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SEC Issues 2022 Examination Priorities

The SEC's Division of Examinations (Division) recently released its 2022 examination priorities. The Division's Acting Director, Richard R. Best, stated, "[i]n this time of heightened market volatility, our priorities are tailored to focus on emerging issues, such as crypto-assets and expanding information security threats, as well as core issues that have been part of the SEC's mission for decades – such as protecting retail investors" and urged firms to consider updating their compliance programs to address the broad landscape of potential risks identified by the 2022 priorities.

The report begins with metrics about the Division's examination program. It notes that the Division completed over 3,040 examinations in 2021 (a 3% increase from 2020) and issued more than 2,100 deficiency letters (an increase of 100 letters from 2020). More than 2,200 registered investment advisers (RIAs) and more than 125 investment company complexes were examined during 2021. The Division examined approximately 16% of RIAs, compared to 15% in the prior two years, although the report indicates that the Division will likely have to lower the annual coverage target "as the growth in the number of RIAs continues to grow at a rate that far outpaces staffing increases." The Division notes that the number of RIAs has increased 20% over the last five years to over 14,800 and the asset management industry continues to grow in complexity.

The Division also reaffirmed its long-standing commitment to, and focus on, promoting compliance despite last year's name change from the Office of Compliance Inspections and Examinations to the Division of Examinations. The Division emphasized that compliance is at the forefront of its work, noting that it engages with compliance officers routinely on each examination and looks for outreach and engagement opportunities with compliance professionals. The Division observed that a key characteristic of an effective compliance program is resiliency, meaning programs should be developed and designed to be effective and withstand changes due to changes in market conditions, key personnel and investor demand.

The 2022 priorities are grouped into the following categories:

  • Private Funds
  • ESG Investing
  • Standards of Conduct for Retail Investors
  • Information Security and Operational Resiliency
  • Emerging Technology and Crypto-Assets

Private Funds

The SEC continues to focus on private fund advisers and private funds, as evidenced by the 2022 priority list, as well as recent rule proposals and a 2021 risk alert regarding private fund advisers. The Division's report notes that there has been a 70% increase in the assets managed by private fund advisers in the last five years, and more than 5,000 advisers (representing over 35% of all RIAs) manage approximately $18 trillion in private fund assets.

The Division stated that it will review fiduciary duty issues, such as the potential preferential treatment of certain investors by RIAs, and will assess risks by focusing on compliance programs, the calculation and allocation of fees and expenses, compliance with the custody rule, fund audits, valuation, conflicts of interest, disclosures of investment risks, and controls around material non-public information. The Division will also focus on portfolio strategies, risk management and investment recommendations and allocations, concentrating on conflicts and related disclosures. The Division will also review private fund advisers' practices, controls and investor reporting concerning risk management and trading for private funds that show indicia of systemic importance, such as large counterparty or gross notional exposure.

ESG Investing

The Division will continue its focus on RIAs and investment products (such as registered funds and private funds) that employ ESG strategies or incorporate ESG criteria as part of their overall investment strategy. In particular, the Division will review whether advisers and funds are:

  • Accurately disclosing their ESG investment strategies (and have adopted corresponding compliance procedures, including review of their portfolio management processes and practices);
  • Voting client securities in accordance with proxy voting policies, including in alignment with ESG-related disclosures and investment mandates; and
  • Misrepresenting or embellishing the ESG factors considered or incorporated into investment decision making (e.g., "greenwashing"), such as in performance advertising and other marketing materials.

Standards of Conduct: Regulation Best Interest, Fiduciary Duty and Form CRS

The Division will continue to focus on standards of conduct for broker-dealers and RIAs with retail clients. This review will include assessing how advisers are satisfying their obligations under the Advisers Act fiduciary standard, which requires advisers to act in the best interests of retail clients without placing their own interests ahead of retail clients' interests. Examinations will include evaluating advisers' practices regarding the consideration of investment alternatives, how advisers manage conflict of interest, and practices relating to trading, disclosures (such as those in Form ADV and Form CRS), rollover recommendations and account conversions. Focus areas for examinations of advisers to retail clients include:

  • Revenue sharing arrangements;Recommending or holding more expensive share classes when lower cost share classes are available to the client;
  • Recommending or holding more expensive share classes when lower cost share classes are available to the client;
  • Recommending wrap fee accounts without analyzing whether the accounts are in the best interests of clients; and
  • Recommending proprietary products with higher fees or additional fees.

Information Security and Operational Resiliency

The Division will assess advisers' practices that are intended to prevent interruptions to mission-critical services and to protect client information, records and assets. The Division will continue to focus on whether advisers have taken sufficient measures to:

  • Prevent intrusions and safeguard client accounts;
  • Oversee service providers' cybersecurity efforts;
  • Address phishing or account intrusions or other malicious email activities;
  • Respond to incidents, such as ransomware attacks;
  • Identify and detect red flags relating to identity theft; and
  • Manage operational risk (such as those relating to hybrid working environments).

The Division will also review advisers' business continuity and disaster recovery plans and will focus on whether such plans address climate risk and substantial disruption to normal business operations. Cybersecurity continues to be a perennial focus area in the Division's exam priorities, but this year's report demonstrates the Division's focus on new cyber topics, such as the use of emerging technologies across registrant types.

Emerging Technologies and Crypto-Assets

The Division will also review advisers that are using emerging financial technologies to assess whether the unique risks of such activities are incorporated into the firms' compliance programs. Emerging financial technologies include digital investment advice (i.e., "robo-advising") and the proliferation of trading in crypto-assets. Examinations of advisers will focus on firms employing or claiming to employ these technologies or investing in such assets and assess whether (1) operations and controls in place are consistent with disclosures made, the standard of conduct owed to investors and other regulatory obligations; (2) advice and recommendations are consistent with investors' investment strategies and the standard of conduct owed to them; and (3) controls contemplate the unique risks associated with these practices.

Additional Comments Regarding Examinations of Advisers and Investment Companies

The report also included comments regarding the Division's review of compliance programs and other focus areas during a typical examination.

Advisers. The Division will review an adviser's compliance program in one or more of the following focus areas: marketing practices; custody and safety of client assets; valuation; portfolio management; brokerage and execution; conflicts of interest; and related disclosures. The Division will also focus on whether investment advice is in each client's best interest, whether there are sufficient resources for an adviser to perform its compliance duties and whether oversight of service providers is sufficient. The Division will also focus on disclosures by advisers and issues relating to fees and expenses, including advisory fee calculation errors (and whether they were properly adjusted), inaccurate calculation of tiered fees (such as failing to provide breakpoints or aggregating household accounts), and failures to refund prepaid fees for terminated accounts or to pro-rate fees for new clients.

Investment Companies. The Division will continue to focus on registered funds' compliance programs and governance practices. Focus areas will include disclosures, accuracy of SEC reporting, and compliance with new rules and exemptive orders (including ETF rules and non-transparent ETFs). The Division will also focus on registered funds' liquidity risk management programs to determine whether the programs are reasonably designed to assess and manage the funds' liquidity risk and review the implementation of liquidity classifications and oversight of third party service providers. The Division will also review certain fund practices, such as advisory fee waivers and trading activities of portfolio managers.

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