Each year, the SEC’s Division of Examinations (referred to in this article as “EXAMS”) publishes a helpful guide that serves as a road map for where it expects to focus. The 2021 Examination Priorities was released on March 3, 2021, a bit later than usual (typically we see the Priorities released in January or February).
The checklist below highlights key items in the 2021 Examination Priorities. Your firm can use this resource to address some of the major risks, trends and 2021 exam priorities that apply to RIAs. Not all exam priorities are addressed in this article, so you would benefit from reading the report first. The checklist below will help you identify areas that are already strong at your firm, as well as those that present opportunities.
- My firm’s business continuity plan has been updated, is operational and effective, and addresses increased cybersecurity risks facing firms and investors. That’s a loaded sentence, and there is a lot to unpack here. Start by reviewing the COVID-19 Risk Alert, released by EXAMS on August 12, 2020. Cybersecurity risks have long been a focus of EXAMS, and 2020 was certainly no different. In fact, EXAMS released a report and two additional risk alerts in 2020 that are worth reviewing as well – the Cybersecurity and Resiliency Observations released in early 2020, a July 10, 2020 alert on ransomware attacks and a September 15, 2020 alert on safeguarding client accounts against “credential stuffing.” All of these publications taken together underscore the need for solid policies and procedures and robust technology infrastructure for your firm’s – and your clients’ – protection. If this is an area where you feel that your firm could benefit from some outside expertise, know that there are many service providers in this space. Many have free resources available on their websites, and they can often customize paid offerings to help your firm shore up its business continuity plans and cybersecurity.
- My firm is meeting all Form CRS requirements. EXAMS released two additional alerts about requirements that took effect in 2020 – one covering Regulation Best Interest, which applies to broker-dealers, and another covering Form CRS, which applies to broker-dealers and investment advisers. EXAMS has determined that while many RIAs are correctly following the Form CRS instructions, but there was room for improvement in the readability of some Form CRSs and in the adequacy of responding to the Form CRS disciplinary disclosure requirements.
- My firm’s chief compliance officer (CCO) is in a position of sufficient seniority and with the necessary authority to discharge the duties of that role. In a November 2020 speech, EXAMS Director Peter Driscoll stressed the significance of the CCO role and emphasized the need to dedicate adequate resources to compliance. He also highlighted the benefits of the right “tone at the top” regarding compliance in his speech. One takeaway from the speech is how important it is for CCOs of RIAs to be fully empowered in the CCO role.
- My firm, as a fiduciary, has fulfilled – and continues to fulfill – its duties of care and loyalty. The SEC’s 2019 adoption of the Interpretation Regarding Standard of Conduct for Investment Advisers reaffirms these duties. EXAMS continues to prioritize the protection of retail investors, particularly seniors and individuals saving for retirement. During examinations, EXAMS has indicated that it will focus on whether RIAs provide advice that is in the best interest of their clients, based on their clients’ objectives. Disclosure of conflicts of interest is also a key factor, as are risks associated with fees and expenses, complex products, best execution, and undisclosed or inadequately disclosed, compensation arrangements.
- My firm is in compliance with its anti-money laundering (AML) obligations. EXAMS plans to review AML programs to ensure that they meet certain requirements, including having adequate policies and procedures in place that are reasonably designed to identify suspicious activity and illegal money-laundering activities.
- My firm is prepared to transition away from LIBOR. The discontinuation of LIBOR is another area that EXAMS has targeted as a priority for 2021; therefore, having a documented plan for the transition will be helpful.
- My firm’s compliance program and its policies and procedures are reasonably designed, implemented and maintained. EXAMS stated that it is committed to continuing to prioritize examinations of RIAs that have not been examined for several years, or have never been examined, and will be laser-focused on the strength of their compliance programs. If your firm’s business model has changed over the years, it is worth devoting some time and effort to analyzing whether your compliance program continues to align with your firm’s operations.
- If applicable, my firm properly uses financial technology (FinTech) and technology to facilitate compliance with regulatory requirements (RegTech). With respect to FinTech, EXAMS has indicated that it will focus on whether firms are operating consistently with their representations, whether firms are handling customer orders in accordance with customer instructions, and review compliance around trade recommendations made in mobile applications. EXAMS will also focus on the implementation and integration of RegTech in firms’ compliance programs. In addition, EXAMS will look closely at whether firms are implementing appropriate controls and compliance around the use of data gleaned from non-traditional sources (alternative data). For firms engaged in the digital asset market, EXAMS will heighten its scrutiny of that use as well.
- If my firm offers ESG investment strategies, the disclosures provided to clients are adequate. EXAMS intends to review the consistency and adequacy of the disclosures RIAs provide to clients regarding ESG strategies. This area represents new territory for EXAMS, and its entry into the examination priorities coincides with the SEC’s formation of a dedicated Climate and ESG Task Force in its Division of Enforcement. Look for EXAMS and other divisions within the SEC to take a more active approach with respect to ESG strategies, in 2021 and beyond.
- If applicable, my firm maintains an effective compliance program as an RIA that is dually registered as, or is affiliated with, a broker-dealer, or has supervised persons who are registered representatives of an unaffiliated broker-dealer. EXAMS will focus on the risks associated with these business models, including conflicts of interest that arise from certain compensation arrangements and outside business activities, best execution, and prohibited transactions.
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Diversification seeks to reduce volatility by spreading your investment dollars into various asset classes to add balance to your portfolio. Using this methodology, however, does not guarantee a profit or protection from loss in a declining market.