The SEC’s Division of Examinations (the “Division”) announced its examination priorities for fiscal year 2022.1 According to the Division, examination priorities are published annually to enhance the transparency of its examination program and to provide insights into its risk-based approach, including the areas it believes brings heightened risks to investors, registrants, and the markets.
The Division will review issues related to the fiduciary duties of investment advisers (“advisers”) managing private funds, and will assess risks, including a focus on compliance programs, fees and expenses, custody, fund audits, valuation, conflicts of interest, disclosures of investment risk, and controls around material non-public information. The Division will continue to review: (i) the calculation and allocation of fees and expenses; (ii) the potential preferential treatment of certain investors by advisers to private funds that have experienced issues with liquidity; (iii) compliance with the Custody Rule under the Investment Advisers Act of 1940 (the “Advisers Act”); (iv) the adequacy of disclosures and compliance with any regulatory requirements for cross trades, principal transactions, or distressed sales; and (v) conflicts around liquidity.
Environmental, Social, and Governance (“ESG”) Investing
The Division will continue to focus on ESG-related advisory services and investment products and will typically focus on whether advisers are: (i) accurately disclosing their ESG investing approaches and have adopted and implemented policies, procedures, and practices designed to prevent violations of federal securities laws in connection with their ESG-related disclosures; (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.
Standards of Conduct: Fiduciary Duty and Form CRS
The Division will continue to address standards of conduct issues for advisers, focusing on how they are satisfying their obligations under the Advisers Act fiduciary standard to act in the best interests of retail investors and not place their own interests ahead of retail investors’ interests. Examinations will include assessments of practices regarding management of conflicts of interest, trading, and disclosures. Examinations will focus on the effectiveness of compliance programs, testing, and training that are designed to support retail investors.
Information Security and Operational Resiliency
The Division will continue to review whether advisers have taken appropriate measures to: (i) safeguard customer accounts and prevent account intrusions; (ii) oversee vendors and service providers; (iii) address malicious email activities, such as phishing or account intrusions; (iv) respond to incidents, including those related to ransomware attacks; (v) identify and detect red flags related to identity theft; and (vi) manage operational risk as a result of a dispersed workforce in a work-from-home environment. In the context of these examinations, the Division will focus on compliance with Regulation S-P and Regulation S-ID, where applicable. The Division will review advisers’ business continuity and disaster recovery plans with particular focus on the impact of climate risk and substantial disruptions to normal business operations.
Emerging Technologies and Crypto Assets
The Division will conduct examinations that will focus on advisers that are, or claim to be, offering new products and services or employing new practices to assess 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. In particular, the Division will review whether market participants involved with crypto assets have met their respective standards of conduct when recommending to or advising investors with a focus on duty of care and initial and ongoing understanding of products; and routinely review, update, and enhance their compliance practices, risk disclosures, and operational resiliency practices.
The London Inter-Bank Offered Rate (LIBOR) Transition
The Division will continue to conduct examinations and outreach efforts to assess advisers’ exposure to LIBOR, preparation for cessation of many LIBOR rates, and the transition to an alternative reference rate.
Additional Focus Areas for Advisers
The Division will assess whether advisers’ policies and procedures are reasonably designed to prevent violations of the Advisers Act and its rules, including breaches of the adviser’s fiduciary duty in violation of the anti-fraud provisions; review whether advisers have implemented oversight practices to mitigate any heightened risks; and continue to focus on advisers’ disclosures and other issues related to fees and expenses.
2021 Exam Statistics
In fiscal year 2021, the Division conducted 3,040 examinations of registered advisers, investment companies and broker-dealers, of which 190 were referred to the Division of Enforcement, and issued 2,100 deficiency letters. Examinations of registrants resulted in more than $45 million returned to investors. The Division completed 2,200 examinations of advisers in fiscal year 2021, which was approximately 16% of all advisers registered with the SEC.
Characteristics of Effective Compliance Programs
The Division emphasized the importance of compliance programs, chief compliance officers, and other compliance staff, and stated several characteristics of effective programs. The Division observed that resilient, well-designed compliance programs: commonly include inclusivity and participation of compliance staff across all businesses and operational lines; have established processes in place to monitor effectiveness and pivot or be updated when appropriate; and include periodic review and testing of policies and procedures to ensure the ongoing adequacy and effectiveness of a compliance program.
In view of the continued frequency and scope of the Division’s exams, advisers should regularly review the adequacy and effectiveness of their compliance programs, policies, and procedures. Seward & Kissel, and our compliance consulting service SKRC, are available to assist firms with SEC exam prep, mock audits, compliance reviews and compliance training.