SEC Publishes Examination Priorities for 2022
April 1, 2022
On March 29, the SEC’s Division of Examinations (EXAMS) issued its examination priorities for 2022. As noted in the published priorities, during a typical examination, the examination staff reviews the compliance programs of advisers “in one or more of the following core areas: marketing practices, custody and safety of client assets, valuation, portfolio management, brokerage and execution, conflicts of interest, and related disclosures.” The published priorities, along with Risk Alerts that are published periodically, together are helpful in describing current areas of examination focus.
Not surprisingly, this year’s published priorities – the first under SEC Chair Gary Gensler – are very much in line with his regulatory initiatives as reflected in the recent wave of rulemakings directed at advisers. These include:
Continued areas of review include a focus on compliance programs, fees and expenses, custody, fund audits, valuation, conflicts of interest, disclosures of investment risks, and controls around material nonpublic information (MNPI). Other areas include investments in Special Purpose Acquisition Companies (SPACs), particularly where the private fund adviser is also the SPAC sponsor. Examiners will also be looking at the practices, controls, and investor reporting around risk management and trading for private funds with indicia of systemic importance, such as outsized counterparty exposure or gross notional exposure when compared to similarly situated firms.
As expected, EXAMS will continue to focus on ESG-related advisory services and investment products (e.g., mutual funds, exchange-traded funds (ETFs), and private fund offerings) and will focus on whether RIAs and registered funds are: (i) accurately disclosing their ESG investing approaches and have adopted and implemented policies, procedures, and practices designed to prevent violations of the federal securities laws in connection with their ESG-related disclosures, including review of their portfolio management processes and practices; (ii) voting client securities in accordance with proxy voting policies and procedures and whether the votes align with their ESG-related disclosures and mandates; or (iii) overstating or misrepresenting the ESG factors considered or incorporated into portfolio selection (e.g., greenwashing), such as in their performance advertising and marketing.
Fiduciary Duty, Reg BI, and Form CRS
With respect to advisers, EXAMS will focus on whether advisers are acting consistently with their fiduciary duty to clients, including best execution obligations, financial conflicts of interest and related impartiality of advice, and any attendant client disclosures. Other areas of focus include: (i) revenue sharing arrangements; (ii) recommending or holding more expensive share classes of investment products when lower cost classes are available (e.g., RIAs that recommend no-transaction-fee mutual fund share classes that have 12b-1 fees in wrap fee accounts where the RIA may be responsible for paying transaction fees); (iii) recommending wrap fee accounts without assessing whether such accounts are in the best interests of clients, including the impact of the move to zero commissions on certain types of securities transactions by a number of broker-dealers; and (iv) recommending proprietary products resulting in additional or higher fees.
Information Security and Operational Resiliency
EXAMS will continue to review whether firms have taken appropriate measures to safeguard customer accounts, oversee vendors and service providers, address malicious email activities, respond to cyber incidents, identify red flags related to identity theft, and manage operational risk (e.g., resulting from a dispersed workforce in a work-from-home environment). In connection with these exams, the SEC staff will also assess compliance with Regulations S-P and S-ID, where applicable.
There will be a continued focus on reviewing registrants’ business continuity and disaster recovery plans (BCPs), with particular focus on the impact of climate risk and substantial disruptions to normal business operations. The scope of these examinations will include a focus on the maturation and improvements to BCPs over the years as well as these registrants’ resiliency as organizations to anticipate, prepare for, and respond and adapt to both sudden disruptions and incremental changes stemming from climate-related situations.
Emerging Technologies and Crypto Assets
Rounding out the big five regulatory areas will be an increasing focus on digital engagement practices (DEPs) and the use of technology in the provision of investment advice (i.e., digital advisers). Firms that are, or claim to be, offering new products and services or employing new practices (e.g., fractional shares, “Finfluencers,” or DEPs) will be assessed as to whether: (i) operations and controls in place are consistent with disclosures made and the standard of conduct owed to investors and other regulatory obligations; (ii) advice and recommendations, including by algorithms, are consistent with investors’ investment strategies and the standard of conduct owed to such investors; and (iii) controls take into account the unique risks associated with such practices. The IAA has provided comments to the SEC on advisers’ use of technology to provide advice and DEPs.
EXAMS will continue to review the custody arrangements of advisers that engage in crypto assets and will assess the offer, sale, recommendation, advice, and trading of such assets. In particular, EXAMS will focus on whether advisers (i) have met their fiduciary duty when recommending or advising investors with respect to these products, including the initial and ongoing understanding of the products (e.g., blockchain and crypto asset feature analysis); and (ii) routinely review, update, and enhance their compliance practices (e.g., crypto-asset wallet reviews, custody practices, anti-money laundering reviews, and valuation procedures), risk disclosures, and operational resiliency practices (i.e., data integrity and BCPs). EXAMS will also conduct examinations of mutual funds and ETFs offering exposure to crypto assets to assess, among other things, compliance, liquidity, and operational controls around portfolio management and market risk.
The published priorities also provide several other notable takeaways.
The IAA will be holding a webinar to discuss the published priorities. More information to come.
In the meantime, please contact the IAA legal staff at email@example.com if you have any questions.