The SEC’s Division of Examinations will continue to emphasize protection for retail investors in the coming year, particularly for seniors and individuals saving for retirement.
The Examination Division will evaluate whether registered investment advisers (RIAs) meet standards of conduct and will examine whether firms appropriately mitigate and disclose conflicts, regulators recently announced in releasing the SEC’s Examination Priorities for 2021. Examiners will also probe sales of retail investment products.
The priorities are a continuation of the SEC’s efforts to protect retail investors. In the fiscal year 2020, the Division of Examinations:
- Issued more than 2,000 deficiency letters, which prompted many firms to take corrective actions, like by amending compliance policies and procedures or enhancing their disclosures.
- Ordered firms to return more than $32 million to investors for fees that were improperly calculated and charged.
- Referred more than 130 cases to the SEC’s Enforcement division, including referrals related to registered investment advisers selecting higher-cost mutual fund share classes for clients when lower-cost options were available; advisers failing to disclose conflicts of interest, and broker-dealers failing to supervise registered representatives who made unsuitable recommendations to retail customers.
“The SEC’s focus on retail investors speaks to the need for education and training for registered representatives, broker-dealers, and investment advisers,” said Margie Webber, director of regulatory compliance for RegEd.
Firms can protect themselves by addressing the following SEC 2021 examination priorities through compliance action items.
Standards of Conduct
Examiners will focus on compliance with Regulation Best Interest (Reg BI), Form CRS, and whether RIAs have fulfilled their fiduciary duties of care and loyalty. With a compliance date of June 30, 2020, the standards have a “direct impact on the retail investor experience with broker-dealers and RIAs,” the SEC stated in its report on its 2021 examination priorities.
“Your policies and procedures should clearly define what standard applies to any given situation,” Webber said.
Firms and examiners have been adapting to the Reg BI and Form CRS standards since they were adopted in June 2019. In the past year, the SEC has developed new examination approaches for Reg BI and Form CRS “to both promote compliance and inspect firms in both our broker-dealer and investment adviser/investment company programs,” the SEC stated in its priorities report.
The SEC has also communicated with firms about Reg BI and Form CRS, beginning by publishing two risk alerts in April 2020: Examinations that Focus on Compliance with Regulation Best Interest and Examinations that Focus on Compliance with Form CRS. Regulators then shared preliminary observations from their initial examinations at a Roundtable on Regulation Best Interest and Form CRS in October 2020.
Regulation Best Interest
Reg BI requires a broker-dealer to put a retail customer’s interests first when recommending a securities transaction or an investment strategy involving securities. A broker-dealer must meet a four-part standard of conduct that includes obligations for Disclosure, Care, Conflict of Interest, and Compliance.
The SEC says that its initial examinations for compliance with Reg BI showed “that firms generally responded” by updating their written supervisory procedures (WSPs) and conducting training. However, though some firms incorporated specific compliance processes into their WSPs, others “simply restated the standards, but did not provide any meaningful guidance as to how these should be implemented.”
In December, the SEC issued a Statement on Recent and Upcoming Regulation Best Interest Examinations that identified Reg BI components that could be included in future examinations, including how firms consider costs in making a recommendation and the processes firms use to recommend complex products.
And now, per its recently released priorities report, the SEC has advised firms that in 2021 it will also conduct enhanced transaction testing and “will evaluate firm policies and procedures designed to meet additional elements of Regulation Best Interest, the recommendation of rollovers and alternatives considered, complex product recommendations, assessment of costs and reasonably available alternatives, how sales-based fees paid to broker-dealers and representatives impact recommendations, and policies and procedures regarding how broker-dealers identify and address conflicts of interest.”
SEC Commissioner Caroline Crenshaw believes that examination and enforcement data “will illuminate whether the rule is working as promised, or whether changes may be required,” WealthManagement.com reported in an article about the SEC’s plans to assess Reg BI performance, which was based on an interview with Crenshaw.
Form CRS requires broker-dealers and RIAs to give retail investors a brief customer or client relationship summary. “The relationship summary is intended to inform retail investors about: the types of client and customer relationships and services the firm offers; the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services; whether the firm and its financial professionals currently have reportable legal or disciplinary history; and how to obtain additional information about the firm.” Firms must also file their relationship summaries with the SEC and post them on their websites.
Firms filed more than 13,000 Form CRSs in the past year, the SEC noted in its report on 2021 examination priorities. The SEC stated, “We saw a wide variety of approaches that firms used to comply with the requirements of Form CRS, and generally observed firms complying with the Form’s requirements. Many firms appeared to make effective use of hyperlinks in their digital Form CRSs. We also observed that many firms are generally avoiding legalese and generic boilerplate language, but we also noted the readability of some Form CRSs could still be improved.
“Some firms did not adequately respond to the Form CRS disciplinary disclosure requirements, an area all firms should ensure they address. In addition, we identified and notified hundreds of firms that they had failed to timely file a Form CRS.”
The SEC will examine broker-dealers and RIAs to assess compliance with Form CRS in 2021.
