Alan Halfenger is a Managing Director in Treliant’s New York office. A former Chief Compliance Officer from the banking, securities, and investment management industry with experience in securities/brokerage, wealth management, private banking, and asset management. Alan advises clients on compliance program development, regulatory risks related to global securities and commodities,…
Over (virtual) holiday drinks, a former compliance colleague said that she was happy for 2020 to be over and looking forward to a fresh start in 2021. “After all, it can’t get worse,” she said. Being a little superstitious, I touched wood and nervously laughed. As I began to draft this article, I thought about her hopeful statement and all of the things that may change over the coming year.
Never have we simultaneously been at such significant crossroads on so many fronts:
- a struggling global and national economy, decoupled from record IPO and financial markets;
- a new presidential administration working with a divided Congress;
- a shifting global landscape driven by the growing influence of China, the uncertainty of Brexit, and continued instability in the Middle East;
- social movements, unrest, and protests in a polarized country;
- an explosion of new technology and technology-driven commercial changes; and
- last but not least, the ongoing impact of COVID.
In this context, this article aims to identify securities regulators’ focus areas for 2021 and discuss ways for compliance officers, regulatory attorneys, and risk officers to get ahead of the curve.
COVID: Doing business remotely
After speaking with many clients, industry vendors, and medical experts, it is clear that while we are hopefully moving in the right direction, this pandemic is not yet over. Many firms will continue to operate remotely, restrict travel, and limit face-to-face meetings through the second half of the year. This will put continued pressure on salespeople and dealmakers to find creative ways to make this all happen. Many audit, finance, and supervisory functions will continue to be done remotely. And continued stress will be placed on compliance, control, and risk functions.
So how does this impact the regulatory environment?
During 2020, regulators appear to have quickly adapted to working remotely. This has been especially true of examination teams from the Financial Industry Regulatory Authority (FINRA) and Securities and Exchange Commission (SEC). Even prior to the pandemic, these teams often performed exams across a firm’s multiple locations, combining visits in the field with electronic communications. While the hands-on and face-to-face models can be faster, less prone to confusion, and altogether easier for both sides, remote correspondence exams and conference calls have usually worked well enough.
One CCO told me that their exam during the pandemic actually went more smoothly, since it was narrowly focused. Exams have generally narrowed in on a number of critical areas, though there have still been some full-scope examinations. These areas include: supervising remote employees, especially in sales and marketing; cybersecurity and remote working; supervision of electronic communications; money and security controls; and the quality of business continuity and disaster recovery programs.
FINRA and SEC enforcement also seemed to continue without much slowdown or distraction in 2020. As an example, this past year had a record number of whistleblower enforcement cases in both total number and dollars awarded/fined. We also continue to see the fallout from this enforcement period in the sheer number of monitorships and independent consultancies required by regulators. COVID appears to have had little impact on rulemaking, which may however pick up due to political change.
So, if I am still stuck at home, how do I prepare for 2021?
Since at least the first half of 2021 should continue to look like 2020, keep doing what you were doing last year! There are markets and moments in which survival is a measure of success, and for 2020 this is true on multiple personal and business levels. That said, there are several things you should be doing to prepare for the coming year.
- Take a look at all of the projects and enhancements you put on hold and priorities you let slip. You need to quickly review them and determine which ones really can’t wait any longer. For example, regulators have made it very clear that they will be expanding the scope of Regulation Best Interest (Reg BI) examinations, that the “A for effort” approach of last year is over, and that you should have your program fully implemented by now. If you need help, you need to ask management for it and immediately clean up those critical items that were placed on hold.
- Test and document your 2020 compliance program, both generally and more specifically for the exceptions and modifications you made last year. Having an independent review of the program and last year’s results could never be more critical. This will allow you to demonstrate to regulators and management that despite the crisis you and your team got the job done (mostly!).
- Review the areas that have been stressed due to remote working, including sales practice and advertising supervision; cybersecurity; processing controls and fraud; and selling away/outside activities.
Political Environment: How will the change of administration affect the current regulatory environment?
Securities regulation over the last several years has been marked by a number of significant trends, including:
- The SEC has been supportive of market and business growth and expansion, especially in areas such as FinTech, cryptocurrencies, liberalizing rules on securities offerings and private placements, and looser advertising rules.
- Policy and rulemaking activities have been at an all-time low, resulting in no significant new requirements and an overall lowering of the regulatory burden.
- Examination teams continued to conduct all forms of exams during the pandemic and to publish guidance on the trends they were finding—though working remotely and focusing more narrowly.
- While the aggressive enforcement experienced during earlier administrations has generally subsided, especially in the private funds arena, it has not gone away completely. We continue to see significant fines, cases, and settlements. In particular, we have noticed an increased emphasis on the financial crimes space.
So what can we expect under the new administration?
While a common sentiment on Wall Street has been fear of increased regulation and an anti-financial services enforcement culture, there are several factors that may initially trend in favor of the securities industry.
