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SEC examination priorities for 2022

Insight 3 May 2022

SEC examination priorities for 2022

The Securities and Exchange Commission’s (the “SEC”) Division of Examinations recently announced its 2022 examination priorities

The Securities and Exchange Commission’s (the “SEC”) Division of Examinations recently announced its 2022 examination priorities. They are:

  • Private Funds
  • Environmental and Social Governance (“ESG”)
  • Information and Security and Operational Resiliency
  • Standards of Conduct
  • Emerging Technologies and Crypto Assets

While reminiscent of prior years’ priorities, there is a decidedly deeper focus on crypto-assets, ESG and emerging technologies.

Over the past five years, assets managed by private funds have increased by 70%, now estimated to be $18 trillion. The SEC plans to focus on issues under the Investment Advisers Act of 1940 (the “Advisers Act”) and will assess risks faced by funds as well as compliance programs, fees and expenses, custody arrangements, valuation methods and disclosures.

Specifically, the SEC’s Division of Examinations will review five areas:

  1. Calculation and allocation of fees and expenses
  2. Potential preferential treatment by some Registered Investment Advisers (“RIAs”) to funds that have experienced issues with gates, liquidity, suspensions, and withdrawals
  3. Compliance with the Advisers Act Custody Rule, including the audit exception and related reporting and updating of Form ADV regarding the audit
  4. Adequacy of disclosures and compliance with any regulatory requirements for cross trades, principal transactions or distressed sales
  5. Conflicts around liquidity and secondary transactions

Priorities 2 and 5, above, seem to get a head start on recent SEC proposals severely limiting preferential treatment and secondary transactions, which Sanne discussed in a previous publication.[1] The SEC will also focus on examining the portfolio strategies, risk management and investment recommendations and allocations. This will include fund investments in SPACs as well as operational controls and investor reporting.

[1] https://www.sannegroup.com/our-thinking/insights/2022/sec-proposals-aplenty-the-ric-ification-of-private-funds-and-the-impact-on-clients/

ESG investing (and marketing) is a growing trend.  The SEC continues to be concerned with false claims and representations, and will focus on three key areas:

  1. Accuracy of the disclosures regarding ESG investing and assurance that RIAs have implemented policies and procedures meant to prevent violations of the federal securities laws in connection with their ESG-related disclosures
  2. Assurance that the voting of client securities is in accordance with proxy voting policies and procedures and whether the votes align with the ESG disclosures
  3. Evaluation of whether RIAs are overstating or misrepresenting the ESG factors used in portfolio selection (i.e., greenwashing)

Recently, the SEC revealed its proposal to require registered/reporting companies to disclose climate-related risk and greenhouse gas emissions information beyond what is currently required. Further, the proposed rule would define climate-related metrics and impose related governance, risk management, attestations and outlooks disclosure requirements to determine how companies integrate climate risks and opportunities into their governance and corporate strategy.

Although those proposed climate disclosure rules do not directly impact private funds, recent SEC proposals that we spoke of in a previous article[2] and these exam priorities (including climate related “operational resiliency”, discussed below) seem to support our argument that there is an approaching convergence in the treatment of private and registered funds.

[2] https://www.sannegroup.com/our-thinking/insights/2022/sec-proposals-aplenty-the-ric-ification-of-private-funds-and-the-impact-on-clients/

Information security controls and business continuity remain a major SEC exam focus. Examinations will consider whether advisers’ practices are designed to prevent interruptions to critical services and protect investor information:

  • Measures taken to safeguard customer accounts and prevent intrusions
  • Steps to oversee vendors and service providers
  • Actions taken to address malicious email activities
  • Response to incidents
  • Precautions taken to identify and detect red flags
  • Ability to manage operational risks as a result of a dispersed workforce

While the factors are familiar, the SEC states it will have “particular focus on the impact of climate risk as well as these registrants' resiliency as organizations to anticipate, prepare for, respond to, and adapt to both sudden disruptions and incremental changes stemming from climate-related situations.”

Examinations will include reviews of various disclosures and recommendations to ensure compliance programs satisfy their respective obligations under Regulation BI. Examinations will include an assessment of practices regarding:

  • Considerations of alternatives
  • Management of conflicts of interest
  • Trading disclosures provided in Form ADV and Form CRS
  • Effectiveness of compliance programs, testing, and training designed to support retail investors

Registered investment adviser examinations will focus on whether RIAs are acting consistently with their fiduciary duties to clients. Focus areas will include:

  • Revenue sharing arrangements
  • Recommending or holding more expensive classes of shares
  • Recommendation of shares that carry fees
  • Recommendations regarding proprietary products

Compliance policies and procedures and their design and implementation will also be evaluated. The SEC stated that although it is the chief compliance officer’s responsibility to develop and maintain a compliance program, they require participation and input from all business and operational lines. Operational leads can offer expertise and diverse perspectives to the development of compliance programs and the design of effective controls. Additionally, collaboration across the organization can create a sense of shared ownership and result in an inclusive approach to compliance.

The SEC has observed an increase in the usage of robo-advisers by RIAs to provide automated digital investment advice to clients, as well as an increase in the sale and trading of crypto-assets. As such, examinations will review the adviser’s use of developing financial technologies and crypto-assets.

Examinations will focus on the review of robo-advisers and the growing trends in this area to assess whether operations and controls currently in place are consistent with disclosures, standards of conduct and other regulatory obligations.

Examinations will look at the RIAs’ controls, including custody arrangements, to understand whether the offer, sale, recommendation and advice for the crypto assets have met their respective codes of conduct. Examinations will also evaluate whether RIAs routinely review, update and enhance their compliance practices (i.e., crypto-asset wallet reviews, custody practices, anti-money laundering reviews) and operational resiliency reviews.

What actions are required?

RIAs should consider reviewing the examination priorities and their firm’s policies and procedures to ensure they apply and make adjustments as required. It is also important to note that although the priorities will steer the SEC’s examinations, the list is not exhaustive, and the SEC can look into other areas.

For additional information, or to discuss any of the topics highlighted above, please get in touch with Daryoush, Michael or Paul directly

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Regulatory Overview
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Daryoush Niknejad General Counsel, North America - Dallas
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Michael Barakat Assistant Director - Dallas
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Paul Séjournant Director, Product Development - United Kingdom
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