SEC Compliance Outreach Program: Recap of 2022 Seminar

Several years ago, the SEC initiated the CCOutreach program, now called the Compliance Outreach Program, to promote open communications and coordination among various industry related entities – mutual funds, investment advisers and broker-dealers – on compliance issues.  The program was designed to foster communication and provide a forum to share experiences and to learn about effective compliance practices, while hearing directly from the regulators themselves.  The Program for investment companies and investment advisers is co-sponsored by the SEC’s Division of Examinations (“EXAMS”), Division of Investment Management and the Division of Enforcement’s Asset Management Unit (“AMU”) with coordination for broker-dealers from the Division of Trading and Markets and the Financial Industry Regulatory Authority (“FINRA”).

 

Investment Advisers and Investment Company Compliance

The mission of the Program is to “improve compliance by opening the lines of communication between SEC staff and Chief Compliance Officers (CCOs) and other senior officers of registered investment advisers and investment companies.”[1]

Originally the Program’s audience was intended to collaborate with CCOs, but in 2011, it was expanded to all senior officers in an effort to place emphasis throughout a firm’s business operations.  The Program features regional and national events at locations in SEC regional offices throughout the country to a national seminar held in Washington, DC.  The Program espouses a dedicated email as well as contact information for local offices whereby a firm can raise questions and concerns regarding industry or individual practices.  Firms can also inquire and request anonymity if they so desire.

National seminars are held every two years. Prior to Covid, it was held at the SEC headquarters in Washington DC.  The seminars consist of panel discussions with SEC staff, CCOs, and other industry representatives.  Recently, they have been held virtually in order to reach a larger audience.  Seminars are recorded and available for review post seminar by visiting their website.[2]

 

Opening Remarks by Chair Gensler

The SEC held its 2022 National Compliance Outreach Program on Tuesday, November 15, 2022.  The day began with a panel discussion that provided an overview of the 2022 Examination Priorities[3],  rulemaking agenda, and enforcement actions.  Throughout the day, panels included topics on fiduciary obligation, Form CRS and Regulation Best Interest, the new Marketing Rule, ESG investing, and a host of hot topics from cybersecurity to digital assets.

Chair Gensler opened the seminar with remarks identifying compliance officers as “good counselors”. As he relayed the concept from Shakespeare in 1623, “Measure for Measure”, he quantified that “Good counselors lack no clients.”[4]  He continues that the Hammurabi Code indicated that even in the 1700s there was an acknowledgement that there were inherent conflicts of interest when it comes to financial affairs.  Good counselors, or CCOs, act as a gatekeeper with the laws, rules, and regulations to maintain what the financial systems need in order to function and protect investors.  Acting as the first line of defense, navigating the business functions of the firm, but maintaining segregation of responsibilities, builds trust in the firm as well as in the industry.  Recognizing that sometimes a compliance officer needs to say “no”, maintaining relationships with the business and “working with them to find compliant solutions.”[5]

Gensler continued with the topic of Regulation Best Interest and the Advisers Act Fiduciary Duty and stated that the SEC staff plans to issue more guidance to firms regarding placing the best interest of investors and clients over the interests of the firm.  Gensler states:

“At the heart of Reg BI and the IA fiduciary standard…you have to put your client’s interest first.  Advisers have to comply with specific duties relating to care and loyalty.  To meet these duties, advisers, guided by their compliance officers, need, among other things, to prevent their own interests from inappropriately influencing their recommendations and advice. If advisers can’t do that, they have decisions to make: eliminate the conflict, don’t give the advice, or find some other way to ensure that they don’t put their interests ahead of the investor’s interests.”[6]

This reiterates the SEC’s continued focus on fiduciary duty, conflicts of interest, and investor protection, the cornerstone of the Advisers Act and the Investment Company Act.

 

Key Concepts Discussed in 2022 Seminar

The panels and discussions by the SEC Directors reviewed the following areas:

Enforcement: The SEC has seen yet another year of record-breaking enforcement actions, collecting almost $2.6 billion more than was collected in 2021, in over 700 enforcement actions.  Director Grewal stressed engagement, education, and execution are paramount to mitigating issues leading to enforcement.  He further highlighted that compliance professionals must understand the risks unique to the firm’s business; firms must stay on top of regulatory developments, including SEC Risk Alerts and enforcement actions; “off the shelf” and policies and procedures that are not tailored to the firm pose additional risks and are not sufficient to complete a compliance program; and finally, enforcement staff continues to see firms’ failure to follow their own policies and procedures. Director Grewal also indicated that the SEC would continue to bring “messaging” cases and that firms should use these settled cases to craft appropriate compliance programs.  They are, in a sense, a roadmap to what is expected in a firm’s policies and procedures.

Exam Priorities: Richard Best outlined the continued focus on ESG investing, private funds, and standard of conduct.  The private fund space is of particular interest given the amount of assets currently invested in private funds.

In the last 5 years, advisers to private funds have increased more than 70%, now comprising about 35% of all RIAs.  Focus in this area will include reviewing adviser’s fiduciary duty, compliance programs, fees and expenses, along with compliance with other rules such as custody, fund audits, and valuation.

He also noted that despite the share class initiatives, remediation and enforcement actions, the staff continues to see issues with these recommendations.  He further states the staff will review whether a recommendation is in the best interest of that particular investor.

Remote exams are decreasing as business gets back to normal in a post-pandemic environment.  Where there are opportunities to conduct in person examinations, onsite exams are anticipated.

