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21 Compliance Considerations for 2021

By January 12, 2021July 21st, 2022No Comments

For most of us, this past year brought many unexpected changes. The world’s workforce had to quickly adapt to going remote, while capital markets fluctuated and investment priorities shifted amid global health concerns and a bellowing call to address social injustices and foster more inclusivity across all areas of society.

For our area of focus, financial regulators continued on a steady path of enforcement and the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) signaled increased attention on several key areas for investment managers. As we kick off 2021, with a new administration and regulatory leaders, Silver has outlined the following 21 considerations for compliance teams in the investment management industry.


1-14: Regulatory and Compliance Considerations for Investment Advisers

  1. SEC’s Model Compliance Program: The SEC held a National Seminar for investment companies and investment advisers and put forth points on how to model a regulatory compliance program to prevent violations and mitigate operational and regulatory risks, as well as highlighted key attributes and responsibilities of a CCO. Even when working remotely, it is imperative that CCOs of SEC regulated investment advisers continue to adhere to their supervisory responsibilities over the activities of the adviser.
  2. CCO Personal Liability:  A recent notable enforcement action, in which the investment adviser was fined and the CCO was held liable for lack of supervision and fraudulent behavior, has brought the concern of CCO Liability to the forefront (read this Insights piece, “Dear CCO: The SEC Has Its Eyes on You” by Silver’s CEO, Fizza Khan, for more on this topic).
  3. Importance of Fiduciary Duty Standard: The SEC has increased enforcement actions under the fiduciary duty standard umbrella, including “Duty of Care” and “Duty of Loyalty” to clients, rather than citing to specific rules and regulations under the Advisers Act. Areas of enforcement under this umbrella include the adviser’s management of client and propriety funds, investment allocation, fee and expense allocation, conflict of interest disclosures to clients and more. Investment advisers should ensure the entire firm is properly trained to understand and ensure its fiduciary duty.
  4. Investment Style Continuity: Market volatility has expanded demand for complex investment products and the SEC has scrutinized investment style drift, charging advisers with multiple violations of rules and regulations under the Advisers Act, including breach of fiduciary duty, anti-fraud provisions and marketing and advertising rules. Should a firm decide to offer a new product, it must be in line with its investment strategy, include proper disclosures describing the product and educate investors about the financial instruments used to maximize value within the investment mandate.
  5. Portfolio Company Liability:  Firms with a controlling interest in portfolio companies, managerial oversight over operations and representation on company boards may be held liable for regulatory violations of portfolio companies. The SEC, CFTC and DOJ have all been charging private equity firms for regulatory violations in controlled companies, including in connection with cyber-security, the FCPA and the False Claims Act.  As such, it is essential that investors conduct effective regulatory due diligence when assessing the strength of the underlying companies’ compliance programs.
  6. Fund Valuation in the COVID Era:  When market volatility increases, so does the chance a fund manager may manipulate fund valuation and performance to disguise weakness. The SEC has provided valuation guidance as part of its 2021 exam priorities. Ensure all valuation policies and procedures are followed, decisions are evidenced with supporting documentation/calculations and meeting minutes are retained as required in the normal course of business to avoid potential concerns with investors and/or the SEC. For more on the SEC’s focus on fund valuation, view episode one of Silver’s Private Fund 2020 Compliance Playbook Webinar Series here.
  7. Marketing and Advertising Rule Update: On December 22nd, the SEC modernized its marketing rule for investment advisers, amending Rule 206(4)-1 (“Advertising Rule”) and replacing Rule 206(4)-3 (“Cash Solicitation Rule”) – combined, effectively known as “Marketing Rule”. Notably, the Marketing Rule includes an updated definition of “advertisement,” which is more flexible and relevant to evolving technology and industry practices and increased record retention requirements. As such, investment advisers must update all firm marketing policies and procedures to reflect the new Rule by its effective date.
  1. Business Communications:  The remote workforce stemming from the pandemic has even further blurred the lines between “business” and “personal” communications and made it more difficult to properly monitor relevant communications. Through firsthand exam experience, Silver has noticed that the SEC is highly scrutinizing retention of business communications over text messages. Use of messaging platforms such as iMessage and WhatsApp for business communication poses increased risks to compliance under Rule 204-2 of the Advisers Act.  It is not sufficient in the current environment to simply have policies and procedures in place – compliance needs to appropriately monitor business communication activity, in addition to employees’ attestations to follow business communications policies.
  2. Digital Assets and Compliance: Digital assets, like crypto, are at the forefront of anti-crime initiatives aiming to curtail its use by criminal organizations. Any firm entering the digital asset space should expect to be subject to increased regulatory risks. For more on crypto-compliance and the SEC’s focus on digital assets, reference previous Silver insights here and here.
  3. Custody of Digital Assets: On December 23rd, the SEC stated that, for a five-year period, broker-dealers will not be subject to enforcement action on the basis it is deemed to have custody of a customer’s fully paid and excess margin digital asset securities for the purposes of paragraph (b)(1) of Rule 15c3-3 of the Exchange Act. In order to avail itself of this exception, the broker-dealer must limit its business to digital asset securities, establish and implement policies and procedures reasonably designed to mitigate risks associated with digital asset securities and provide customers with certain disclosures regarding risks of engaging in transactions involving digital asset securities.
  4. Rule 13h-1 Compliance Programs: On December 16th, the OCIE released a Risk Alert pertaining to Rule 13h-1 of the Exchange Act and “Large Traders”, finding that many firms have inadequate procedures to identify and track activity that would qualify them as “Large Traders”. Rule 13h-1 is in place to measure the effect Large Traders have on the market as a whole.  In compliance with the rule, broker-dealers and investment advisers that qualify as a “Large Trader” must file Form 13h with the SEC annually or upon a material change, as well as properly track trades to monitor for any potential breach of Rule 13h-1 thresholds.
  5. Cybersecurity Initiatives: Cybersecurity risk in the financial services industry remains a top enforcement focus for the SEC. Firms need to create robust policies and procedures to address cyber threats in accordance with local and industry regulatory guidance; conduct testing and internal investigations; and maintain proper records and documentation. For more insights on the growing threat of Cyber Security in the financial industry, see Silver’s CEO Fizza Khan moderate a discussion hosted by CFA New York.
  6. Annual Updates to Compliance Program:  Pursuant to Advisers Act Rule 206(4)-7, investment advisers must conduct an annual review of their compliance programs.  The SEC has recently stressed it is imperative for firms to formally document the annual review was conducted or else be cited for violations of Advisers Act requirements. The annual review must identify necessary regulatory and firm business updates and incorporate any new SEC/regulatory guidance issued throughout the year.
  7. Important Regulatory Deadlines: With the new year comes another round of important deadlines that firms need to prepare for, including:
    • Form ADV: Filing of Parts 1 and 2A are due within 90 days of the firm’s fiscal year-end, in addition to the distribution of the Part 2A and updated Part 2B to investors.
    • Form PF: Filing is due within 120 days of firm’s fiscal year-end.
    • Audited Financial Statements: Per Rule 206(4)-2 (the “Custody Rule”), financial statements should be distributed to all investors within 120/180 days (strategy driven).

