SEC Division of Examinations – 2022 Examination Priorities
The U.S. Securities and Exchange Commission (“SEC”) Division of Examinations (the “Division”) recently published its 2022 examination priorities for market participants. The priorities are largely similar to the 2021 priorities, but with a heightened focus on the following:
Private funds;
Environmental, social and governance (“ESG”) investing;
Standards of Conduct;
Information Security; and
Emerging Technologies and Crypto-Assets.
Private Funds: The Division is continuing its focus on the private fund industry. Exams will assess private fund risks with a focus on:
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;
the potential preferential treatment of certain investors by advisers to private funds that have experienced issues with liquidity, including imposing gates or suspensions on fund withdrawals;
compliance with the custody rule under the Investment Advisers Act of 1940, including the “audit exception” to the surprise examination requirement, and related reporting and updates of Form ADV regarding the audit and auditors;
the adequacy of disclosure and compliance with any regulatory requirements for cross trades, principal transactions or distressed sales; and
conflicts around liquidity, such as adviser-led fund restructurings and secondary transactions.
The Division will also review private fund advisers’ portfolio strategies, risk management, and investment recommendations and allocations, focusing on conflicts and disclosures around these areas. Also, the Division will review private funds’ investments in Special Purpose Acquisition Companies, particularly where the private fund adviser is also the SPAC sponsor.
ESG: Examinations will continue to focus on whether registered investment advisers (“RIAs”) and registered funds are accurately disclosing their ESG investing approaches and practices. The Division highlighted that disclosures regarding portfolio management practices could involve materially false and misleading statements or omissions, which can result in misinformed investors. The Division noted that this risk may be compounded by the following factors:
the lack of standardization in ESG investing terminology (e.g., strategies that are referred to as sustainable, socially responsible, impact investing, and environmental, social and governance conscious, which incorporate ESG criteria); and
the variety of approaches to ESG investing (e.g., a portfolio may be labeled as ESG because of consideration of ESG factors alongside traditional financial, industry-related, and macroeconomic indicators, among others; other portfolios may use ESG factors as the driving or main consideration in selecting investments; or some portfolios engage in impact investing seeking to achieve measurable ESG impact goals).
Standards of Conduct: The Division will continue to review and address standards of conduct issues for RIAs and broker-dealers to ensure that retail investors and working families are receiving recommendations and advice in their best interests. Examinations will include assessments of practices regarding consideration of investment alternatives, management of conflicts of interest, trading, disclosures, account selection, and account conversions and rollovers.
Information Security: The Division emphasized that the consequences of information security failures by RIAs and broker-dealers may extend to other market participants and retail investors, requiring “vigilant protection of data critical to the operation of financial markets and the confidence of its participants.” Specifically, the Division will continue to review whether firms have taken appropriate measures to:
safeguard customer accounts and prevent account intrusions, including verifying an investor’s identity to prevent unauthorized account access;
oversee vendors and service providers;
address malicious email activities, such as phishing or account intrusions;
respond to incidents, including those related to ransomware attacks;
identify and detect red flags related to identity theft; and
manage operational risk as a result of a dispersed workforce in a work-from-home environment.
Emerging Technologies and Crypto-Assets: The Division will continue to examine RIAs and broker-dealers that are (or claim to be) offering new robo and/or crypto products and services to identify whether these activities present additional risk and how such risk(s) is being considered when developing compliance programs. There will be a heightened focus on firms that are offering new products and services or employing new practices (e.g., fractional shares, “Finfluencers,” or digital engagement practices) to assess whether:
operations and controls in place are consistent with disclosures made and the standard of conduct owed to investors and other regulatory obligations;
advice and recommendations, including by algorithms, are consistent with investors’ investment strategies and the standard of conduct owed to such investors; and
controls take into account the unique risks associated with such practices.
In regard to crypto-assets, the Division will continue to review whether market participants involved in crypto assets:
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
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).
If you have any questions about this alert, or any other regulatory matters, do not hesitate to reach out to:
Daniel Viola (Partner – Head of the Regulatory group) at 212.573.8038 or via email at dviola@sadis.com
Nicole Arrow (Associate) at 212.573.8148 or via email at narrow@sadis.com.
