The long-awaited 2021 examination priorities of the Securities and Exchange Commission (SEC) were released Wednesday, providing investment firms and broker-dealers with a breakdown of the issues the Division of Examinations will focus on this year.
The influence of President Joe Biden’s political agenda is evident in a number of the priorities, including climate- and ESG-related risks, fiduciary duties under Regulation Best Interest (Reg BI), and risks related to emerging technologies. The Division of Examinations (formerly the Office of Compliance Investigations and Examinations, or OCIE) publishes its exam priorities every year “to provide insights into its risk-based approach, including the areas it believes present potential risks to investors and the integrity of the U.S. capital markets,” the SEC said.
“This year, the Division is enhancing its focus on climate and ESG-related risks by examining proxy voting policies and practices to ensure voting aligns with investors’ best interests and expectations, as well as firms’ business continuity plans in light of intensifying physical risks associated with climate change,” said Acting Chair Allison Herren Lee in a statement. “Through these and other efforts, we are integrating climate and ESG considerations into the agency’s broader regulatory framework.”
Gary Gensler, nominated by Biden to lead the SEC, made it clear the agency under his leadership will be laser-focused on risks posed to corporations by climate change during his confirmation hearing before the Senate on Tuesday. Gensler’s nomination is expected to be confirmed by next week.
“Increasingly, investors want to see climate risk disclosures,” Gensler said during the hearing. He added that he will consider launching a rulemaking process to clarify how companies should disclose climate change risks. But, responding to several different senators on the question, he repeatedly asserted those disclosures must meet the legal standard of materiality.
Carlo di Florio, former OCIE director who now serves as global chief services officer with ACA Compliance Group, said the new priorities “reflect a significant shift and increase in focus on climate and ESG-related risks and strategies.”
He said the division has indicated its examiners “will focus on the consistency and adequacy of the disclosures that registered investment advisors and fund complexes provide to clients regarding these strategies.” Other areas of emphasis by examiners, he said, will be to determine whether firms’ processes and practices match their disclosures; whether fund advertising is accurate or includes false or misleading statements; and whether proxy voting policies and procedures and votes align with the strategies. All of these exam touchpoints will be measured against firms’ climate and ESG disclosures.
The division’s 2020 priorities did not mention climate-related risks, although it did mention ESG-related risks, said Les Abromovitz, senior director at the compliance vendor Foreside.
He said last year’s release did state that examiners were particularly interested in the accuracy and adequacy of disclosures provided by registered investment advisors (RIAs) “offering clients new types or emerging investment strategies, such as strategies focused on sustainable and responsible investing, which incorporate environmental, social, and governance (ESG) criteria.”
According to the 2021 Examination Priorities, the division in 2020 performed examinations on about 15 percent of the 13,900 registered investment advisors overseen by the SEC, whose assets under management were worth $97 trillion.
In its priorities, the division said in 2021 it will focus on regulated entities’ compliance with fiduciary obligations outlined in Reg BI and Form CRS. Examiners will attempt to measure how well-regulated entities are upholding their fiduciary duties with less experienced retail investors, particularly seniors and those saving for retirement. The division will also focus attention on investment products that pose elevated risks to those groups, including mutual funds, exchange-traded funds (ETFs), municipal securities, fixed-income securities, variable annuities, private placements, and microcap securities.
Firms should ensure they are properly mitigating conflicts of interest and providing adequate disclosures about the risks involved with these products to investors, the SEC said.
The division will refocus its examinations of firms’ information security and operational resiliency through the lens of climate change. “As climate-related events become more frequent and more intense, the division will review whether firms are considering effective practices to help improve responses to large-scale events,” it said, particularly on how firms are safeguarding the data they store on their customers and how they respond to cyber-attacks and data breaches.
Financial technology, including apps and cryptocurrency, will be under increased scrutiny by examiners, the SEC said. Firms should ensure trade recommendations ordered via mobile apps are in the best interest of the investor, not the firm. For digital assets, including cryptocurrency, firms will be assessed on “whether the assets are in the best interest of investors; portfolio management and trading practices; safety of client funds and assets; pricing and valuation; effectiveness of compliance programs and controls; and supervision of representatives’ outside business activities.”
The division will review firms’ compliance with anti-money laundering (AML) programs and with the transition away from the London Interbank Offered Rate (LIBOR) to an alternative rate.
The division also broke down its specific exam priorities in 2021 for investment advisors and investment firms and for broker-dealers.
For investment advisors and firms, the division will continue to evaluate the effectiveness of their compliance programs, as well as the content of their disclosures to investors. This year, investigators will place a particular emphasis on disclosures regarding ESG-related investments to “determine whether the firms’ processes and practices match their disclosures, review fund advertising for false or misleading statements, and review proxy voting policies and procedures and votes to assess whether they align with the strategies.” The same scrutiny will also be applied to disclosures related to registered funds, mutual funds, and ETFs, the SEC said.
For broker-dealers, exam priorities will include assessing the “adequacy of internal processes, procedures, controls, and compliance with requirements for borrowing securities from customers,” as well as “compliance with best execution in a zero commission environment.”
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Biden influence apparent in SEC 2021 examination priorities