15-21: Compliance Priorities for Investment Managers Considering ESG Factors*

  1. Investor Due Diligence Questionnaires: As more investors have begun to focus on ESG, investor due diligence questions related to ESG are increasing in complexity. Investors have especially heightened their focus on climate-related efforts and initiatives. New regulatory standards and proposals related to climate change are constantly being released and we expect these changes to continue to inform investor requests for information in the years ahead. Firms that have not formalized their thinking on climate risk should evaluate and engage on this topic in the short term. For further insights from Silver regarding climate risks for private funds, read Trysha Daskam’s piece “Climate for Change” here.
  2. PRI Transparency Reports:  In November 2020, PRI released a comprehensive update to its reporting requirements  for Signatories. Firms that have signed onto PRI (“Signatories”) will be required to use the updated framework for the 2021 transparency reporting cycle, which is open between January 1 – March 31, 2021.
  3. Internal ESG Reviews: Many firms have committed to regular reporting on ESG factors both internally and externally (e.g., to the Limited Partner Advisory Committee or other body). While reporting, remember to review side-letters and other ESG reporting obligations, including internal commitments related to ESG review and communication.
  4. ESG Regulation: The European Commission is not expected to delay the March 10, 2021 compliance date for Regulation (EU) 2019/2088 (the Sustainable Finance Disclosure Regulation or “SFDR”); however, the level two measures under SFDR are not expected to be phased in until early 2022.  With the compliance date for level one measures under SFDR coming quickly, it is prudent for managers to determine if (and how) they will be directly or indirectly covered by the regulation.
  5. Corporate Social Responsibility (“CSR”), or Citizenship, Statement Review and Distribution: Frequently, firms are in a position to demonstrate their corporate alignment with their commitment and effort on ESG.  In our view, Corporate Social Responsibility (“CSR”) statements should stand alone from a firm’s ESG policy. The former should provide an overview of the firm and its corporate activities that are in-line with ESG (e.g., firm efforts to reduce the environmental impact of day-to-day office operations); the latter provides the firm’s approach and commitment to addressing ESG at the investment level. Now is a good time for managers to review these individual pieces for alignment and accuracy.
  6. ESG Policy Review and Distribution/Website Review: As with all policies, a firm’s ESG policy should be reviewed and updated annually to capture changes to ESG practices and focus areas. Additionally, public-facing ESG information, including ESG-related detail on the firm’s website, should be reviewed and updated as needed. Managers should ensure documentation and communication requirements, as required by their ESG policy, are completed, including any distribution requirements that such updates may trigger.
  7. ESG Training: When reviewing your firm’s ESG policy, ensure that comprehensive or topic specific ESG training is conducted for all relevant staff members to communicate any changes to the ESG program and to refresh relevant personnel on the firm’s commitment to ESG.

*Read this article, ESG Regulatory Landscape for Private Funds in 2021, by Silver Regulatory Associates’ Head of ESG Strategy, Trysha Daskam for a more in-depth analysis of compliance priorities for investment managers considering ESG factors.