Weekly RoundUp
July 30, 2021

Agencies Publish Notice and Request for Comment on Proposed Interagency Guidance on Third-Party Relationships

In This Weekly Roundup Issue. The federal bank regulatory agencies requested public comment on proposed guidance designed to help banking organizations manage risks associated with third-party relationships; the Office of the Comptroller of the Currency (OCC) announced the appointment of Darrin Benhart as its Climate Change Risk Officer and its membership in the Network of Central Banks and Supervisors for Greening the Financial System; and the Securities and Exchange Commission’s (SEC) Division of Examinations released two risk alerts, one regarding fixed income principal and cross trades by investment advisers, and the other regarding observations from examinations of advisers associated with wrap fee programs. These and other developments are discussed in more detail below.


Regulatory Developments

Agencies Publish Notice and Request for Comment on Proposed Interagency Guidance on Third-Party Relationships

The Federal Reserve Board, the FDIC and the OCC have proposed issuing interagency guidance on managing risks associated with third-party relationships. The proposed guidance is based on these agencies’ existing guidance concerning third-party relationships, including relationships with fintech companies and other service providers, and would establish a framework for managing risk at all stages in the lifecycle of third-party relationships that takes into account the level of risk, complexity, and size of the banking organization, as well as the nature of the third-party relationship. The proposal is intended to harmonize existing guidance and, if adopted, would replace each agency’s current guidance on this topic.

OCC Announces Appointment of Climate Change Risk Officer

On July 27, the OCC announced the appointment of Darrin Benhart as its Climate Change Risk Officer, a position that will report to the Senior Deputy Comptroller for Supervision Risk and Analysis. The OCC also announced that it has become a member of the Network of Central Banks and Supervisors for Greening the Financial System to collaborate with central banks and peer supervisors in sharing best practices and contributing to the development of climate risk management in the financial sector. The Acting Comptroller of the Currency, Michael Hsu, noted in the announcement that “[p]rudently managing climate change risk is a safety and a soundness issue.”

SEC Publishes Risk Alert Regarding Compliance Issues Around Fixed Income Principal and Cross Trades

On July 21, the SEC Division of Examinations (Division) released a risk alert regarding fixed income principal and cross trades by investment advisers. Cross trades, as explained by the Division, occur when an adviser effects a trade between two or more of its advisory clients without charging a fee, triggering potential fiduciary duty concerns. Principal trades, as explained by the Division, occur when an adviser arranges for a security to be purchased or sold to a client from its own account. The Division conducted examinations of more than 20 SEC-registered investment advisers that engaged in cross trades, principal trades, or both, involving fixed income securities (Advisers), with nearly two-thirds of them having received staff-issued deficiency letters.

By examining the trades, the Division observed five common issues:

  • compliance issues where Advisers took action that was inconsistent with their policies and procedures;
  • hard-to-follow written standards and guidance made it difficult for Advisers to abide by the standards and guidance;
  • untested compliance policies and procedures which resulted in Advisers making unreported trades;
  • trades that resulted in clients receiving inconsistent prices and unfair treatment; and
  • failure to make certain required disclosures.

The Division then offered guidance for Advisers to mitigate the above-mentioned issues: (1) adopt compliance policies and procedures that (i) incorporate regulatory requirements, (ii) clearly articulate the activities covered by the policies, (iii) set standards that address expectations, (iv) include supervisory policies, and (v) establish controls to determine whether the policies and procedures are being followed properly; (2) conduct testing for compliance with the written policies and procedures; (3) place conditions on trades to promote compliance with the Advisers’ fiduciary obligations; (4) provide clients with full and fair disclosure of all material facts surrounding cross trades, including descriptions of the Advisers’ potential conflicts of interests; and (5) provide disclosures to clients regarding trading practices in the Form ADV, advisory agreements, written communications to clients and private fund offering documents (if applicable). Finally, the Division recommends all Advisers review their written policies and procedures regarding principal and cross trades keeping in mind the suggested safeguards.

“The changes announced today will enable the agency to be more proactive in accelerating the development and adoption of robust climate change risk management practices, especially at larger banks.”
Acting Comptroller of the Currency Michael J. Hsu

Division of Examinations Prioritizing Examinations of Advisers Associated with Wrap Fee Programs

On July 21, the SEC Division of Examinations (Division) issued a risk alert providing insight into the Division’s focus on wrap fee programs and examinations of advisers associated with these programs. The Division conducted over 100 examinations of advisers associated with wrap fee programs and identified deficiencies in compliance and oversight, and disclosures regarding conflicts, fees and expenses. The Division’s staff observed that adviser monitoring of client trading accounts was ineffective, that advisers omitted compliance policy and procedures, and that advisers did not have a “reasonable basis” to establish that wrap fee programs were in the best interest of the client.

 The Division also noted that there is no “one size fits all” approach to compliance and provided recommendations and observations for improved policy and practices based on its examinations. Advisers are encouraged, initially and periodically, to perform reviews of wrap fee programs, to remind clients to report any changes to “their personal situations” that might impact the client’s risk tolerances and investment allocations after completing initial best interest reviews, and to actively communicate with clients to “prepare and educate” them when recommending a conversion from non-wrap fee accounts to wrap fee programs. The Division suggests that advisers provide clients with disclosures regarding conflicts of interest related to executed transactions within wrap fee programs and to provide “clear disclosures” about whether certain services or expenses are included in the wrap fee program or not. Regarding compliance programs, the Division’s staff notes the importance of implementing written compliance policies and procedures for assessing recommendations to clients participating in wrap fee programs, implementing compliance programs that monitor and ensure advisers provide “best execution for client’s transactions,” as well as define what advisers consider to be “infrequently” traded accounts when determining whether the wrap fee program continues to be in the client’s best interests.

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