Monday, March 08, 2021

SEC examinations chief outlines new Division’s priorities, including ESG, Form CRS compliance

By Amanda Maine, J.D.

Pete Driscoll, director of the SEC’s Division of Examinations, spoke at the 2021 Investment Adviser Association (IAA) conference about the newly-elevated Division’s goals and priorities. Driscoll’s remarks follow the Division’s recently issued overview of how it plans to approach examinations in 2021, including a focus on issues related to environmental, social, and governance (ESG) factors.

New year, new Division. IAA General Counsel Gail Bernstein asked Driscoll for his thoughts on the elevation of the former Office of Compliance Inspections and Examinations (OCIE) to the Division level. Driscoll remarked that he had been advocating for this move since his appointment as OCIE head in 2017. The importance of examinations has grown as the industry has grown, he said, and raising the SEC’s exam program to the level of other divisions sends a message that compliance is important.

Regardless of the status of the Division, its mission remains the same, Driscoll emphasized—promoting compliance, preventing fraud, identifying and monitoring risk, and informing policy. With these priorities, it makes sense that the office became an SEC Division. He added that from a morale standpoint, the team at the newly-minted Division is excited. "One of the highlights of my career was telling the team on Zoom that we’re now a Division," Driscoll said.

COVID impact on exams. Driscoll also addressed the impact of the pandemic and telework on the examination program and whether remote exams would be more routine in the future. He praised the work of the SEC and firms being examined for adapting to the new remote environment. Before the COVID-19 pandemic, Driscoll said around 30 percent of examinations were conducted through correspondence. While there is no substitute for being onsite for an exam, many exams are actually conducive to a virtual environment, he advised. In certain circumstances, the staff should be onsite for examinations, including when investigating issues about information security. "I do think the world is going to change coming out of this," Driscoll said. He also noted that by conducting virtual examinations, travel time is cut down. Staff can spend what used to be Monday and Friday travel time doing work "instead of hoofing it to the airport," he explained.

Driscoll noted that the Division formerly known as OCIE paused routine examinations in the early stages of the COVID shutdown. While overall, examinations were down 4 percent, OCIE still managed 15 percent coverage of examinations of investment advisers. Given the challenges of conducting examinations in a remote environment, Driscoll praised the work of the staff. However, he added that the same number may be difficult to achieve in 2021 without more resources.

2021 priorities. The Division recently issued a document outlining its examination priorities for 2021. Bernstein queried Driscoll on how COVID informed the Division’s 2021 priorities and whether it plans on issuing Risk Alerts in the near future. Driscoll remarked that the switch to a remote workforce presented new cybersecurity challenges that the Division will look at, such as issues with recordkeeping. While there were some "blips" the investment advisory industry had to deal with during the pandemic—such as issues involving paper documents, obtaining notaries, and even receiving mail—it responded very well to moving to a remote work environment. Driscoll said that anecdotally, examiners observed that working remotely resulted in a workplace change: instead of traders sitting at desks in proximity to each other, there was a big uptick in email communications and applications using instant chat.

Regarding possible future Risk Alerts, Driscoll advised that the Division recently issued an Alert on digital assets. There are also some Alerts in the pipeline, including one on ESG. The upcoming ESG Risk Alert is based on exams OCIE conducted last year, noting that it is timely and a priority. The industry wants to be in compliance with the areas the SEC is focused on, and that includes ESG, Driscoll explained.

On the ESG front, Bernstein asked how deeply the Examinations Division is drilling down beyond disclosure in its exams to see how a firm’s practices match up with what is disclosed. Driscoll said that the staff will look at the firm’s trading and compare its trading to the benchmarks they follow. The staff will also examine a firm’s advertising relating to ESG strategies. Driscoll also drew attention to the Division’s focus on business continuity plans as an area of focus. Bernstein inquired whether ESG would be part of all exams or more targeted on particular firms or regions. Driscoll responded it would depend on the firm and whether ESG is a large part of what the firm does.

Other areas of focus: Form CRS and private funds. Driscoll was also asked about Form CRS (Relationship Summary), which was adopted as a part of a suite of financial conduct rules by the SEC in June 2019 under Regulation Best Interest. While most firms were mostly compliant with Form CRS as mentioned at an SEC roundtable on Reg BI last year, Driscoll remarked that OCIE had identified hundreds of firms that should have filed a Form CRS but failed to do so. Although OCIE conducted outreach to those firms, Driscoll lamented that a large number did not respond at all to the SEC’s request. In response, the Division has opened up examinations on firms who failed to respond to two inquiries about noncompliance with Form CRS, he said. He also touted the usefulness of Form CRS when it comes to examinations—it is probably the first document examiners will read to get an overview of the firm before they dig deeper into Form ADV.

Bernstein also asked Driscoll about the Division’s approach to private funds. Driscoll highlighted last year’s Risk Alert on private fund examinations drawn from the previous year’s observations. For the upcoming year’s examinations, Driscoll said that the Division intends to look at the mainstays of fees and expenses, valuations, disclosures, affiliations, cross-trades, distressed sales. The staff will also look at conflicts around liquidity if there are adviser restructurings. In addition, the staff will look at concentrations of structured products like CLOs, he advised. In addition, if a private fund owns a portfolio including a company impacted by the recent economic conditions, including the so-called "meme stocks," recently the focus of mainstream media attention, Driscoll advised.