On March 3, 2021, the Division of Examinations (formerly known as the “Office of Compliance Inspections and Examinations”) of the U.S. Securities and Exchange Commission (“SEC”) released its 2021 Examination Priorities, an annual report discussing the Division of Examination’s areas of focus including investment advisers registered with the SEC (“RIAs”) for the coming year. In this report, the Division of Examinations (“Division”) noted that it intends to continue to prioritize examinations of SEC registered investment advisers, broker-dealers, and dually registered or affiliated firms, particularly those that have never been examined or have not been examined recently. In doing so, the Division will emphasize protection of retail investors and those saving for retirement.
Investment Adviser Exam Priorities
The 2021 Examination Priorities address a diverse array of practices and situations that investment advisers registered with the SEC can expect the Division to scrutinize in the event of an SEC examination, a selection of which is summarized below. In addition, RIA Compliance Consultants encourages all investment advisers, including state-registered firms, to read the SEC’s entire 2021 Exam Priorities, which is available here.
During an examination, the Division of Examination will evaluate whether the investment adviser and its Chief Compliance Officer (“CCO”) have sufficient resources to perform core compliance responsibilities and will review whether the investment adviser’s policies and procedures are reasonably designed, implemented and maintained. In particular, the SEC will assess an investment adviser’s compliance policies and procedures regarding account selection, portfolio management, custody, best execution, fees & expenses, business continuity, valuation of client assets for consistency and appropriateness of methodology.
While the SEC does not technically have different standards for different firms, the Division of Examinations appears to expect that an investment adviser firm’s investment in its compliance program be commensurate to its resources and its risks. For example, very large investment advisers engaged in complex business practices may be expected to have one or more dedicated compliance personnel whereas smaller firms with a lower risk profile might reasonably have a single CCO who also fills other roles. Regardless of investment adviser firm size, the role of the CCO cannot be overstated. Every investment adviser must ensure that its CCO has the time, knowledge, resources, and authority to adequately implement and maintain the investment adviser’s compliance program.
RIA Compliance Consultant has prepared a sample checklist, CCO – Determining Who to Designate as CCO of RIA, to assist an investment adviser when selecting a chief compliance officer.
Form ADV Part 3/Form CRS
The Division will prioritize examinations of investment advisers to assess compliance with Form CRS, including whether the Form CRS has been timely filed and amended. In addition, the Division has identified a pattern of deficiencies across firms related to inadequate or missing disciplinary event disclosures. Investment adviser firms should take care to ensure that all disciplinary events are identified and properly disclosed on the Form ADV Part 3/Form CRS.
RIA Compliance Consultants has developed several Form ADV Part 3 sample compliance form and training materials, including the Sample WSP/CoE Section: Form ADV Part 3, Form ADV Part 3 – Compliance Review Module, Form ADV – Part 3 – Conversation Starters Script, and Form ADV – Part 3 – Cover Letters for Relationship Summary.
The SEC’s Division of Examination will continue to assess whether investment advisers, as fiduciaries, have fulfilled their duty of care and duty of loyalty to clients and will assess whether investment advisers are providing advice that continues to be in the best interests of the client. The Division of Examinations will assess whether investment advisers eliminate and/or make full and fair disclosures of all conflicts which might incline the investment adviser (consciously or unconsciously) to render advice which is not disinterested. In reviewing for an investment adviser’s execution of its fiduciary duty, the Division of Examination will focus on risks associated with fees and expenses, complex products, best execution, and undisclosed or inadequately disclosed compensation arrangements.
For more details about an investment adviser’s fiduciary duties, RIA Compliance offers a recorded webinar, Investment Adviser Fiduciary Duty, which details the SEC’s Interpretation – Standard of Conduct for Investment Advisers.
Conflicts of Interests
The SEC’s Division of Examinations will review revenue sharing arrangements between investment advisers and issuers, service providers and others, and will review direct or indirect compensation for personnel for executing client transactions. The Division of Examination will prioritize examinations of investment advisers operating and utilizing turnkey asset management platforms.
RIA Compliance Consultants has developed several sample checklists, Conflicts of Interest – Checklist and Outside Business Activity – Investigation Checklist, to assist an investment adviser when trying to identify and eliminate/mitigate a conflict of interest.
The SEC’s Division of Examinations will seek to identify fee errors that have disadvantaged investment advisory clients, including failures to aggregate certain accounts for purposes of calculating fee discount contrary to disclosures, failures to exclude certain holdings from management fee calculations, inaccurately calculated tiered fees (including failure to provide breakpoints and aggregate household accounts), and failures to refund prepaid fees for terminated accounts.
RIA Compliance Consultants has created a sample spreadsheet, Fee – Audit Spreadsheet – Internally Calculated Asset-Based Investment Adviser Fees, to assist an investment adviser self-identify fee audit issues and document such review.
ESG, Accredited Investors & Opportunity Zones
The SEC’s Division of Examination will review consistency & adequacy of an investment adviser’s disclosures regarding ESG strategies and will determine whether an investment adviser’s processes and practices match its disclosures. The Division of Examination will also review an investment adviser’s advertising for misleading statements and review whether proxy voting policies and procedures and actual proxy vote(s) align with the strategies disclosed to clients.
