On March 30, 2022, the U.S. Securities and Exchange Commission’s (“SEC”) Division of Examinations released its exam priorities for fiscal year 2022 (the “2022 Priorities”). As in years past, these exam priorities naturally follow from SEC rulemakings, statements, risk alerts and other guidance issued in the past year, and reflect practices or topics that may pose higher risk for referral to the SEC’s Division of Enforcement.
The 2022 Priorities include broader thematic “Significant Focus Areas,” which may be applicable to both broker-dealers and registered investment advisers, as well as more tailored focus areas specific to each type of SEC-registrant. While many of the focus areas are reminiscent of prior exam priorities, the 2022 Priorities also include “new” focuses, such as crypto-assets, and areas that staff appear to prioritize as compared to years past, such as private fund advisers and emerging technologies. This also marks the first examination period for newly SEC-registered security-based swap dealers, which will focus on the policies and procedures related to compliance with the security-based swap rules generally.
We have included a summary and highlights of the “Significant Focus Areas” below:
- Private Funds. Areas of focus include: (1) fee and expense calculation and allocation; (2) preferential treatment of certain investors; (3) compliance with the Custody Rule under the Investment Advisers Act of 1940 (“Advisers Act”) (including the audit exception); (4) disclosures and compliance with regulatory requirements for cross trades, principal transactions and distressed sales; (5) disclosures and conflicts related to portfolio strategies, risk management, and investment recommendations and allocations, (including investments in adviser-sponsored Special Purpose Acquisition Companies); (6) risk management practices and trading for funds with indicia of systemic importance; and (7) management and disclosure of conflicts around liquidity, such as adviser-led restructurings and stapled secondary transactions.
- Environmental, Social and Governance (ESG) Investing. Staff will continue to review ESG-related disclosure and whether practice (including proxy voting and portfolio management) is consistent with ESG-related mandates, policies, disclosures and advertisements. Examinations will also focus on whether advisers overstate or misrepresent ESG factors used in portfolio selection (e.g., greenwashing).
- Regulation BI, Fiduciary Duty and Form CRS. Examinations will include review of a variety of disclosure, recommendation and other practices to ensure registrants satisfy their respective obligations under Regulation BI and the Advisers Act fiduciary standard, including best execution obligations and management of conflicts with client interests. Areas of focus include recommendations and sales practices for non-traditional, proprietary and more expensive products sold to retail investors; and revenue sharing, compensation structures and resulting conflicts.
- Information Security and Operational Resiliency. Examinations will include review of whether firms have taken appropriate measures to: (1) safeguard customer accounts, (2) oversee vendor and service providers, (3) address malicious email activities (e.g., phishing), (4) respond to security incidents, (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. Examinations will also focus on business continuity and disaster recovery plans with a particular focus on the impact of climate risk and substantial disruptions to normal business operations, and consideration of how a firm’s disaster planning has evolved and matured over the years.
- Emerging Technologies and Crypto-Assets.
- Examinations of registrants using emerging technologies (e.g., mobile apps, robo-advisers, “finfluencers,” fractional share trading, etc.) will assess whether: (1) operations and controls in place are consistent with disclosures, standards of conduct and other regulatory obligations; (2) advice and recommendations are consistent with investors’ investment strategies and the standard of conduct owed to investors; (3) controls consider unique risks associated with the use of emerging technologies.
- Examinations of registrants engaged with crypto-assets will continue to review custody arrangements for such assets and will assess the offer, sale, recommendation, advice and trading of crypto-assets, including, in particular, whether registrants: (1) have met their respective standards of conduct when recommending crypto-assets or advising investors on crypto-assets 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).
As noted above, the 2022 Priorities also include focus areas tailored to each type of SEC-registrant, which may or may not tie back to a “Significant Focus Area.” Many of these registrant-specific focus areas are areas of continued focus for the SEC (e.g., continued focus on RIA fee and expense disclosures and calculations), while others are new and reflect recent market developments (e.g., broker-dealer compliance with revised SEC Rule 15c2-11).
If you have questions on any of the matters highlighted above, please reach out to any of the listed authors or your regular MVA firm contact.
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