- Financial reformers in Congress are not very focused on securities. While there is always significant populist anti-Wall Street rhetoric, many of the specific policy initiatives concern banking, lending, and the Consumer Financial Protection Bureau (CFPB).
- While President Biden’s nomination of former Commodity Futures Trading Commission (CFTC) Chair Gary Gensler to lead the SEC is a clear move toward a more aggressive enforcement environment, implementation of this will take time. As chair, he will need to rebuild the SEC’s enforcement infrastructure and redirect rule making efforts. Rule making will likely include a progressive focus on things such as board diversity; executive compensation; conflicts of interest, Environmental, Social, and Governance (ESG); and consumer protection items, such as sales practice and disclosure requirements.
- With an economy being stressed from numerous directions, this is no time to attack investments and the stock market, which represent one of the few bright spots in the broader economy and which have significantly increased the value of many retirement plans and 401ks in 2020.The administration knows that the private equity, FinTech, crypto, and venture communities can be sources of economic expansion, providing needed jobs growth and new revenue to be taxed.
While I do not think this hands-off approach will last, especially if we begin to see a market disruption, it should see us through 2021.
Meanwhile, the message I keep hearing from CCOs is a 2021 focus on basic or core functionality. No one is making major or significant changes to their programs, especially given limited growth in systems, budgets, and staff. Still, they want to be ready if regulators become more aggressive, so they are not cutting back much either.
Many of us remember how it was when the SEC started doing multiyear lookbacks in the private funds industry in the early 2000s. Many firms got caught for older problems and practices that they had more recently resolved. Firms should be well positioned if they continue to test and monitor the risks in their businesses and look for ways to resolve conflicts and potential issues. Adding significant staff and systems does not appear to be on the agenda for 2021, but using variable labor to focus on financial crimes topics, revise disclosure documents, enhance Reg BI processes, and improve surveillance and monitoring are all on the agenda.
Business and Infrastructure Themes for 2021: New markets, firm efficiency, and technology enhancements
In 2021 compliance and risk professionals will continue to play catch-up with next-generation technologies. A major impact of the pandemic has been the need to monitor and supervise business activities being conducted remotely, and this trend will continue in 2021. To keep up with the pace of business change, compliance officers must leverage existing technology and try to implement new tech where possible. Some examples of technology that we see being enhanced and implemented include:
- Electronic Communications Monitoring: Several vendors have enhanced their capabilities to include text communications, social media, and even third-party systems with built-in communications platforms. As the amount of online marketing continues to increase, firms will struggle with communications capture, monitoring, and analysis. Many will continue to look to artificial intelligence to solve this problem, while others will turn to contractors and part-time staff to handle the increased monitoring.
- Marketing and Advertising Review Software: With every sales person feeling like they have the capabilities of a publishing house in their own home office, supervisory principals and compliance officers will need to increase the speed and ease with which they review advertising and marketing materials. Firms continue to implement workflow/approval and marketing library tools for advertising, as well as dabbling with outsourcing these reviews to lower costs. While they have had success with automating these processes, overseas outsourcing has generally caused problems including quality issues driving firms to outsource instead to U.S.-based compliance professionals.
- Employee Compliance: While most firms have adopted automated tools for employees’ personal trading and disclosures, many enhancements are becoming available in this area. Two that seem to be of interest are enhanced reporting and surveillance around political donations, whether purchased from standalone vendors or more established employee compliance vendors. Another is improved monitoring of conflicts within deals and other firm activities, often performed by the firm’s control room.
- Surveillance and Data Loss Prevention Tools: Improvements in many off-the-shelf systems can address financial crime, securities, and data loss prevention monitoring. A number of systems are rolling out enhancements that will allow firms to upgrade their existing programs.
- Staffing: We are seeing changes to staffing models in many compliance and risk programs that allow firms to use more part-time and contract labor. This lets them flex both up and down depending on the needs of the program. Outsourcing and co-sourcing also allow firms to gain the benefits of experienced and skilled professionals to meet their financial goals.
Against this backdrop, what are regulators’ priorities?
Regulators can be expected to move in a number of critical areas, focusing on:
- Protections for retail and especially elderly investors;
- Conflicts of interest, including Reg BI and private funds disclosure initiatives;
- Financial crimes and fraud compliance, especially anti-money laundering;
- Continued focus on COVID issues, such as remote supervision and cyber risk;
- Trading abuses, such as market manipulation and insider trading;
- Private fund issues, such as valuation and performance reporting; and
- New products and businesses such as cryptocurrencies.
Additionally, ESG, a long-standing issue for many investors and a significant issue in Europe, has received some attention recently by the acting SEC Commissioner. Progressive issues such as board diversification, executive compensation, and consumer protection should move to the forefront of regulatory agendas. While this list may not seem ambitious, let’s remember that regulators must first address the macro issues discussed above, as well as completing a change of leadership resulting from the election. All in all, there seems to be quite a bit of work for each of us, and the constraints placed on us by the markets will require us to do more with less. (I am glad that I touched wood, when my colleague said that things could not get any worse than they were in 2020!)