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In the report, the SEC outlines its areas of specific focus, which include private funds, standards of conduct, information security and operational resiliency, emerging technologies and crypto assets, and environmental, social, and governance (ESG) investing, among other areas.
One week prior to publishing the report, the SEC named Richard Best as the new Acting Director of the Division of Examinations (Exams). Most recently, Mr. Best was SEC Regional Director in New York. AdvisorLaw anticipates that there will be a substantial increase in the number of enforcement actions brought by the Department of Enforcement as Mr. Best ramps up in his new role. The types of infractions will most likely reflect the priorities outlined in this year’s report.
Private Funds currently make up about 35% of advisories with a whopping $18 trillion in assets, representing one of the largest sectors of the RIA space. The assets managed by these funds have increased by 70% over the last five years.
Due to the sheer size of the market, as well as its complex and expansive nature, Exams will focus on numerous challenges under the Investment Advisers Act of 1940, including:
- fiduciary duties;
- compliance with the Custody Rule;
- disclosure and compliance for cross trades, principal transactions, and distressed trades; and
- conflicts surrounding liquidity, such as RIA-led fund restructurings.
Exams will also conduct reviews of advisers’ conflicts and disclosures around portfolio strategies, risk management, and investment recommendations and allocations, including investments in Special Purpose Acquisition Companies (SPACs). All aspects of trading for private funds with indications of systemic importance will also be closely reviewed.
Environmental, Social, and Governance (ESG) Investing
ESG methods and criteria are increasingly being offered and evaluated by RIAs and registered funds. But many regulators are warning that these investments are risky, specifically because disclosures related to portfolio management practices could potentially involve materially false and misleading statements or omissions.
Exams will continue to analyze issuers’ climate-risk disclosures for any omissions or inaccuracies, as well as investment advisers’ and funds’ ESG strategies for any issues related to disclosure or compliance. A dedicated task force will follow up on tips, referrals, and whistleblower complaints related to ESG issues.
Standards of Conduct
This area focuses specifically on Regulation Best Interest (Reg BI), fiduciary duty, and Form CRS. Examiners will scrutinize advisers’ consistency in regard to their fiduciary duties, conflicts, and disclosures. There are four key areas:
- revenue-sharing arrangements;
- recommending or holding more expensive classes of shares;
- recommendation of shares carrying fees; and
- proprietary product recommendations.
Policies and procedures for compliance, as well as their design and implementation, will also be assessed.
One area of Exams’ areas of interest includes dually registered RIAs and broker-dealers. Potential conflicts of interest, such as those arising from account recommendations and investment allocations across accounts, will be evaluated. Exams will look into:
- sales and recommendations of high-fee products;
- sales and recommendations of firm affiliate proprietary products;
- incentives for placing financial professionals’ own firms’ interests ahead of those of their customers and clients;
- compensation structures’ influence on investment recommendations; and
- written policies and procedures.
Information Security and Operation Resiliency
Exams will continue to review measures taken by RIAs to prevent interruptions to mission-critical services, safeguard investor information, protect customer accounts, and prevent account intrusions — both in-house and through vendor and service provider monitoring. Exams will review how RIAs deal with harmful email and ransomware attacks, identify and respond to red flags related to identity theft, and manage operational risk as a result of a scattered, still partially at-home, workforce.
Emerging Technologies and Crypto-Assets
RIAs are increasingly providing automated digital investment advice to clients, which means that examiners will be paying close attention to the use of “robo-advisers,” as well as the growing trends and risks associated with them.
Exams observed “a proliferation of the offer, sale, and trading of crypto-assets” and stated that its examination of market players involved with crypto-assets will cover custodial arrangements and communications in the offer, sale, recommendation, advice, and trading of such assets. Mutual funds and ETFs that offer exposure to crypto-assets will be examined to assess compliance, liquidity, and operational controls around portfolio management and market risk.
Is your RIA compliant with these priorities?
Now is the time to review your RIA’s policies and procedures and conflicts of interest, as well as its compliance with Reg BI and the firm’s fiduciary duties to clients. The smartest and most efficient way to protect yourself and your assets is to hire experienced counsel who not only understands SEC rules and regulations but knows how to design a compliance program to keep your business in line with them.
AdvisorLaw’s team of RIA compliance specialists is made up of a group of attorneys that leverages its state and SEC regulatory expertise to provide RIAs with all-encompassing and ongoing compliance services.
With top-tier technology and the oversight of our compliance attorneys, AdvisorLaw can help you meet all of your obligations to best position your RIA to stand up to its next audit.
Give us a call today at 303-952-4025, or for a complimentary consultation, please fill out the form below: