Publications

The Securities and Exchange Commission’s (the “SEC”) Division of Examinations (the “Division”) recently announced its examination priorities for 2022. The exam priorities reflect the Division’s focus on unique or emerging risks to investors and capital markets in general, as well as areas which, in their view, present core and perennial risks. The key points of the Division’s priorities are summarized below.

Private Funds

• The Division will continue to prioritize registered investment advisers (“RIAs”) with private fund clients. RIA examinations will focus on compliance with the Investment Advisers Act of 1940 (the “Advisers Act”), including the RIA’s fiduciary duty to the private fund with respect to the calculation and allocation of fees and expenses charged to the private fund, as well as potential preferential treatment of certain investors in a fund that has experienced liquidity issues (i.e., imposing a withdrawal gate or suspending withdrawals altogether).
• RIA exams will focus on compliance with Rule 206(4)-2 under the Advisers Act (commonly known as the “Custody Rule”). Particular emphasis will be placed on the audit exception to the surprise examination requirement, which is commonly utilized by RIAs advising private funds. Related examination issues include reporting on Form ADV regarding the auditors performing such audits.
• The Division will also focus on disclosure and compliance with respect to cross-trades, principal transactions or distressed asset sales and any liquidity-related conflicts, such as stapled secondary transactions (i.e., when a purchaser acquires existing fund interests from current investor(s) while also committing to a new fund under common control) and fund adviser sponsored special purpose acquisition company (“SPAC”) investments. Examination areas will include private fund strategy, risk management and investment recommendation disclosure to investors. Finally, the Division will continue to prioritize reviewing practices, controls and reporting with respect to risk management and trading for funds that have an indicia of systematic importance (i.e., a large amount of counterparty exposure when compared to similarly situated funds).

Environmental, Social, and Governance (“ESG”)

• Given the increased investor demand for ESG-focused investments and strategies, the Division will examine both RIAs and registered funds to ensure disclosures regarding portfolio management practices are not materially false or misleading as they relate to ESG investing and considerations.
• The Division’s review will focus on whether RIAs and registered funds are accurately disclosing their approach to ESG investments and whether these RIAs and registered funds have adopted and implemented policies and procedures reasonably designed to prevent violation of securities laws with respect to any ESG-related disclosures.
• Additionally, the Division will examine RIA and registered fund client securities voting practices and whether such votes align with both (i) any existing proxy voting policies and procedures and (ii) any ESG-related disclosure or mandates. The Division will also focus on potential instances of “greenwashing”, which can occur when an RIA or registered fund overstates or misrepresents the ESG factors used in making portfolio selections.

Retail Investors and Working Families

• The Division will examine whether broker-dealers and RIAs act in accordance with the standard of conduct required to protect retail investors and working families. This includes a focus on how broker-dealers and RIAs comply with their obligations under Regulation Best Interest and the Advisers Act, respectively. Particular emphasis will be placed on the provision and adequacy of the Form CRS disclosure to retail investors.
• For both broker-dealers and RIAs, the Division will examine the effectiveness of all compliance programs and training designed to ensure that retail investors and working families receive recommendations and investment advice in their best interest. This involves, among other things, disclosure of any alternatives to investment recommendations, management of conflicts of interest, and the general impartiality of advice. In the Examination Priorities Report, the Division noted that dually registered broker-dealers and RIAs remain a particular focus for examinations.

Information Security and Operational Resiliency

• Because of the growing popularity of remote-working arrangements, the Division will be monitoring a registrant’s information security and business continuity plans. The Division’s focus here will be protection of investor information, records and assets and prevention of any disruption to critical investor services. The Division will now pay particular attention to a registrant’s plans to address climate-related disaster risks and the general improvements to a business continuity and disaster recovery plan over a given period of time.

Emerging Technologies and Crypto-Assets

• Given RIAs’ increased utilization of automated digital investment advice services, the Division will pay particular attention to the compliance programs of RIAs and whether such programs adequately address the risks associated with such automated digital services.
• With respect to crypto-assets and digital currency in general, the Division will continue to examine custody arrangements for such assets and whether registrants have met their requisite statutory obligations when recommending crypto-assets to clients (i.e., adequately explaining the risks involved with such assets). The Division will also focus on a registrant’s compliance program, specifically with respect to anti-money laundering procedures, valuation procedures and liquidity procedures.

Takeaways

Registrants should review their compliance policies and procedures, as well as any disclosures to ensure they are compliant with the relevant statutory and/or regulatory requirements. Additionally, registrants should consider the priorities listed above and be prepared to address related issues during any future examinations.

The complete description of the Division’s priorities can be found at: https://www.sec.gov/files/2022-exam-priorities.pdf. The Division’s published description of priorities is not exhaustive and the staff will also conduct examinations focused on risks, issues, and policy matters arising from market developments and new information learned from examinations or other sources, including tips, complaints, referrals and other regulators.

For more information on the topic discussed, contact:

• Wayne H. Davis  |  davis@thsh.com  |  212-508-6705
• Michele Itri  |  itri@thsh.com  |  212-508-6732
• Haylie Gordon  |  gordon@thsh.com  |  212-508-6745
• Beth Smigel  |  smigel@thsh.com  |  212-702-3176
• Michael G. Tannenbaum  |  tannenbaum@thsh.com  |  212-508-6701