Thanks to Heidi for today’s post. – Alan

Today, the SEC put out its 2021 Exam Priorities, available here.   It is about 40 pages long and covers a lot of topics.  While I encourage everyone to read through the document, here are the primary focus items for 2021:

Overarching Themes / Focal Points:

  • Regulation Best Interest and Form CRS: Primary focus of 2021 exams based on its prominence in the letter and all the recent guidance we’ve seen.  Make sure to review the recent (December 2020) statement the SEC put out on what, specifically, it will be looking at during these exams.  That statement is located here.
  • Compliance Culture. Importance of a top-down approach to compliance, starting with Firm CCOs who are knowledgeable and empowered to make necessary changes.
  • Fees and compensation. Whether its looking at the reasonableness of a fee, whether the fee creates a conflict of interest, whether a fee is properly disclosed, or how the fee is calculated (for advisory fees), there are now a tremendous number of issues (and potential charges) that flow from fees.  If you understand how you are compensated, ensure fees are imposed properly, properly identify where that compensation creates a potential conflict, and properly disclose that conflict, you will have covered most of the areas on this year’s priority list.  Remember this is any compensation – not only compensation paid by clients.

Specific Points of Interest during Exams:

  • Best Interest Recommendations. The SEC will be looking at whether and how firms make best interest recommendations.  This will be more than just reviewing policies and paperwork – they will be conducting enhanced transaction testing to test those procedures.
  • RIA Fiduciary duties. This one is evergreen.  The SEC will be looking at whether RIA advice is in client’s best interest and whether there has been a full disclosure of conflicts of interest.  Continued focus on fees, costs, and undisclosed compensation that could result in a conflict of interest between a firm and its clients (note: its unimportant whether the conflict ever manifested or had any impact – the potential is enough to require disclosure).
    • Sustainable Investing/Socially Motivated Trading. The SEC devotes a separate section to investment strategies focused on “socially responsible” investment strategies. It’s really a subpoint of the fiduciary obligation.  If you offer investment strategies with these focuses, you need to make sure your disclosures, recommendations, and supervision of the same are accurate.
  • Form CRS and related disclosures. Broker dealers now have a similar obligation to disclose fees and potential conflicts.  BDs should be thinking hard about compensation or benefits they receive that has the potential to lead to conflicted advice.  Here, we can learn lessons from the disclosure cases brought previously against IAs.
  • Specific retail investors: Recommendations made to seniors, teachers, military personnel and “individuals saving for retirement” get special focus.  The last one on this list is a doozy.
  • Account type recs. Especially if it’s a rollover.
  • Complex products. They will be looking for best-interest grounds for the sale and, if the product is only for accredited investors, making sure customers are properly accredited under the new definition of the term.
  • Mutual Funds and ETFs. The SEC is looking for proper risk disclosures (especially with more risky options) and examining recommendations in funds that provide “incentives” to firms and their professionals.
  • Fixed Income. The Pandemic has stressed many municipal entities.  So, SEC is looking for proper risk disclosures re: muni issuer as well as whether the trades themselves show proper mark-ups/down, pricing, and achieve best execution.
  • Microcaps.  Another evergreen item. You know what they are looking for here.
  • Safeguarding customer info. Protection from hacks, email phishing, ransomware, etc. and protecting for your customer’ info whether held by you or a vendor. Especially now, as much of the country is working remotely. The SEC will be looking at how information security is handled in the new work-from-home setting.
  • Business Continuity. This has long been a focus, getting a lot of attention when Hurricane Sandy hit New York.  The pandemic only reinforced the importance of being able to respond to unexpected natural events.
  • Financial technology. Robo advisors, new software, mobile apps, digital assets.
  • AML.  Again, you’ve seen this one before.  Long-standing focus.
  • Fund examinations. The SEC will review funds’ compliance programs and governance, focusing on disclosures (including website language).
  • How RIAs treat private funds.  With a focus on funds that have experienced issues (liquidity, withdrawal freezes) or which have a high concentration of structured investments.  And, as always, surrounding disclosures