SEC Division of Examinations Announces 2021 Examination Priorities for Registered Funds and Their Advisers

On March 3, 2021, the Division of Examinations (the Division) of the Securities and Exchange Commission (SEC) issued its 2021 examination priorities. The Division noted its continued emphasis on the protection of retail investors (particularly seniors and individuals saving for retirement) and highlighted a number of focus areas in this regard. Below is a summary of some of the key areas concerning registered funds and their advisers.

Protection of Retail Investors

Standards of Conduct

The Division noted it will continue to examine investment advisers to assess whether they have fulfilled their fiduciary duties of loyalty and care. This process will include assessing whether firms make full and fair disclosure of all conflicts of interest that may incline investment advisers to render investment advice that is not disinterested. In this regard, the Division will focus on risks associated with fees and expenses, complex products, best execution, and undisclosed or inadequately disclosed compensation arrangements.

Retail-Targeted Investments

The Division indicated it would focus on mutual funds and ETFs, as they are the primary investment vehicles for many retail investors. Examinations will focus on, among other things, financial intermediaries’ recommendations and disclosures involving ETFs (particularly in niche and leveraged or inverse ETFs) as well as the incentives provided to financial services firms and professionals that may influence the selection of particular higher-cost mutual fund share classes when lower-cost options are available.

Information Security and Operational Resiliency

The Division noted the sharp increase in remote operations as a response to the COVID-19 pandemic and the increased concerns about data security, data loss, remote access, third-party communication systems and vendor management in relation to the remote work environment. The Division intends to review whether firms have taken appropriate measures to (i) safeguard customer assets, (ii) oversee vendors and service providers, (iii) address malicious email activity, (iv) respond to cybersecurity incidents, and (v) manage operational risk as a result of the remote work environment. A particular focus on controls surrounding online and mobile account access to investor account information and electronic storage of personally identifiable information was highlighted as well.

Anti-Money Laundering (AML)

The Bank Secrecy Act requires financial institutions, including registered funds and broker-dealers, to establish tailored AML programs to detect and address risks associated with terrorist financing, public corruption, market manipulation and a variety of other fraudulent behaviors. The Division noted it will continue to prioritize examinations of registered funds and broker-dealers for compliance with their AML obligations. It intends to assess, among other things, whether firms have established appropriate customer identifications and whether firms are satisfying their filing obligations, conducting due diligence on customers, complying with beneficial ownership requirements, and conducting robust and timely independent tests of their AML programs.

London Inter-Bank Offered Rate (LIBOR) Transition

LIBOR is expected to be discontinued by the end of 2021, which may have a significant impact on the financial markets generally and could pose material risks for certain market participants. The Division indicated it would monitor market participants’ preparation for the transition away from LIBOR, including through examinations to assess their understanding of LIBOR exposure, preparations for transition to an alternative reference rate, and disclosures relating to the risks inherent in the transition away from LIBOR.

Additional Focus Areas Impacting Registered Funds

The Division noted that it reviews funds’ compliance programs with a focus on disclosures to investors, valuation, SEC filings, personal trading activities, and contracts and agreements. A particular focus on valuation in market sectors that experienced stress due to the pandemic (such as energy, real estate and high-yield bonds) was noted, as well as resulting impacts on performance, liquidity and risk disclosures.

The Division indicated that it will prioritize examinations of mutual funds and ETFs that have not previously been examined or have not been examined in a number of years, and will focus on compliance programs, financial condition, advisory fee waivers and compliance with exemptive relief.

Liquidity risk management programs were also noted to be a focus of the Division for the 2021 period, given the high degree of customization inherent in such programs. The Division will assess mutual funds’ liquidity risk management programs to determine whether they are reasonably designed to assess and manage funds’ liquidity risk and implementation of required liquidity classifications.

In light of increased offerings of investment strategies focused on ESG practices, the Division will look to focus on advisers that are offering such platforms in the realm of open-end funds, ETFs and qualified opportunity funds. It will review consistency and adequacy of disclosures relating to ESG practices and determine whether fund advertising, disclosures and proxy voting policies appropriately align with the firms’ use of ESG strategies.

The full text of the release can be found at the SEC website.