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SEC Division of Examinations Releases 2021 Examination Priorities

The SEC Division of Examinations (the “Division” and formerly known as the Office of Compliance Inspections and Examinations) has released its 2021 Examination priorities. A recap of 2020, as well as key 2021 areas of focus relating to Registered Investment Advisors (RIAs) are discussed below.

2020 Recap

With respect to 2020 – the year of  the “live business continuity test”, the Division notes the following:

“Generally, we observed that the financial markets operations and systems continued to work as designed, with exchanges, clearing agencies, investment advisers, broker-dealers and other market participants adapting to significant remote work and continuing to operate largely without incident.  While we observed adjustments to many processes, particularly those that involved manual processing or were not automated, overall, the delivery of financial services continued in the pandemic environment as it should have and as investors and other market participants have come to rely and depend upon.”

The Division initially released its 2020 examination priorities in January 2020.  As would be expected, its priorities evolved over the course of the year, although the expected drop in exams due to the pandemic was not as large as might have been expected.  The SEC completed 2,952 examinations in FY 2020, a decline of only 4.4% from FY 2019.  Exams shifted to more correspondence exams, and focused on business continuity plans and cybersecurity risks.  With respect to RIAs, the SEC notes that, over the past five years, the number of RIAs overseen by the SEC has increased from approximately 12,000 to 13,900, and assets under management increased from approximately $67 trillion to $97 trillion.  In 2014, the Division covered 10% of RIAs; that number peaked 17% in 2018 and dropped to 15% for 2020.  That included over 100 examinations of investment company complexes, an area that will remain a core focus in 2021.  The Division also notes its continued concern that resource constraints create the risk of diminished exam coverage for a still-growing RIA population.  Addressing this through added resources appears to be a front-burner issue for 2021 and beyond.

2021 Priorities

  • Similar to 2020, the Division’s exams continue to be grounded in the following four pillars:
    • Promoting compliance
    • Preventing fraud
    • Identifying and monitoring risk
    • Informing policy
  • Appropriateness of investment recommendations made to the retail marketplace, particularly in the context of concerns regarding fees and expenses and conflicts of interest, continues to be one of the Division’s primary concerns. Within the retail marketplace, the Division emphasizes recommendations made to seniors (including broad advising provided to retirement communities), teachers, military personnel and those saving for retirement.  The Division also is focusing on recommendations relating to “complex products,” which include structured products, exchange-traded products, real estate investment trusts, private placements, annuities, digital assets, municipal and other fixed-income securities and microcap securities.
  • While microcap securities were also identified as an area of focus in last year’s examination priorities, the Division noted an uptick in microcap issuers making “questionable claims regarding testing, treatments and vaccines, among other things”.
  • Compliance with recent changes to the definition of “accredited investor” when recommending private offerings.
  • The ongoing review of an advisor’s business continuity and disaster recovery plans will be enhanced to include an assessment of whether such plans, particularly those of systematically important registrants, account for the growing physical and other risks associated with climate change.
  • The criteria that determine whether a RIA is selected for examination (how recently has an RIA been examined, has it ever been examined, is it affiliated with a broker-dealer) remain largely unchanged. In its examinations of RIAs, the Division will continue to review the RIA’s compliance program, especially in cases where 1) the RIA has not been examined for several years and 2) the RIA has experienced significant growth or a change in its business model.
  • The Division will also, in its examinations, address investment strategies, products and services that may be identified as “sustainable, socially responsible, impact and ESG conscious” by an RIA or fund complex. Their goal is to ensure that disclosures regarding these strategies are consistent with the RIA’s or fund complex’s  processes and practices, review advertising (if applicable) for false or misleading claims, and review proxy voting policies and procedures and votes to assess whether they align with the strategies.
  • Digital assets are also an area of emphasis, including 1) whether investments are in the best interests of investors; 2) portfolio management and trading practices; 3) safety of client funds and assets; 4) pricing and valuation; 5) effectiveness of compliance programs and controls and 6) supervision of representatives’ outside business activities.

Withum Commentary

Although likely consistent with everyone’s collective observations, it is gratifying to see the Division’s overall assessment that systems and operations worked as designed over the last year through an environment that no one could have foreseen.  Climate change and sustainable investing have also found their way onto the Division’s priorities list.  It will be interesting to watch how an assessment of sustainability-related initiatives unfolds, given that there is currently no uniform, empirical definition of terms such as “sustainability” and “socially responsive” that serve as objective criteria against which to measure compliance.  Emphasis on digital assets (which include, but are not limited to, cryptocurrency) is expected, given that this market segment is evolving more rapidly than the related regulatory compliance framework.  The SEC has recently (in February 2021) issued “The Division of Examinations’ Continued Focus on Digital Asset Securities,” which discusses digital assets in further detail.

Contact Withum’s Financial Services Team for any further questions.

Financial Services

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