Due to the lack of a Risk Alert from the Division of Examinations, RIA Compliance Consultants has a compiled a best compliance practices checklist, ESG Investing – Best Compliance Practices Checklist, for investment advisers utilizing ESG strategies.
In light of growing risks, the SEC’s Division of Examinations will review an investment adviser’s procedures to safeguard accounts and prevent malicious intrusions. The Division of Examination will review an investment adviser’s policies and procedures to oversee vendors and service providers, address malicious email (e.g., phishing and account intrusions), and address operational risks as result of work-from-home environment. Furthermore, the Division will review an investment adviser’s controls of mobile applications with access to client information, controls of electronic storage via cloud service providers, and an investment adviser’s planned and/or actual response to cybersecurity incidents, including ransomware.
To assist investment advisers, RIA Compliance Consultants has prepared Cybersecurity – Best Practices Checklist. Additionally, we have prepared Cybersecurity – Training to Avoid Phishing for supervised persons of an investment adviser.
Business Continuity & Disaster Recovery
The SEC’s Division of Examination acknowledged the growing impact of climate-related events and expects investment advisers and other registrants, such as broker dealers, to continuously learn and improve their business continuity and disaster recovery plans, as needed, in light of evolving largescale events and risks. Recent events, such as Hurricane Sandy, the COVID-19 pandemic, and Texas’ winter storm and power outage in February 2021, continue to emphasize that investment advisers should be prepared for regional (or greater) business disturbances lasting days or weeks due to extreme weather.
The SEC’s Division of Examination notes that RegTech, i.e., managing regulatory processes through technology, “when implemented appropriately, may increase the efficiency of compliance staff, reduce manual processes, and exponentially increase transaction review capabilities. However, misused or improperly configured RegTech may lead to compliance program deficiencies.” In particular, investment advisers should ensure that RegTech is appropriately supervised and regularly tested so that risks and errors are not inadvertently missed due to overreliance on the technology.
Investment Advisers Managing Digital Assets
For investment advisers managing digital assets, such as cryptocurrency, the SEC’s Division of Examinations will review whether investments are in the best interests of investors. In addition, the Division of Examination will review portfolio management and trading practices, safety of client funds and assets, pricing and valuation, effectiveness of compliance programs and controls, and the supervision of outside business activities of the firm’s representatives who also invest in digital assets.
Dual RIA/BD Registrants
For investment advisers that are dually registered as, or are affiliated with, broker-dealers, or that have supervised persons who are registered representatives of unaffiliated broker-dealers, the SEC’s Division of Examinations will review whether the investment adviser maintains effective compliance programs to address the risks associated with such business models. In particular, the Division of Examinations will focus on conflicts of interest that arise from compensation arrangements, outside business activities, best execution, and prohibited transactions.
Mutual Fund Share Class
The SEC’s Division of Examinations will also continue it focus from prior years on mutual fund share class selection. Investment advisers should not accept compensation or other incentives, whether directly or indirectly, that could incentivize the firm to select higher cost mutual fund share classes when lower cost classes are available. In addition, even in cases where an investment adviser does not receive an incentive, the investment adviser’s duty of best execution requires that the lower cost share be selected.
RIA Compliance Consultants encourages investment advisers to closely review the SEC’s 2021 Examination Priorities in light of their current compliance policies and procedures as well as the investment adviser’s actual practices. For a deeper dive into the 2021 Examination Priorities, click here to purchase our 2021 Exam Priorities Webinar (or available to current subscribers in their online subscription account).
RIA Compliance Consultants has also developed several sample forms and checklists to assist an investment adviser firm in preparing for an SEC examination: Preparing for SEC Exam; SEC Exam – Best Practices Checklist; SEC Exam – Log of Requested Docs & Info; SEC Exam – Mock Exam Document Request List; and SEC Exam – Response to Deficiency or Findings Letter from Securities Regulator.
Contact RIA Compliance Consultants
If your investment adviser firm is an existing client of RIA Compliance Consultants and would like assistance in reviewing your policies and procedures or practices relating to branch offices, we encourage you to speak with your compliance consultant. Or, if you are not an existing client of RIA Compliance Consultants, click here to set up an introductory call with our Business Development Team.
SEC Is Focusing on ESG Investing by RIAs – March 5, 2021
Form ADV Part 3 FAQs – Last Updated February 8, 2021
SEC Risk Alert – Investment Adviser Compliance Programs – Dec. 17, 2020
Form CRS/Form ADV Part 3 Testing for Compliance – June 18, 2020
SEC Announces 2020 Exam Priorities – January 16, 2020
Posted by RCC
Labels: ADV Part 3, ESG, Examination Priorities, SEC
Tagged: ADV Part 3, Chief Compliance Officer, Conflict of Interest, Cybersecurity, Digital Assets, ESG, Examination, Examination Priorities (primary), Fiduciary Duty, Form CRS, SEC, SEC Inspections