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Regulation and Compliance > Federal Regulation > SEC

Don’t Wait! Get Ahead of SEC Scrutiny With Mock Examinations

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What You Need to Know

  • The SEC will prioritize examinations of several significant focus areas that pose unique or emerging risks to investors or the markets.
  • ESG/sustainable investments have become a sensible focus area for a mock exam to measure alignment between ESG investing and compliance.
  • Mock exams draw on the experience of RIA firms’ chief compliance officers and/or third-party consultants, many of whom are former SEC staff members.

Over the past several years, the Securities and Exchange Commission has steadily increased its examinations of RIAs In fact, in the 2021 fiscal year, the Commission conducted 2,251 exams on 16% of RIAs, up from 10% in fiscal year 2015.

Meanwhile, the agency has introduced a more rigorous regulatory agenda this year that will prioritize examinations of several significant focus areas that pose unique or emerging risks to investors or the markets. These focus areas include private funds and their advisors; environmental, social and governance investing; standards of conduct; information security and operational resiliency; and emerging technologies and crypto-assets.

RIA examinations will continue to assess their compliance programs in core risk areas. Typically, the SEC prioritizes firms that have not yet been examined, including those recently registered or those which have not been examined in a number of years.

In response to investor demand, advisors have expanded their various approaches to ESG investing and increased the number of product offerings across multiple asset classes.

Combining these factors with a lack of standardized and precise ESG definitions, and the fact that this is a developing category, may present heightened compliance risks as highlighted in the SEC’s Risk Alert last year. These issues make ESG/sustainable investments a sensible focus area for a mock exam to measure alignment between ESG investing and compliance.

Cybersecurity breaches, including social engineering fraud and ransomware, also are presenting increasing compliance challenges.

In addition, combined civil and standalone SEC enforcement actions against Registered Advisors/Investment Companies are the second highest among 13 total reported categories, increasing to 28% of total actions in fiscal year 2021, from 23% in fiscal year 2020.

Taken together, this heightened regulatory focus combined with emerging new areas of exposure could challenge the compliance capacity of advisors and make strong compliance policies and procedures more important than ever.

Mock Exams Make Sense

Many advisor firms are turning to mock examinations as a key tool to enhance their SEC compliance programs. Mock exams draw on the experience of RIA firms’ chief compliance officers and/or third-party consultants, many of whom are former SEC staff members. These experts employ compliance testing methodologies focused on SEC Risk Alert topics and areas addressed in similar exams of peer advisor firms, making mock exams highly effective at identifying and mitigating compliance risks.

For RIAs that have not yet done a mock exam, it is often because they lack the resources or perceive the potential return on investment as insignificant. Yet the case for conducting them has never been more compelling.

In an effort to reduce potential claims under advisors’ Errors and Omissions insurance coverage, several insurers, including Chubb, reimburse a portion of the cost of mock exams provided by third-party consultants, where permitted by law. The resulting net cost of the mock exam can be less than or comparable to many E&O insurance deductibles, which are paid out of pocket by an advisor at the time of a claim.

An actual SEC exam that yields findings worthy of a full investigation and potential enforcement actions can produce major financial impacts, as defense expenses can run into millions of dollars. The reputational damage can be even more concerning for RIAs, resulting in potential loss of client confidence that could lead to asset redemptions.

While not guaranteed, addressing compliance weaknesses identified in a mock exam could help keep an SEC exam from escalating to a full-blown investigation, which could trigger an E&O insurance claim and deductible, and further enforcement action.

With the increasing number and scope of SEC exams, combined with the potential severe financial and reputational damages from a formal SEC investigation, it makes good bottom-line sense for RIAs to take a proactive approach with mock exams to help prevent these impacts.


Steven F. Goldman is president of Chubb’s North America Financial Lines division. He can be reached at [email protected].