Division of Examinations - 2022 Examination Priorities

     

Division of Examinations 2022 Examination Priorities

Each year, the U.S. Securities and Exchange Commission’s (“SEC’s”) Division of Examinations (the “Division”) publishes its examination priorities for the upcoming year. These priorities are designed to enhance the transparency of the Division’s examination program and to provide insight into their risk-based approach. The Division conducts examinations in order to promote compliance and ensure market integrity for investors. In 2021, the Division conducted approximately 3,040 examinations of registered investment advisors and approximately 70% resulted in at least one or more written deficiencies. Over the course of the past twelve months, we’ve witnessed significant proposals and rule changes to the Investment Advisers Act of 1940 (“Advisers Act”) and other regulations that impact registered investment advisers. Most notably, the SEC recently proposed two additional rules and regulations, including a Private Fund Compliance and Cybersecurity Rule. Both rules are currently in a sixty (60) day comment period. While these rules likely won’t go into effect until 2023, they aid in supplementing the Division’s regulatory priorities for 2022. While the priorities outlined below are critical, this list of priorities is not comprehensive and remains flexible as these will not be the only areas or issues the Division addresses in examinations. STANDARDS OF CONDUCT: FIDUCIARY DUTY, AND FORM CRS The Division will continue to ensure both duty of care and duty of loyalty in the decision-making of investment advisors. In particular, examiners will review the advisor’s ability to uphold their fiduciary duty to clients through their efforts to fulfill best execution obligations as well as efforts to mitigate the potential for financial conflicts. Policies and procedures surrounding revenue-sharing arrangements, mutual fund share class selection, the recommendation of wrap fee programs, and the recommendation of higher-cost proprietary investment products should demonstrate impartial fiduciary advice and be supported by the appropriate level of due diligence. Furthermore, the Division will continue to narrow its focus on advisors with dual registration and/or affiliated firms as compensation structures and cost considerations create the potential for incentives to act on behalf of the firm rather than the client. Lastly, the Division will look to confirm that disclosures are in place that allows the client to provide informed consent to their relationship with the advisor. Clients must understand the risks and costs of investing prior to signing any agreements and subjecting their assets to the decisions of a money manager. From a transparency standpoint, the Form CRS is crucial for SEC-registered firms in communicating practices, services, and fees to the presumably uneducated retail investor. INFORMATION SECURITY AND OPERATIONAL RESILIENCY As the markets and investment advisory space grow more and more complex, so too is the potential for cyber-related fraud and intrusions, regardless of the sophistication and/or size of the advisor. Examinations will focus on, among other things, the protection of client's personal financial information through identity verification controls to prevent unauthorized access, oversight of vendors and third-party service providers, approaches to addressing malicious email activity such as phishing attempts, procedures in place that safeguard against ransomware attacks, operational risks and vulnerabilities concerned with a dispersed work-from-home environment, and compliance with Regulations S-P and S-ID. A key component of an effective business continuity and data integrity plan is operational resiliency, which has never been more apparent as advisors continue to address pandemic-related change. As a result, the Division will continue to focus on the impact of climate risk and substantial disruptions to normal business operations along with assessing an advisor’s ability to anticipate, prepare for, respond to, and adapt to both sudden disruptions and incremental changes stemming from climate-related situations. In addition to the Division’s priority on information security and operational resiliency, the SEC recently proposed new regulations that would require advisors to adopt written policies and procedures that address cybersecurity risks that face the firm as well as enhance reporting and recordkeeping as it pertains to cybersecurity threats and incidents. The rule proposal and continued focus area come on the heels of the Division’s continued cybersecurity examination initiatives. ENVIRONMENTAL, SOCIAL, AND GOVERNANCE INVESTING The Division has also identified Environmental, Social, and Governance (“ESG”) as an area of focus for 2022. In recent years, these strategies have become increasingly popular in the investment industry as a product offering, investment strategy, and screening/analysis method. With no standardized ESG regulations and guidelines currently put in place by the SEC, it is important for advisors to have established frameworks around how they approach ESG as the Division will be scrutinizing disclosures by advisors that advertise or claim to incorporate ESG strategies/criteria, to ensure there is no materially false and misleading statements or omissions. Examinations will also have a continued focus on whether advisors are (i) adopting and implementing policies, procedures, and practices aimed to prevent violations of securities laws as it pertains to their ESG-related disclosures, (ii) voting Client proxies in accordance with policies and procedures and whether this is contradictory to an RIA’s ESG-related disclosures and policies, and (iii) misrepresenting or overstating their ESG incorporation into the investment process. PRIVATE FUNDS The Division noted that over 35% of advisors manage more than 18 trillion private fund assets deployed in a variety of investment strategies in various fund types, including hedge funds, private equity funds, and real estate funds. This number is likely to continue to grow as advisors look for different ways to expand their service offerings and distinguish themselves. Given the continued growth in the private fund market, the Division will review advisors managing funds to ensure they are meeting their fiduciary duty under the Investment Advisers Act of 1940 (“Advisers Act”), and will assess risks, including a focus on compliance programs, fees and expenses, custody, fund audits, valuation procedures, conflicts of interest, disclosures of investment risks, liquidity issues or limitations, and controls around material nonpublic information (“MNPI”). In addition to the Division’s focus on private funds, the SEC has also voted to propose new rules and enhancements to improve the regulation of private fund advisors. The proposed rules focus on enhanced disclosure to investors and would mandate a quarterly statement be sent to clients, detailing the fees, expenses, and performance of the fund. These changes would also address reporting and documentation, with proposed increases to the documentation of fund audits, books and records, and advisor-led secondary transactions. These efforts, paired with measures to increase accountability among private fund advisors, aim to protect investors and establish stronger regulations in the private fund space. EMERGING TECHNOLOGIES AND CRYPTO-ASSETS The SEC sees the advancements in the financial technology (“FINTECH”) space moving at a rapid pace. As such, in order to stay abreast with the developments and advancements, examinations will focus on advisors offering new and emerging products and services, such as crypto-assets, automated digital investment advice (robo-advisers), fractional shares, social media influencers, or any other digital engagement tool In addition to the aforementioned regulatory priorities, the Division will continue to prioritize examinations over advisors that have never been examined, including recently registered firms, and those that have not been examined for a number of years. To read the full report, click here: 2022 SEC Examination Priorities.

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