The SEC is out with its 2021 Examination Priorities, and while they are in large part similar to those in recent year, this year RIA firms can expect to see an emphasis on adjustments to the impacts of the COVID-19 pandemic, Reg BI and Form CRS compliance, and a much more significant focus on ESG matters.
On March 3, the Securities and Exchange Commission’s Division of Examinations (EXAMS), formerly the Office of Compliance Inspections and Examinations (OCIE), released the 2021 examination priorities in a 42-page PDF document.
A March 4 brief from law firm McGuireWoods LLP analyzing the priorities said this year firms can expect EXAMS to consider firms’ assessments of, and adjustments to, the impacts of the pandemic. Firms should also be prepared for examinations relating to Reg BI and Form CRS compliance.
“With regard to broker-dealers, this new compliance program obligation under Reg BI is the first time that a failure to have reasonable procedures and systems in place may result in a failure to supervise enforcement action without the Commission needing to establish underlying violations resulting from the lack of a reasonable program,” the brief states. “Finally, the 2021 examination priorities re-emphasize growing regulatory interest on ESG strategies and disclosures, and firms should be prepared for there to be continued focus in this area.”
In a press release, SEC Acting Chair Allison Herren Lee said, “This year, the Division is enhancing its focus on climate and ESG-related risks by examining proxy voting policies and practices to ensure voting aligns with investors’ best interests and expectations, as well as firms’ business continuity plans in light of intensifying physical risks associated with climate change. Through these and other efforts, we are integrating climate and ESG considerations into the agency’s broader regulatory framework.”
Another legal brief, this one from Burr & Forman, says Acting Chair Lee has been stumping for the Biden Administration’s climate-change agenda, calling for the SEC to take the lead among other financial regulators in developing a global set of standards and agenda, including increased climate disclosures. “In addition, the Division of Examinations will look at the implications of climate change upon registrant’s operations, the materiality and adequacy of climate-change and ESG disclosures and compliance in the context of ESG-oriented investment vehicles,” the brief says.
“Our priorities reflect the complicated, diverse, and evolving nature of the risks to investors and the markets, including climate and ESG. In this unprecedented time, the Division is committed to continuing to adapt examination processes and find innovative ways to enhance the effectiveness of examinations and our risk-based approach,” said Division Director Pete Driscoll. “However, the bedrock of our examination program remains unchanged. The work we do, from examinations to publishing risk alerts and conducting outreach, serves our mission to promote compliance and protect investors.”
Overview of Priorities
The SEC provided the following overview of the 2021 examination priorities:
Retail Investors, Including Seniors and Those Saving for Retirement, Through Reg. BI and Fiduciary Duty Compliance: The Division will focus on compliance with Regulation Best Interest, Form CRS, and whether registered investment advisers have fulfilled their fiduciary duties of care and loyalty. The Division will examine whether firms 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, the Division 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.
Information Security and Operational Resiliency: The Division will continue to review business continuity and disaster recovery plans of firms, but will shift its focus to whether such plans, particularly those of systemically important registrants, are accounting for the growing physical and other relevant risks associated with climate change. As climate-related events become more frequent and more intense, the division will review whether firms are considering effective practices to help improve responses to large-scale events. The Division will also review whether registrants 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.
Financial Technology (Fintech) and Innovation, Including Digital Assets: Among other areas, examinations will focus on evaluating whether registrants are operating consistently with their representations, whether firms are handling customer orders in accordance with their instructions, and review compliance around trade recommendations made in mobile applications. Examinations of market participants engaged with digital assets 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: The Division will continue to review for compliance with applicable anti-money laundering (AML) requirements, including evaluating whether broker-dealers and registered investment companies have adequate policies and procedures in place that are reasonably designed to identify suspicious activity and illegal money-laundering activities.
The London Inter-Bank Offered Rate (LIBOR) Transition: The Division will continue to engage with registrants through examinations to assess their understanding of any exposure to LIBOR, their preparations for the expected discontinuation of LIBOR and the transition to an alternative reference rate, in connection with registrants’ own financial matters and those of their clients and customers.
The overview continues with descriptions of focus areas relating to investment advisors and investment companies, and of broker-dealers and municipal advisors.
Finally, if SEC Chairman nominee Gary Gensler is approved and sworn in as expected, the possibility exists for adjustments to examination priorities. Although, as the McGuireWoods brief notes, the stated priorities appear to be largely consistent with some of the focus areas that have been already been articulated by Gensler.