SEC Division Of Examinations Releases Its 2022 Examination Priorities –

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On March 30, 2022, the SEC’s Division of Examinations (the
“Division”) released its 2022 examination priorities (the
“Priorities”).1 The Priorities include five
significant focus areas: (i) private funds; (ii) environmental,
social and governance (“ESG”) investing; (iii) standards
of conduct, including Regulation Best Interest, fiduciary duty and
Form CRS; (iv) information security and operational resiliency; and
(v) emerging technologies and crypto-assets.

In addition, the Priorities include specific examination topics
under the Investment Adviser and Investment Company Examination
Program, including mutual funds and exchange traded funds
(“ETFs”), and under the Broker-Dealer and Exchange
Examination Program, including microcap, municipal fixed income and
over-the-counter securities, brokerdealer operations, national
securities exchanges, security-based swap dealers, municipal
advisors, and transfer agents. Below is a summary of highlights
from the Division’s release, which encompasses Priorities
stemming from recent rulemaking proposals and echoes long-standing
areas of focus.

A. Significant Focus Areas

1. Private Funds

The Division will continue to prioritize its review of
registered investment advisers (“RIAs”) to private funds,
pointing to the size, complexity and significant growth of private
funds over the past several years. The Division also noted the
significance of examination findings over the past several years in
identifying RIAs to private funds as an area of focus. The Division
identified that it will review issues under the Investment Advisers
Act of 1940 (the “Advisers Act”), including an
adviser’s fiduciary duty, compliance programs, fees and
expenses, custody, fund audits, valuation, conflicts of interest,
disclosures of investment risks, and controls around material
nonpublic information (“MNPI”).

Specifically, the Division will review: (i) 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; (ii) the potential preferential
treatment of certain investors by RIAs to private funds that have
experienced issues with liquidity, including imposing gates or
suspensions on fund withdrawals; (iii) compliance with the custody
rule under the Advisers Act, including the “audit
exception” to the surprise examination requirement and related
reporting and updating of Form ADV; (iv) the adequacy of disclosure
and compliance with any regulatory requirements for cross trades,
principal transactions, or distressed sales; and (v) conflicts
around liquidity, such as RIA-led fund restructurings, including
stapled secondary transactions where new investors purchase the
interests of existing investors while also agreeing to invest in a
new fund.2 While this list includes many long-standing
priorities, including the custody rule generally, the
Division’s mention of the “audit exception” in the
custody rule appears to be a more targeted area of focus in
2022.

The Division will also review private fund advisers’
portfolio strategies, risk management, and investment
recommendations and allocations, focusing on conflicts and
disclosures around those areas. During the course of an
examination, the Division said that it will review private
funds’ investments in Special Purpose Acquisition Companies
(“SPACs”), particularly where the private fund adviser is
also the SPAC sponsor.3 In addition, the Division
indicated that it will review the practices, controls, and investor
reporting around risk management and trading for private funds with
indicia of systemic importance, such as outsized counterparty
exposure or gross notional exposure when compared to similarly
situated firms. We note that a 2021 priority to focus on private
fund advisers that have a higher concentration of structured
products is not included in the private fund adviser section of the
2022 Priorities.

2. ESG Investing

Compared to the Division’s 2021 priorities, ESG investing
appears to be of greater focus for the Division in 2022. The
Division recognized that RIAs and registered funds are increasingly
offering and evaluating investments that employ ESG strategies or
incorporate certain ESG criteria.4 The Division stated
that disclosure regarding an adviser’s portfolio management
practices could involve materially false and misleading statements
or omissions.5 Disclosure pitfalls could be compounded
by a lack of standardization in ESG investing
terminology,6 a variety of approaches to ESG
investing,7 or failing to address legal and compliance
issues effectively. The Division explained that examinations will
typically focus on whether RIAs and registered funds are: (i)
accurately disclosing their ESG investing approaches and have
adopted and implemented policies, procedures, and practices
designed to prevent violations of the federal securities laws in
connection with their ESG-related disclosures, including review of
their portfolio management processes and practices; (ii) voting
client securities in accordance with proxy voting policies and
procedures and whether the votes align with their ESGrelated
disclosures and mandates; or (iii) overstating or misrepresenting
the ESG factors considered or incorporated into portfolio selection
(e.g., greenwashing),8 such as in their performance
advertising and marketing.

3. Standards of Conduct: Regulation Best Interest,
Fiduciary Duty, and Form CRS

Similarly to the 2021 Division of Examinations Priorities, the
Division will continue to address standards of conduct issues for
broker-dealers and RIAs. Reviews will focus on how broker-dealers
and RIAs are satisfying their obligations under Regulation
BI9 and the Advisers Act fiduciary standard10
to act in the best interests of retail investors and not to place
their own interests ahead of retail investors’ interests.
Examinations will include assessments of practices regarding
consideration of alternatives (e.g., with regard to potential
risks, rewards, and costs), management of conflicts of interest
(e.g., incentive practices that favor certain products or
strategies over others), trading (e.g., RIA best execution
obligations), disclosures (e.g., disclosures provided in Form ADV
and Form CRS and made pursuant to Regulation BI), account selection
(e.g., brokerage, advisory, or wrap fee accounts), and account
conversions and rollovers. The effectiveness of compliance
programs, testing, and training that are designed to support retail
investors receiving recommendations and advice in their best
interests will also be a focus of the Division.

a. Broker-Dealers

For broker-dealer examinations, the Division will review
firms’ recommendations and sales practices related to SPACs,
structured products, leveraged and inverse exchange traded products
(“ETPs”), REITs, private placements, annuities, municipal
and other fixed income securities, and microcap securities. The
Division will review practices, policies, and procedures concerning
the evaluation of costs and reasonably available alternatives as
they relate to recommendations of these products being in the
investor’s best interest. Examinations will also evaluate the
compensation structures for financial professionals, including the
conflicts created by such structures, and may focus examinations on
the sales of securities by financial professionals that are highly
compensated.

b. RIAs

For RIA examinations, the Division will focus on whether
advisers are acting consistently with their fiduciary duty to
clients, looking at both duties of care and loyalty, including best
execution obligations, financial conflicts of interest and related
impartiality of advice, and any attendant client disclosures.
Specifically, the Division highlighted revenue sharing
arrangements, recommending or holding more expensive classes of
investment products when lower cost classes are
available,11 recommending wrap fee accounts without
assessing whether such accounts are in the best interests of
clients, including the impact of the move to zero commissions on
certain types of securities transactions by a number of
broker-dealers, and recommending proprietary products resulting in
additional or higher fees. The multiple references to wrap fee
accounts is a notable change from the Division’s 2021
priorities, which did not specifically include wrap accounts as an
area of focus. The Division will also assess the adequacy of
RIAs’ compliance policies and procedures designed to address
conflicts and ensure advice in the best interests of clients
(including the cost of investing) and disclosures to enable
investors to provide informed consent.

c. Dually Registered RIAs and Broker-Dealers

For examinations of dually registered RIAs and broker-dealers,
the Division will particularly emphasize potential conflicts of
interest present at these dually registered firms, including
account recommendations and allocation of investments across
different accounts. For example, examinations will focus on the
sale or recommendation of high fee products or proprietary products
of the firms or their affiliates, incentives for financial
professionals to place their own or their firms’ interests
ahead of customers/clients,12 and compensation
structures that inappropriately influence investment
recommendations. The Division will review whether these firms have
implemented written policies and procedures to mitigate and address
conflicts effectively and to minimize the risk of, and monitor for,
misaligned incentives that may result in recommendations and advice
to retail investors…



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