The SEC’s Division of Examinations (the “Division”) announced its examination priorities for fiscal year 2021.1 According to the Division, examination priorities are published annually to enhance the transparency of its examination program and to provide insights into its risk-based approach, including the areas it believes present potential risk to investors and the integrity of U.S. capital markets.
The Division’s 2021 examination priorities include the following:
Retail Investors, Including Seniors and Individuals Saving for Retirement
The Division will again prioritize the protection of retail investors, particularly seniors and those saving for retirement. Specifically, the Division will focus on (i) standards of conduct, with emphasis on Regulation Best Interest, registered investment adviser (“adviser”) fiduciary duty, and Form CRS; (ii) fraud, sales practices and conflicts; and (iii) retail-targeted investments, including mutual funds and ETFs, municipal securities and other fixed-income securities, and microcap securities.
Information Security and Operational Resiliency
The Division will focus on working with firms to identify and address information security risks, including cyber-attack related risks. In response to concerns arising out of remote operations as a result of the pandemic, the Division will review whether firms have taken appropriate measures to: (i) safeguard customer accounts and prevent account intrusions, including verifying an investor’s identity to prevent unauthorized account access; (ii) oversee vendors and service providers; (iii) address malicious email activities; (iv) respond to incidents, including those related to ransomware attacks; and (v) manage operational risk as a result of dispersed employees in a work-from-home environment. The Division will focus in particular on controls surrounding online and mobile application access to investor account information and electronic storage of books and records and personally identifiable information maintained with third-party cloud service providers, and policies and procedures to protect investor records and information. Given the past year’s disruptions to normal business operations, the Division again will be reviewing registrants’ business continuity and disaster recovery plans.
Financial Technology (Fintech) and Innovation, Including Digital Assets
As innovations in financial technology and capital formation continue, the Division will focus on evaluating whether firms are operating consistently with their representations, handling customer orders in accordance with customer instructions, and will review compliance around trade recommendations made in mobile applications. Examinations will also focus on the implementation and integration of technology to facilitate compliance with regulatory requirements. Reviews will include examining whether firms are implementing appropriate controls and compliance around the creation, receipt, and use of alternative data, or data gleaned from non-traditional sources. Examinations of market participants engaged with digital assets will assess: (i) whether investments are in the best interests of investors; (ii) portfolio management and trading practices; (iii) safety of client funds and assets; (iv) pricing and valuation; (v) effectiveness of compliance programs and controls; and (vi) supervision of representatives’ outside business activities.
Anti-Money Laundering (AML)
The Division will prioritize examinations of broker-dealers and registered investment companies for compliance with their AML obligations in order to assess, among other things, whether firms have established appropriate customer identification programs and whether they are satisfying their Suspicious Activity Report (SAR) filing obligations, conducting due diligence on customers, complying with beneficial ownership requirements, and conducting robust and timely independent tests of their AML programs.
The London Inter-Bank Offered Rate (LIBOR) Transition
The Division intends to conduct examinations to assess the understanding of advisers, broker-dealers, registered investment companies, and other firms regarding their 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.
Additional Focus Areas for Advisers
- In evaluating the effectiveness of a compliance program, the Division will review whether an adviser appears to have sufficient resources to perform core compliance responsibilities.
- The Division will continue to focus on advisers that have never been examined, including new advisers and advisers previously registered that are yet to be examined.
- With respect to advisers offering investment strategies focused on sustainability, including strategies that are referred to by terms such as sustainable, socially responsible, impact, and ESG conscious, the Division will review the consistency and adequacy of the disclosures that advisers and fund complexes provide to clients regarding these 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.
2020 Exam Statistics
The Division completed 2,952 examinations of firms in fiscal year 2020, which was a 4.4% decrease from the prior year. The Division noted that this small decrease should be viewed in light of the impact of the pandemic. The Division examined 15% of all advisers in fiscal year 2020.
Hallmarks of Effective Compliance
The Division emphasized the importance of compliance programs, chief compliance officers, and other compliance staff, and stated several “hallmarks” of effective programs.
- Compliance’s active engagement in most facets of firm operations and early involvement in important business developments, such as product innovation and new services.
- Knowledgeable and empowered chief compliance officers with full responsibility, authority and resources to develop and enforce the firm’s policies and procedures.
- A commitment to compliance from C-level and similar executives to set a tone from the top that compliance is integral to the organization’s success and tangible support for compliance at all levels of an organization.
In view of the continued frequency and scope of the Division’s exams, firms should regularly review the adequacy and effectiveness of their compliance programs, policies and procedures.
Seward & Kissel, and our compliance consulting service SKRC (Seward & Kissel Regulatory Compliance), assist firms with SEC exams, mock audits, compliance reviews and compliance training.