Page 48 - Investment Advisor June 2022

WEALTH & RISK

By Steven F. Goldman

Don’t Wait! Get Ahead of SEC Scrutiny

With Mock Examinations

Being proactive can avoid the agency’s glare and help reduce Error &

Omissions claims.

ver the past several years, return on investment as insignificant.
the Securities and Exchange Yet the case for conducting them has
O Commission has steadily never been more compelling.
increased its examinations of RIAs In fact, In an effort to reduce potential claims
in the 2021 fiscal year, the Commission under advisors’ Error & Omissions
conducted 2,251 exams on 16% of RIAs, insurance coverage, several insurers,
up from 10% in fiscal year 2015. including Chubb, reimburse a portion
Meanwhile, the agency has introduced of the cost of mock exams provided by
a more rigorous regulatory agenda this third-party consultants, where permit-
year that will prioritize examinations of compliance challenges. ted by law. The resulting net cost of the
several significant focus areas that pose In addition, combined civil and mock exam can be less than or compa-
unique or emerging risks to investors or standalone SEC enforcement actions rable to many E&O insurance deduct-
the markets. These focus areas include against Registered Advisors/Investment ibles, which are paid out of pocket by an
private funds and their advisors; envi- Companies are the second highest among advisor at the time of a claim.
ronmental, social and governance invest- 13 total reported categories, increasing An actual SEC exam that yields find-
ing; standards of conduct; information to 28% of total actions in fiscal year 2021, ings worthy of a full investigation and
security and operational resiliency; and from 23% in fiscal year 2020. potential enforcement actions can pro-
emerging technologies and crypto-assets. Taken together, this heightened regu- duce major financial impacts, as defense
RIA examinations will continue to latory focus combined with emerging expenses can run into millions of dol-
assess their compliance programs in new areas of exposure could challenge lars. The reputational damage can be
core risk areas. Typically, the SEC prior- the compliance capacity of advisors and even more concerning for RIAs, result-
itizes firms that have not yet been exam- make strong compliance policies and ing in potential loss of client confidence
ined, including those recently registered procedures more important than ever. that could lead to asset redemptions.
or those which have not been examined While not guaranteed, addressing
in a number of years. MOCK EXAMS MAKE SENSE compliance weaknesses identified in a
In response to investor demand, advisors Many advisor firms are turning to mock mock exam could help keep an SEC
have expanded their various approaches to examinations as a key tool to enhance exam from escalating to a full-blown
ESG investing and increased the number their SEC compliance programs. Mock investigation, which could trigger an
of product offerings across multiple asset exams draw on the experience of RIA E&O insurance claim and deductible,
classes. Combining these factors with a firms’ chief compliance officers and/ and further enforcement action.
lack of standardized and precise ESG defi- or third-party consultants, many of With the increasing number and scope
nitions, and the fact that this is a developing whom are former SEC staff members. of SEC exams, combined with the poten-
category, may present heightened compli- These experts employ compliance test- tial severe financial and reputational
ance risks as highlighted in the SEC’s Risk ing methodologies focused on SEC Risk damages from a formal SEC investigation,
Alert last year. These issues make ESG/ Alert topics and areas addressed in simi- it makes good bottom-line sense for RIAs
sustainable investments a sensible focus lar exams of peer advisor firms, making to take a proactive approach with mock
area for a mock exam to measure alignment mock exams highly effective at identify- exams to help prevent these impacts.
between ESG investing and compliance. ing and mitigating compliance risks.
Cybersecurity breaches, including For RIAs that have not yet done a Steven F. Goldman is president of Chubb’s
social engineering fraud and ransom- mock exam, it is often because they lack North America Financial Lines division. He Adobe Stock
ware, also are presenting increasing the resources or perceive the potential can be reached at: [email protected].

46 INVESTMENT ADVISOR JUNE 2022 | ThinkAdvisor.com