The U.S. Securities and Exchange Commission’s (SEC) Division of Examinations ("EXAMS" or the "Division") released its annual priorities on March 3, 2021 in a 42-page report of exam priorities. Among other things, the list includes an ongoing emphasis on the overall strength of financial advisers’ compliance programs and a growing interest in the evolving risks to investors related to relevant climate and environmental, social, and governance (ESG) funds.
The Division issued more than 2,900 deficiency letters in 2020, despite obvious limitations imposed by the COVID-19 pandemic. This year, the examination staff will continue its efforts to see that the policies and procedures at financial advisory firms are reasonably designed, implemented, and maintained while reviewing such areas as business continuity plans, portfolio management practices, the custody and safekeeping of client assets, best execution, and fees and expenses.
Chief compliance Officers ("CCOs") should also be prepared to address two additional areas of concern from the Division in 2021.
ESG Investing
Six days before EXAMS released its annual list of priorities, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin with general information on the concept of ESG funds and related questions investors should ask ESG advisers. ESG investing also is referred to as socially responsible investing, sustainable investing, or impact investing. Between 2018 and 2020, total assets under management in U.S.-domiciled retail and institutional ESG funds grew 42%, to $17.1 trillion, up from $12 trillion, according to the Forum for Sustainable and Responsible Investment’s 2020 trends report. Assets in ESG funds now represent 33% of the $51.4 trillion in total U.S. assets under professional management. Since definitions used for the environmental, social, and governance aspects of mutual funds, ETFs, and other ESG investment vehicles can vary widely among investment management firms, the SEC encourages investors to carefully read and review all of the available information provided in the fund prospectus and most recent shareholder report and understand the fund’s fees and expenses. Investors can access the information on the SEC's EDGAR database, from their financial adviser, or directly from the fund company. Transparency and delivery of material information to investors remain a concern. Accordingly, the Division will focus on the type of ESG disclosure language provided to investors - in fund offering documents, and adviser's Form ADV and marketing collateral, and will compare that to the investment manager’s actual practices, with trading, proxy voting and other practices, to confirm whether the firm’s activities align with what has been disclosed to investors in setting expectations.The Importance of Business Continuity Plans
The record-setting low temperatures that forced millions of Texans to endure lengthy power outages and cope for several days without access to potable water and electricity represent a textbook example of the way a significant event can impact an adviser's ability to service investors. No matter if you are in Colorado with winter storms or in California where the risk of additional wildfires have soared, these environmental factors have, in part, prompted the Division to create a new Event and Emerging Risks Examination Team (EERT) to ensure firms are better prepared to address exigent threats, incidents, and emerging risks. Among other things, EXAM's efforts will focus on whether firms have a Business Continuity Plan ("BCP") in place that include appropriate policies and procedures for information security and operational resilience. The Staff will be reviewing If an adviser's BCP was updated to address client communications, supervisory considerations and cyber risks.Additional 2021 Exam Priorities
- Retail Investors, Including Seniors – An ongoing emphasis on compliance with Regulation Best Interest and whether investment advisers have met their fiduciary obligations set forth in the duty of loyalty and duty of care for Investors. Compliance officers also should check if firm protocols include knowing an investor's profile and evaluating the accounts and program types that would be in the client's best interest prior to making a reasonable basis recommendation. Such impartial conduct also necessitates mitigating conflicts of interest and providing important disclosure, as needed.
- Financial Technology and Digital Assets – Examinations will review compliance with instructions on handling customer orders and trade recommendations made in mobile applications. Advisers engaged with digital assets should review the effectiveness of compliance controls and practices and whether investments are in the best interest of customers.
- LIBOR – The Division is interested in whether advisers have assessed their exposure in advance of the expected discontinuation of the London Inter-Bank Offered Rate and whether they have prepared for a transition to an alternative reference rate.
- Anti-Money Laundering (AML) Programs – Firms should have adequate policies and procedures in place designed to identify suspicious activity and illegal money laundering.
