The SEC’s Division of Examination’s (formerly OCIE) annual announcement of its exam priorities is always noteworthy. It provides helpful insight into this division’s thinking and can serve as a roadmap for regulated entities to focus their compliance and supervision planning. The announcement of these priorities is even more important following a change in the presidential administration and the changes at the Commission that inevitably follow. Not surprisingly, the recently announced Division of Examination priorities for 2021 (summarized below) align with the Biden Administration’s policy priorities and key trends in the financial landscape.
Climate-Related Risks: Examinations will carefully consider environmental, social and governance (ESG) issues, including climate change. In the same way that the Division of Examinations previously focused on entities’ plans and disclosures related to the challenges posed by the COVID-19 pandemic, the Division announced that it will scrutinize business continuity plans to ensure that they “account for the growing physical and other relevant risks associated with climate change.” The Division will be looking for “maturation and improvements to these plans” to ensure that “registrants are considering effective practices to help improve responses to large-scale events.” The announcement of this examination focus also coincides with the Division of Enforcement’s announcement of the creation of a Climate and ESG Task Force.
This focus falls within the Division of Examination’s larger priority of examining information security concerns and cyber-attack risks, which have gained increased importance as remote work has increased and third-party vendors have continued to provide more services to investment advisors, broker-dealers and other registrants.
FinTech, Innovation and Digital Assets: As anticipated, the Division will focus on digital assets such as Bitcoin and tokens offered as part of initial coin offerings (ICOs). This is in keeping with its broader push to examine the multitude of issues presented by the rapidly evolving FinTech landscape, including whether and under what circumstances such assets fall within the definition of a security. For registrants involved in digital assets, the Division will look at whether such assets are in the best interest of investors, trading practices, assets safety, valuation practices, the sufficiency of compliance programs and controls, and the supervision of outside business activities. Last week, the Division even issued a Risk Alert about digital assets that echoed many of these examination priorities.
The Division is also planning to closely monitor how new technologies and services ― such as “robo-advisers,” the use of mobile applications, fractional share purchases, and other emerging trends ― are being properly monitored for their own risks, as well as being integrated into registrants’ existing monitoring and compliance programs.
Retail Investors and Regulation BI: The Division will continue to focus on efforts designed to protect retail investors. Chief among these efforts will be ensuring that broker-dealers and Registered Investment Advisers (RIAs) are, respectively, satisfying the requirements of Regulation Best Interest (Reg BI) and the Interpretation Regarding Standard of Conduct for Investment Advisers. Exams for broker-dealers will have an expanded scope this year, including enhanced transaction testing. Among other things, this will include careful evaluation of policies and procedures to address issues such as conflicts of interest and the additional requirements of Reg BI. RIAs will be scrutinized as to conflicts of interest, risks related to fees and expenses, best execution, disclosure of compensation arrangements, recommendations regarding complex products, and, overall, whether recommendations are in the best interest of clients in light of their investment objectives.
Examinations will focus on certain vulnerable retail investor groups, including seniors, teachers, the military, and those saving for retirement. Product recommendations and sales practices will be carefully considered, especially when complex products are involved. Furthermore, the Division will look to ensure that fee calculations are carried out properly and that customers receive all discounts and fee refunds they are entitled to. Due to their importance to retail investors, the Division also will focus on mutual funds and ETFs, municipal and other fixed income securities, and microcap securities.
Other Priorities: The Division also made note of its focus on (1) anti-money-laundering programs, sufficiently designed to identify suspicious activity; (2) LIBOR transition preparations, designed to mitigate risk, confusion, and disruption when the use of the benchmark rate is discontinued; (3) examining key elements of the market infrastructure, including risk-based exams of clearing agencies, assessments of the national securities exchanges, the operations of transfer agents, and the improvement in the technology infrastructure for these entities; and (4) monitoring FINRA and MSRB to ensure that their regulatory programs are operating effectively.
Registrants should bear these issues in mind as they evaluate the sufficiency of their compliance program for 2021 and beyond. Registrants should consider engaging a compliance firm or qualified legal counsel to help them navigate the dynamic legal environment resulting from the new Administration.
A version of this blog post was originally published on March 9, 2021 in Faegre Drinker’s Enforcement Highlights blog.
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