This year’s SEC exams will place more emphasis on climate-related risks, according to a new report highlighting 2021 priorities for the Division of Examinations (DOE). The focus on environmental, social and governance issues as they pertain to registered brokers and advisors comes as the commission continues to assess how firms are complying (or not) with Regulation Best Interest.
Acting Chair Allison Herren Lee described the prioritization of ESG risks as one step in a larger process of integrating climate and ESG issues into the SEC's “broader regulatory framework.”
The new report affirmed that RIAs are offering more investment strategies focusing on sustainability, including products that may be referred to as being “sustainable, socially responsible, impact and ESG conscious.” The DOE wants to intensify its focus both on products widely available (including open-end funds and ETFs), as well as those products that may be available only to accredited investors.
“The division will review the consistency and adequacy of the disclosures RIAs and fund complexes provide to clients regarding these strategies, 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 report read.
The priorities laid out in the report were likely influenced by the turmoil of the previous year, according to Les Abromovitz, a senior director at Foreside, a compliance and consulting firm for wealth and asset managers. He said the priorities also were shifting along with broader perspectives on climate change, noting the SEC'S 2020 priorities report didn’t mention climate risks at all (though it did refer to the need for examining the accuracy of RIA disclosures in new types of investment strategies that could include sustainable investing using ESG criteria).
Climate risk will also impact how examiners review firms’ business continuity and disaster recovery plans, he wrote in an email to WealthManagement.com.
“The division will now look at whether these business continuity plans are accounting for the growing physical and other relevant risks associated with climate change,” Abromovitz wrote. “As climate-related events become more frequent and more intense, the division will evaluate whether firms are considering effective practices to help improve responses to large-scale events.”
The new exam priorities come one week after Lee directed the SEC’s Division of Corporation Finance to “enhance its focus on climate-related disclosure in public company filings,” an issue that questioners raised on numerous occasions during SEC Chair nominee Gary Gensler’s Senate confirmation hearing this week.
The report also detailed what the SEC would be looking for in terms of compliance with Reg BI. In the initial aftermath of the rule’s implementation, examiners wanted to see "good faith" efforts on the part of firms in meeting compliance mandates, but in the coming year the SEC will “expand the scope of examinations,” assessing whether brokers are making recommendations they believe are in a client’s best interest and looking for how brokers have altered product offerings to comply.
“The division will also conduct enhanced transaction testing as part of these examinations, 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,” according to the report.
But the report also stressed that SEC examiners run the risk of falling behind on their examinations because they don’t have enough resources or staff to keep pace with increasing growth and complexity in the RIA industry.
“While the division has made great strides to improve the coverage rate, the risks of diminished coverage, quality, and effectiveness are possible without further support,” the report read.
Overall, the new exam priorities were more closely aligned with the risks advisors were actually seeing on the ground, according to Brian Hamburger, president and CEO of MarketCounsel.
While he acknowledged he’d been critical of the agency in the past, he said he was happy that the exam priorities focused on Form CRS and that conflicts of interests were receiving more attention, with less emphasis on disclosure and more on how firms are appropriately handling them. But he was surprised by the fact that the priorities didn’t mention a focus on mutual fund share class disclosure or wrap fee programs, and said that with the scrutiny of ESG products, the SEC was offering clients the advice of "buyer beware."
"Let’s make sure it’s not a wolf in sheep’s clothing,” he said. “Let’s make sure that what you’re looking to actually acquire is what you end up acquiring.”