RIA Fiduciary Duty
The Interpretation Regarding Standard of Conduct for RIAs that the SEC released in 2019 with Reg BI and Form CRS affirmed and clarified aspects of an RIA’s fiduciary duty that comprises duties of care and loyalty to its clients.
In evaluating RIAs for compliance in 2021, SEC examiners will assess, “among other things, whether RIAs provide advice, including whether account or program types continue to be, in the best interests of their clients, based on their clients’ objectives, and eliminate or make full and fair disclosure of all conflicts of interest which might incline RIAs—consciously or unconsciously—to render advice which is not disinterested such that their clients can provide informed consent to the conflict.”
Examiners will also focus on risks associated with fees and expenses, complex products, best execution, and undisclosed or inadequately disclosed, compensation arrangements.
Retail Investments and Sales Practices
In addition to evaluating broker-dealers and RIAs for meeting standards of conduct, the SEC has also prioritized determining whether transactions involving retail investors and advice provided to them are appropriate. Examiners will assess whether firms meet their legal and compliance obligations when providing retail customers access to complex strategies, such as options trading, and complex products in particular. They will also focus “on how firms are complying with the recent changes to the definition of accredited investor when recommending and selling certain private offerings,” according to the 2021 examination priorities report.
RegEd’s Webber suggested that firms address legal and compliance obligations related to retail investors in their education and training programs. She also recommended ensuring that standards, procedures, and solutions for conflicts of interest disclosure are in place.
Examiners are particularly concerned about conflicts of interest that could compromise a broker-dealer’s, RIA’s, or firm’s obligation to act in the best interest of retail investors. So, examiners have prioritized reviewing firms’ disclosures regarding their conflicts of interest, including those related to fees and expenses.
“Fee and compensation-based conflicts of interest may take many forms, including revenue-sharing arrangements between a registered firm and issuers, service providers, and others, and direct or indirect compensation to personnel for executing client transactions,” according to this year’s examination priorities report.
Strengthening Compliance for 2021 and Beyond
Securities firms that address the SEC’s 2021 examination priorities in their education and training programs will strengthen their compliance programs by doing so. Many companies will use technology to comply efficiently.
“The use of technology to facilitate compliance with regulatory requirements (RegTech) has experienced immense growth in recent years,” the SEC wrote, noting that examiners will focus on the implementation and integration of RegTech in firms’ compliance programs to ensure that the technology is configured correctly and used properly. “RegTech, when implemented appropriately, may increase the efficiency of compliance staff, reduce manual processes, and exponentially increase transaction review capabilities.”
As fit-to-purpose tools tailored to the needs of broker-dealers and investment advisers, RegEd’s compliance solutions for securities firms are highly effective as well as cost-efficient. Firms can seamlessly manage all aspects of their compliance programs, reducing risks and costs by automating and streamlining processes. And each solution is configured for optimal performance by RegEd’s implementation experts, who have worked with many of the nation’s largest securities firms.
RegEd’s compliance management platform includes the following solutions (among others).
- Education and Training Solution Suite – Advanced learning management technology streamlines the creation of a firm’s annual compliance program, simplifies course enrollment, provides access to timely course materials, and efficiently tracks course completion.
- Policies and Procedures Management Solution – An enterprise workflow, work-process, and task management solution enables comprehensive, end-to-end administration and oversight of all elements of a firm’s policies and procedures.
- Conflicts of Interest Solution Suite – Automated end-to-end management of request processes, compliance monitoring and exception management associated with conflict of interest policies embeds best practices in a firm’s compliance program.
- Outside Business Activities Solution – Centralized, systematized management of OBA disclosures, attestations and amendments reduces review time and facilitates communication on specific requests to speed the decision process.
- Gifts, Gratuities and Contributions Management Solution – Advanced software ensures that all transactions comply with regulations and firm policy, providing insight into violations, trends, conflicts of interest, reducing the risk of non-compliance.
- Personal Securities Account Management Solution – Automating the management of personal trading activities delivers extraordinary efficiency and enhances the quality of supervision while dramatically reducing the risk of non-compliance and related consequences.
Schedule a consultation to learn more about how RegEd’s compliance solutions enable securities firms to improve efficiency, effectiveness, and transparency across the enterprise.
For additional ways to strengthen your firm’s compliance program, view our recent webinar on FINRA’s 2021 Examination and Risk Monitoring Program Report.
RegEd is the market-leading provider of RegTech enterprise solutions with relationships with more than 200 enterprise clients, including 80% of the top 25 financial services firms.
Established in 2000 by former regulators, the company is recognized for continuous regulatory technology innovation with solutions hallmarked by workflow-directed processes, data integration, regulatory intelligence, automated validations, business process automation and compliance dashboards. The aggregate drives the highest levels of operational efficiency and enables our clients to cost-effectively comply with regulations and continuously mitigate risk.
Trusted by the nation’s top financial services firms, RegEd’s proven, holistic approach to RegTech meets firms where they are on the compliance and risk management continuum, scaling as their needs evolve and amplifying the value proposition delivered to clients. For more information, please visit www.reged.com.