Rulemaking: Director Birdthistle focused on three themes in rulemaking; resiliency, transparency, and disclosure.  He specifically referenced the cybersecurity proposal, proposals related to private funds and Form PF, and the disclosure of conflicts and risks associated with ESG investing.

Fiduciary Interpretation and Form CRS: The staff reiterates the use of the term “fiduciary” and that it may not be used in a misleading manner.  Admonition was given to follow the instructions given when developing Form CRS.  Furthermore, the staff continues to see firms providing inconsistent disclosures, specifically where 12b-1 fees, revenue sharing arrangements, cash sweep products and other revenue streams that bring significant conflicts of interest.  The panel further noted that the fiduciary duty as defined under ERISA is separate and distinct from that of the Advisers Act.  Though deficiencies may be noted during an examination, a referral to the appropriate regulatory authority made be made by the SEC.

New Marketing Rule: This was an interesting discussion in that the compliance date of the rule was just a mere 11 days prior to the seminar.  The staff focused on a few areas, mostly covering expectations in upcoming SEC Examinations.  They highlighted the Risk Alert titled the “New Investment Adviser Marketing Rule” that was issued on September 19, 2022.[7]  It was noted that SEC staff was provided extensive training on the new rule and they expect that firms have conducted their own training.  Expect that the staff will issue more guidance in the form of Risk Alerts in the future as they make observations during their examinations on how advisers have complied with the rule.  Furthermore, when making disclosure and applying performance-related metrics, firms should consider facts and circumstances, material underlying risks that may need to be disclosed, and whether it is possible to calculate performance appropriately.

The panel acknowledged that there are challenges facing advisers, such as requirements for model fees, hypothetical performance, and even social media.  The thought is that monitoring past enforcement cases, no action letters, and previous guidance issued by the staff is the foundation of the new Marketing Rule. The way the new marketing rule is written makes it easier for enforcement actions to be brought.  It was mentioned that the staff is not attempting to play “gotcha” with examinations of compliance with the rule but that they are looking for true effort in addressing the related requirements and whether marketing is truly considered “fair and balanced.”

Private Funds:  Advisers to private funds should be focused on evaluating advisers’ relationships with affiliates, advisory fee calculations and expenses, and other high priority areas such as due diligence and disclosure of conflicts of interests with service providers, and custody rule implications.

Registered Funds: As stated with the Exam Priorities, there is continued focus on fees, expenses disclosure, valuation, derivatives, and board oversight.  Complying with new rules such as the new Fund Valuation Rule[8] and Derivatives Risk Management[9] and liquidity risk management and vendor due diligence are important factors in a solid compliance program.

ESG: The staff has seen an increased number of issues related to ESG investing.  Reviewing the Risk Alert issued in April 2021[10] will educate firms on concerns levied by the staff in observations from examinations.  Firms are also encouraged to review the SEC’s proposal to “Enhance Disclosures by Certain Investment Advisers and Investment Companies about ESG Investment Practices”[11] to understand the direction the SEC is taking in this regard.  While policies and procedures are not requirements of the proposed rule, they are consistent with the compliance program rule and other best practices.  Enforcement staff will be focused on materiality, disclosure, and ensuring that the adviser maintains appropriate policies and procedures that reflect their current practices.

SEC Hot Topics:  While no surprise, the panel touched lightly on the following components:

• Digital Assets – Advisers exposure to crypto and disclosures made, risks including best interest, valuation, custodial relationships and if they are qualified or not, marketing, and custody implications. They also suggested that due diligence of providers is a key risk that should be evaluated.
• Electronic advice (Robo Advisers) – The staff considers automated advice to be investment advice. Observations indicate that most deficiencies arise from lack of regulatory awareness and failure to disclose material conflicts of interest.
• Hedge Clauses – They highlighted that few, if any, hedge clauses would not trigger antifraud provisions, even with institutional clients, advisers must still be accurate in their statements.
• Form ADV and Form CRS– While the staff uses data included on Form ADV, it is critical that advisers make necessary updates and amend the Form upon material changes in the firm. The most common observation is failure to update or correct the disciplinary history section of Form CRS.
• Electronic communications – Firms are required to retain communications related to the firm’s business. Firms should define what forms of electronic communications are approved, conduct employee training, collect attestations, and identify prohibited types of communications.
• Cybersecurity – Determining appropriate governance strategies for cybersecurity is paramount to protecting investors. The staff highlighted the need for conducting routine risk assessments, maintaining appropriate policies and procedures with an incident response plan and strategies to address business continuity in the face of a cyber incident.  They also recommended enhanced vendor due diligence and employee training to round out the necessary components to a well-tailored plan.

The Compliance Outreach Program is a great opportunity to understand what is on the minds of the SEC staff.  The staff also enjoys the opportunity to hear from those on the front lines of implementing rules, regulations, and associated guidance.  It is important for them to understand the practicality of the guidance provided.  If you have not had the opportunity to participate in this regulatory event, we hope you will take advantage of it next year.  However, we encourage you to listen to the most recent seminar here.  If you need assistance assessing any of the topics discussed in the seminar, the team at Core Compliance can assist in evaluating any of these topics. For assistance or more information about our services, please contact us at info@corecls.com, at (619) 278- 0020 or visit us at www.corecls.com for more information.

 

Author: Core Compliance & Legal Services (“Core Compliance”). Editor: Tina Mitchell, Managing Director, Consultation, Core Compliance.  We work extensively with investment advisers, broker-dealers, investment companies, hedge funds, private equity firms and banks on regulatory compliance issues.

This article is for information purposes and does not contain or convey legal or tax advice. The information herein should not be relied upon in regard to any particular facts or circumstances without first consulting with a lawyer and/or tax professional.