For each of the past nine years, the U.S. Securities and Exchange Commission’s (SEC) Division of Examinations (previously called the Office of Compliance Inspections and Examinations, or OCIE, and hereinafter referred to as the “Division”) has announced examination priorities for the upcoming year. These priorities indicate the compliance risks and measures, market factors, investor protections and other areas of focus for the Division’s compliance examinations of broker-dealers, investment advisers and other market participants. The Division’s listed priorities give insight into the type of information the Division expects to collect during its inspections, as well as the areas in which the Division or the SEC is likely to publish risk alerts or implement additional forms or regulations. Of course, these priorities are not exhaustive and will not be the only issues addressed by the Division in their examinations, published risk alerts and investor and industry outreach.
Items the Division has stated it will prioritize when examining broker-dealers, investment advisers and other market participants during 2021 include the following:
- Retail Investors. The Division plans to emphasize the protection of retail investors, particularly seniors, teachers, military personnel and individuals saving for retirement. In 2021, the Division will expand the scope of examinations to focus on assessing whether broker-dealers are making recommendations that they have a reasonable basis to believe are in customers’ best interests and evaluating broker-dealer processes for compliance and alterations made to product offerings. The Division will also continue to examine registered investment advisers (RIAs) to assess whether they have fulfilled their duty of care and duty of loyalty by analyzing their disclosure of conflicts of interest, whether accounts or program types are in the best interests of their clients, and fees, expenses, compensation, complex products and best execution obligations. A more detailed summary of previously announced examination priorities related to recently implemented Regulation Best Interest and Form CRS is located here.
- Information Security and Operational Resiliency. With the increase in remote operations over the past year due to COVID-19, the Division has likewise seen an increase in cybersecurity concerns. Thus, the Division will review whether firms have taken appropriate measures to: (1) safeguard customer accounts and prevent account intrusions; (2) oversee vendors and service providers; (3) address malicious email activities, such as phishing or account intrusions; (4) respond to incidents, including those related to ransomware attacks; and (5) manage operational risk as a result of dispersed employees in a work-from-home environment. The Division will also focus on controls surrounding online and mobile application access to investor account information, the controls surrounding the electronic storage of books and records and personally identifiable information maintained with third-party cloud service providers, and firms’ policies and procedures to protect investor records and information.This area of focus aligns with the Division’s recent Risk Alerts warning firms to guard against “credential stuffing” attacks and ransomware attacks.
- FinTech and Digital Assets. Due to the transformation in the ways firms interact with their customers as a result of the innovations in financial technology and capital formation, the Division’s examinations of market participants engaged with digital assets will continue to assess the following: (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.This bolsters the Division’s recent Risk Alert highlighting a number of specific compliance areas that will be monitored closely, including RIA compliance with the Investment Advisers Act custody rule, completeness of disclosures, maintenance of adequate books and records relating to digital assets, proper exercise of fiduciary duties with respect to digital assets and anti-money laundering compliance, among other things.
- RIA Compliance Programs. As always, the Division will review and assess RIA compliance programs to ensure they are reasonably designed, implemented and maintained. The Division will prioritize examinations of RIAs that have not been examined for a number of years to ensure that their compliance programs have been appropriately adapted in light of any growth or change in their business models. In addition, because RIAs are increasingly offering investment strategies that focus on sustainability (such as products and services that are considered sustainable, socially responsible, impactful and ESG-conscious), the Division expects to focus on products in these areas that are widely available to investors. Specifically, the Division will review fund advertising for false or misleading statements regarding sustainability strategies, proxy voting policies and procedures for alignment with firm sustainability strategies, and disclosures provided to clients regarding sustainability strategies. Finally, the Division will prioritize examinations of RIAs that are dually registered as, are representatives of, or are otherwise affiliated with, broker-dealers.
- RIAs to Private Funds. The Division will focus on advisers to private funds and will assess compliance risks, preferential treatment of certain investors, portfolio valuations and any resulting impact on management fees, the adequacy of disclosure and compliance with any regulatory requirements of cross trades, principal investments or distressed sales and, importantly, various conflicts around liquidity. The Division will also focus on advisers to private funds that have a higher concentration of structured products and will examine advisers to private funds where there may have been material impacts on portfolio companies owned by the private fund due to recent economic conditions.This dovetails with the Division’s recent Risk Alert summarizing its observations from examinations of private fund advisers.
- Broker Dealers. The Division plans to prioritize examinations of broker-dealers that focus on their compliance with the Customer Protection Rule, the Net Capital Rule and other similar rules intended to safeguard assets. The Division will also assess compliance with Regulation Best Interest, which was recently implemented to establish a new standard of conduct for broker-dealers and associated persons of a broker-dealer. Finally, the Division will examine broker-dealer trading practices by focusing on compliance with best execution obligations, market maker compliance with Regulation SHO and payment for order flow.
In addition to the areas listed above, the Division has also highlighted that they will pay particular attention to the following items:
- Anti-money laundering compliance, particularly by broker-dealers
- The London InterBank Offered Rate (LIBOR) transition and discontinuation
- Municipal advisors
- Market infrastructure, including clearing agencies, national securities exchanges and transfer agents
- Financial Industry Regulatory Authority (FINRA) and Municipal Securities Rulemaking Board (MSRB) oversight
- Emerging risks relating to environmental, social and governance (ESG) matters and climate change