Exam Priorities for 2021-Investment Advisors

As of December 17, 2020, the Office of Compliance Inspections and Examinations (OCIE) has been renamed as the Division of Examinations of the US Securities and Exchange Commission (“The Examinations Division” or “EXAMS”).

EXAMS has announced their examination priorities for 2021 that contains priorities emphasized in previous years, however this year they outline emerging risks, including those related to environmental, social and governance matters (“ESG”) and climate change.  

The new focus on ESG and climate change-related risks is consistent with recently announced initiatives from the SEC’s staff that further integrate climate change and ESG considerations into the SEC’s regulatory framework. For example, on March 4, 2021, the SEC’s Division of Enforcement announced the creation of a Climate and ESG Task Force, which will develop initiatives to proactively identify ESG-related misconduct and whose initial focus will be to identify material gaps or misstatements in issuers’ disclosure of climate risks under existing rules as well as analyze disclosure and compliance issues relating to investment advisors’ and registered funds’ ESG strategies.

 The themes for 2021 are included here and below is the detail: 

  1. Retail Investors, Including Seniors and Those Saving for Retirement
  2. Information Security and Operational Resiliency
  3. Financial Technology (Fintech) and Innovation, Including Digital Assets
  4. Anti-Money Laundering Programs
  5. Focus Areas Relating to Investment Advisors and Investment Companies
    1. Compliance Programs
    2. Registered Funds, including Mutual Funds and ETFs
    3. RIAs to Private Funds

Retail Investors, Including Seniors and Those Saving for Retirement: EXAMS will focus on compliance with Form CRS and whether investment advisors have fulfilled their fiduciary duties of care and loyalty. Specifically, EXAMS will examine whether registered advisors are appropriately mitigating conflicts of interest and, where necessary, providing disclosure of conflicts that is sufficient to enable informed consent by retail investors. With respect to those investments heavily used by retail investors or those that may present elevated risks, EXAMS will continue to prioritize these products, including mutual funds, exchange-traded funds (ETFs), municipal securities and other fixed income securities, variable annuities, private placements, and microcap securities. EXAMS also noted that examinations will review firms’ disclosures related to fees and expenses as well as registered advisors that operate and utilize turnkey asset management platforms (and whether fees and revenue sharing arrangements in such platforms are adequately disclosed).

Information Security: EXAMS will review whether investment advisors have taken appropriate measures to: safeguard customer accounts and prevent account intrusions, including verifying an investor’s identity to prevent unauthorized account access; oversee vendors and service providers; address malicious email activities, such as phishing or account intrusions; respond to incidents, including those related to ransomware attacks; and manage operational risk as a result of dispersed employees in a work from home environment. These types of risks have increasing become important as registered advisors have adopted remote working environments in light of the COVID-19 pandemic. EXAMS will focus on controls surrounding online and mobile application access to investor account information, the controls 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.

Operational Resiliency/Business Continuity: EXAMS will continue to review business continuity and disaster recovery plans of registered advisors, but for 2021 will shift its focus to whether such plans, are accounting for the growing physical and other relevant risks associated with climate change. As climate-related events become more frequent and more intense, EXAMS has stated that it will review whether investment advisors are considering effective practices to help improve responses to large-scale events.

Financial Technology (FinTech) and Innovation, including Digital Assets and Electronic Investment Advice: EXAMS stated that examinations of market participants engaged with digital assets (including robo-advisory firms or traditional firms that rely on mobile or electronic platforms) will continue to assess the following: whether investments are in the best interests of investors; portfolio management and trading practices; safety of client funds and assets; pricing and valuation; effectiveness of compliance programs and controls; and supervision of representatives’ outside business activities.

Anti-Money Laundering Programs: EXAMS will continue to review for compliance with applicable anti-money laundering requirements, including evaluating whether registered funds have adequate policies and procedures in place that are reasonably designed to identify suspicious activity and illegal money-laundering activities.

Focus Areas Relating Specifically to Registered Advisors and Registered Funds:

Registered Advisor Compliance Programs: EXAMS will continue to review the compliance programs of registered advisors, including whether those programs and their policies and procedures are reasonably designed, implemented, and maintained in accordance with applicable federal securities laws. In evaluating the effectiveness of a compliance program, EXAMS stated that it frequently reviews whether registered advisors appear to have sufficient resources to perform core compliance responsibilities. This year EXAMS noted that it is focusing on registered advisors that employ investment strategies related to ESG factors, particularly products in these areas that are widely available to investors, including open-end registered funds and ETFs, as well as those offered to accredited investors such as qualified opportunity funds. To that end, EXAMS stated that it will review the consistency and adequacy of the disclosures registered advisors and fund complexes provide to clients regarding their ESG strategies, determine whether the firms’ processes and practices match their disclosures, review fund advertising for false or misleading statements, and review proxy voting policies and procedures and votes to assess whether they align with the strategies.

Registered Funds, Including Mutual Funds and ETFs:  EXAMS stated that its examinations of registered funds will focus on disclosures to investors, valuation, personal trading activities, contracts and agreements, and will include a review of fund governance practices and compliance programs.

Similar to prior years, EXAMS noted that it will prioritize examinations of mutual funds or ETFs that have not previously been examined or have not been examined in a number of years, and will generally focus such examinations on fund compliance programs and financial condition, particularly where funds have instituted advisory fee waivers. In addition, EXAMS stated that it will focus on compliance with exemptive relief, including for the newly created non-transparent, actively managed ETFs, and will also review funds’ and advisors’ disclosures and practices related to securities lending.

Registered Advisors to Private Funds: EXAMS will continue to focus on advisors to private funds, and will assess compliance risks, including a focus on liquidity and disclosures of investment risks and conflicts of interest. For 2021, EXAMS stated that it will also focus on advisors to private funds that have a higher concentration of structured products, such as collateralized loan obligations and mortgage backed securities, to assess whether the private funds are at a higher risk for holding non-performing loans and having loans with higher default risk than that disclosed to investors.

For all of the important details around these categories and more, click here for a complete copy of the Exam Priorities for 2021-Investment Advisors.