SEC Releases 2022 Examination Priorities Report

On March 30, 2022, the U.S. Securities and Exchange Commission (“SEC”) released its 2022 Examination Priorities Report. The report is intended to outline the practices, products, and services that financial institutions offer which the SEC believes pose a heightened risk to investors, and, as a result, intends to focus on in the upcoming year.

The priorities are as follows:

A.      Private Funds

There has been a 70% increase in SEC-registered investment advisors (“RIAs”) that manage private fund assets over the last five years — today, totaling 5,000 RIAs that manage approximately $18 trillion in private funds assets. Considering this increase in prevalence, the SEC has prioritized these funds during their examination process. Specifically, the SEC examinations will continue to review:

1. the calculation and allocation of fees and expenses, including the calculation of post-commitment period management fees and the impact of valuation practices at private equity funds;

2. the potential preferential treatment of certain investors by RIAs to private funds that have experienced issues with liquidity, including imposing gates or suspensions on fund withdrawals;

3. compliance with the Advisers Act Custody Rule, including the “audit exception” to the surprise examination requirement and related reporting and updating of Form ADV regarding the audit and auditors that serve as important gate-keepers for private fund investors;

4. the adequacy of disclosure and compliance with any regulatory requirements for cross trades, principal transactions, or distressed sales; and

5. conflicts around liquidity, such as RIA-led fund restructurings, including stapled secondary transactions where new investors purchase the interests of existing investors while also agreeing to invest in a new fund.

In addition, the SEC will review the private fund advisers’ strategic approach to these funds and risk management and investment practices and will make recommendations in accordance with its findings.

B.      Environmental, Social, And Governance (“ESG”) Investing

Because of the increased prevalence of ESG strategies or criteria being incorporated into RIAs offered or evaluated investments, the SEC has prioritized review of these components to ensure that there is no misinformation shared with investors due to a lack of regulatory clarity surrounding ESG, the various approaches to ESG investing, and a potential failure to sufficiently address ESG in a manner that would ensure compliance.

In its review process, the SEC will specifically focus on “whether RIAs and registered funds are:

1. 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;

2. voting client securities in accordance with proxy voting policies and procedures and whether the votes align with their ESG-related disclosures and mandates; or

3. overstating or misrepresenting the ESG factors considered or incorporated into portfolio selection (e.g., greenwashing), such as in their performance advertising and marketing.”

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

To ensure that the obligations of Regulation BI and the Advisers Act fiduciary standards to act in accordance with the “best interest of retail investors and not to place their own interests ahead of retail investors’ interests.”  

Broker-dealer examinations will focus on the firms’ approach to different products, securities, and organizations, the alternatives considered by the broker-dealers in determining the “best interest” of their investors, and the compensation structures for financial professionals.

RIA examination will focus on the advisors’ efforts to comply with fiduciary duties owed to clients, such as their duties of care and loyalty.

Examination of affiliated firms with financial professions who service brokerage customers and advisory clients will focus on:

1. the sale or recommendation of high fee products;

2. the sale or recommendation of proprietary products of the firms or their affiliates;

3. incentives for financial professionals to place their own or their firms’ interests ahead of customers/clients (e.g., transactions that reduce costs to the adviser and increase expenses borne by the client); and

4. compensation structures that inappropriately influence investment recommendations.

D.      Information Security and Operational Resiliency

To ensure institutions are maintaining and deploying sufficient information security controls to protect the institution’s data from “unauthorized access, use, disclosure, disruption, modification, inspection, recording or destruction[,]” examination will focus on “whether firms have taken appropriate measures to:

1. safeguard customer accounts and prevent account intrusions, including verifying an investor’s identity to prevent unauthorized account access;

2. oversee vendors and service providers;

3. address malicious email activities, such as phishing or account intrusions;

4. respond to incidents, including those related to ransomware attacks;

5. identify and detect red flags related to identity theft; and

6. manage operational risk as a result of a dispersed workforce in a work-from-home environment.”

E.       Emerging Technologies and Crypto-Assets

The SEC has observed a significant increase in RIAs offering “automated digital investment advice[,]” using mobile applications, and engaging in the offer, sale, and trading of crypto-assets. Accompanying these new uses and assets available to consumers, the SEC will conduct examinations to ensure that the institution has assessed and is acting in consideration of the “unique risks” posed.

Examination will focus on “whether market participants involved with crypto-assets:

1. have met their respective standards of conduct when recommending to or advising investors with a focus on duty of care and the initial and ongoing understanding of the products (e.g., blockchain and cryptoasset feature analysis); and

2. 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 business continuity plans).”

Although the report makes clear that a significant amount of agency resources will be devoted to the above priorities, it is important to note that the SEC may conduct examination on any combination of existing, emerging, or potential risks facing investors.