On March 3, 2021, the Securities and Exchange Commission ("SEC") Office of Compliance Inspections and Examinations ("OCIE") released its annual top exam priorities for the 2021 calendar year. OCIE* is the SEC division which conducts examinations of registered investment adviser ("RIA") firms and this priority list can help investment advisers be better properly prepared for a regulatory examination. The examination priorities for 2021 include a focus on climate and environmental, social, and governance ("ESG")-related risks and conflicts of interest for investment advisers. In comparison to the SEC’s lists published in past years (2018, 2019, and 2020), there are similar priorities such as compliance programs and business continuity plans.
*Special note: on December 17, 2020, the SEC renamed OCIE to instead be called the “Division of Examinations" and this new name will be used in future blog posts to discuss the SEC's examination efforts.
In 2020, the pandemic challenged the OCIE examination process and required the agency to alter its approach by shifting to remote examining.
- In the 2020 fiscal year, OCIE completed 2,952 examinations compared to over 3,089 in 2019. (-4.4%)
- Examinations of about 2,952 RIA firms took place, covering approximately 15% of total investment adviser firms.
OCIE states that within the priority areas, the agency will be particularly focused on these common and emerging RIA regulatory compliance issues:
- Standards of Conduct: OCIE will focus on examining compliance with Form CRS and how RIA firms are acting according to their fiduciary duties of “care and loyalty”. This priority is in congruence with the risk alert issued in 2020, “Examinations that Focus on Compliance with Form CRS”. The division is looking for a general improvement on the “readability” of the Form CRS submissions as well as close attention to the disclosure requirements. The priorities report also reiterates the importance of filing the Form CRS in a timely manner.
In addition, the report indicates that firms will need to clearly display they are acting in best interest of their clients, reducing conflicts of interest, and providing disclosures of any known conflicts to retail investors.
- Fraud, Sales Practices, and Conflicts: RIA firms can expect an emphasis on disclosures related to fees, expenses, and conflicts of interest during their examinations. In particular, OCIE will evaluate the “appropriateness of recommendations and advice provided to retail investors, with a particular emphasis on: (1) seniors, including recommendations and advice made by entities and individuals targeting retirement communities; (2) teachers; (3) military personnel; and (4) individuals saving for retirement.”
It is also noted that OCIE will focus on sales practices concerning complex product types including, but not limited to exchange-traded products, digital assets, and annuities.
- Information Security and Operational Resiliency: This examination priority builds onto the business continuity and disaster recovery plan reviews in past years, adding focus onto how the plans are designed for the increasing risks associated with climate change and market events. In particular, the plans need to account for significant threats and demonstrate adequate practices in place for such events. Moreover, OCIE will focus on cybersecurity risks by reviewing policies and procedures specifically for how firms are protecting their customer accounts and preventing intrusions. These measures should address the prevention and response for malicious attacks as well as mitigate operational risk in a work-from-home environment. Firms that implement new communication strategies or technologies need to ensure they are simultaneously updating their compliance policies and procedures to meet the regulatory obligations.
- Financial Technology (Fintech) and innovation, including digital assets: OCIE will evaluate if firms are acting consistently with their representations. Regarding digital assets, examinations will 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.”
The report also discusses the increase in adoption of regulatory technology to increase efficiencies of compliance programs and that the examinations will be reviewing the implementation of such technologies.
- Anti-money laundering programs: The OCIE staff highlights the importance of implementing programs designed to identify suspicious or illegal money-laundering activities in accordance with the Bank Secrecy Act. It's also very important to note that while an investment advisory firm's custodian may have the ultimate responsibility to adhere to AML, it's possible that the custodian may require RIA firms to fulfill certain obligations. Though the contractual terms may be vague (“compliance with anti-money laundering rules”), an RIA may be obligated via its custodial contract to follow the same AML rules to which its custodian must adhere.
- The London Inter-Bank Offered Rate (“LIBOR”) transition: The LIBOR transition was mentioned in a risk alert from fiscal year 2020 regarding a likely discontinuation of this global reference rate, which is expected to occur in 2021. As indicated in the current priority list, examinations will shine a light on how registrants are knowingly exposed to the London Interbank Offered rate as well as measure the preparedness for a transition to an alternative reference rate, relative to how it will affect the firm’s own financial matters as well as its customers.
- RIA Compliance Programs: As expected, the focus on compliance programs is once again on the 2021 priorities list. The report describes the focus areas for compliance program examinations to be “appropriateness of account selection, portfolio management practices, custody and safekeeping of client assets, best execution, fees and expenses, business continuity plans, and valuation of client assets for consistency and appropriateness of methodology.” RIA firms that have not been examined in recent years should expect to be a higher priority for OCIE as the division will be looking closely to evaluate whether sufficient updates have been made according to any changes in growth or the business model.
As for registered funds, including mutual funds and ETFs, there will be a focus on disclosures to investors, valuation, filings, personal trading activities, contracts, and agreements, and will include a review of fund governance practices and compliance programs. Mutual funds or ETFs that have not been examined before will be prioritized and OCIE will focus on compliance with exemptive relief, including for the newly created, actively managed ETFs. There will also be a continued focus on RIAs for private funds.
- RIA to Private Funds: With a reported 36% of RIA firms managing private funds, OCIE stated it will be focusing on the liquidity and disclosures of investment risks and conflicts of interest. The report also discusses the focus on advisers to private funds that have a higher concentration of structured products to determine the risks associated and how such risks are disclosed to investors.
- 2020 SEC RIA Examination and Audit Priorities
- 2019 SEC RIA Examination and Audit Priorities
- 2018 SEC RIA Examination and Audit Priorities
- 2017 SEC RIA Examination and Audit Priorities
- 2016 SEC RIA Examination and Audit Priorities
- 2015 SEC RIA Examination and Audit Priorities
- 2014 SEC RIA Examination and Audit Priorities
- 2013 SEC RIA Examination and Audit Priorities