ processes and practices match their disclosures and review advertising materials for false or misleading statements.
Have you communicated to your clients that a fund is environmentally and socially responsible? If so, then your research files must confirm these claims. Moreover, if your firm has added different review processes for ESG products, then your records must show that these processes are executed consistently.
The Division will again emphasize the protection of retail investors, particularly seniors, teachers, military personnel, and individuals saving for retirement. EXAMS will continue to prioritize examinations of RIAs with a focus on investments and services marketed to retail investors, such as mutual funds and exchange-traded products, municipal securities and other fixed-income instruments, and microcap securities those traded over-the-counter.
The Division has of late seemed particularly concerned with RIA practices surrounding the potential incapacitation of aging clients. It is suggested that you discuss such possibilities with your senior clients and have them authorize alternate contacts should you detect a deterioration in their decision-making capabilities.
EXAMS will continue to assess whether RIAs fulfill their fiduciary duty of care and loyalty, including whether advice provided continues to be in the best interests of clients, whether RIAs eliminate or make full and fair disclosure of conflicts of interest, risks associated with fees and expenses, complex products, best execution, undisclosed or inadequately disclosed compensation arrangements and compliance with Form CRS requirements
The Division will concentrate on recommendations regarding account type, conversions, and rollovers, as well as the sales practices used by firms for various product types, such as structured products, exchange-traded products, real estate investment trusts, private placements, annuities, digital assets, municipal and other fixed-income securities, and microcap securities. The Division will also focus on how firms comply with the recent changes to the definition of accredited investors when recommending and selling specific private offerings.
One particular area the Division will prioritize is the examination of RIAs operating and utilizing turnkey asset management platforms (“TAMP”). Such platforms provide RIAs with technology, investment research, portfolio management, and other outsourcing services. The Division’s examinations will seek to assess whether such fees and revenue sharing arrangements are adequately disclosed.
RIAs utilizing TAMPs are under a continuing obligation to assess the all-in adequacy of these programs, including their privacy and cybersecurity measures. This assessment is well-placed among your at-least-annual review of all vendors and custodians. RIAs are further obligated to ensure that clients who utilize TAMP services are not paying excessive fees overall. Also, clients receiving substantially similar comprehensive services through your RIA firm should not be paying substantially different general fees, regardless of what level of behind-the-scenes TAMP services one client may utilize compared to another. Assessment of how TAMP fee arrangement affect clients should be a part of your firm’s routine review of client fee and billing practices
The Division will review whether firms have taken appropriate measures to (1) safeguard customer accounts and prevent account intrusions, including verifying an investor’s identity to prevent unauthorized account access; (2) oversee vendors and service providers; (3) address malicious email activities, such as phishing or account intrusions; (4) respond to incidents, including those related to ransomware attacks; and (5) manage operational risk as a result of dispersed employees in a work-from-home environment. In particular, EXAMS will also focus on controls surrounding online and mobile application access to investor account information, the rules surrounding the electronic storage of books and records and personally identifiable information maintained with third-party cloud service providers, and firms’ policies and procedures to protect investor records and information.
In consideration of substantial disruptions to normal business operations in the past year, the Division will again be reviewing registrants’ business continuity and disaster recovery plans. Building on efforts concerning the Division’s business continuity plan outreach related to the pandemic, the Division will focus on whether such programs account for the growing physical and other relevant risks of climate change. The scope of these examinations will be similar to the post-Hurricane Sandy work of the Division, with a heightened focus on the maturation and improvements to these plans over the intervening years.
In light of firms providing financial services to clients in evolving ways such as Robo-advisers, automated asset allocation, fractional share purchases, customized portfolios, and mobile applications, examinations will evaluate whether firms are operating consistently with their representations and handling customer orders per customer instructions. Examinations will also focus on the use of regulatory technology (RegTech) and whether firms are implementing appropriate controls and compliance around alternative data or data gleaned from non-traditional sources.
Examinations of market participants engaged with digital assets and the use of distributed ledger technology will continue to include whether investments are in the best interests of investors, portfolio management and trading practices, the safety of client funds and assets, pricing and valuation, the effectiveness of compliance programs and controls, and supervision of outside business activities.
https://www.sec.gov/files/2021-exam-priorities.pdf
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