The SEC’s Division of Examinations’ exam priorities for fiscal year 2022 include standards of conduct as well as issues related to technology and investment products.
“The Division will prioritize examinations of several significant focus areas that pose unique or emerging risks to investors or the markets, as well as examinations of core and perennial risk areas. Their importance to investors and the markets, coupled with the seriousness and frequency of observations in prior years’ examinations, demonstrate the need for the Division to remain vigilant in these areas,” according to the 2022 Examination Priorities report released by the SEC on March 29.
The SEC’s exam priorities for 2022 reflect the regulator’s recent areas of emphasis. “The SEC has clearly and consistently communicated its concerns about issues like emerging technologies, new types of investors, and standards for investor protection since releasing its last report on exam priorities a year ago,” said Margie Webber, director of regulatory compliance for RegEd.
2022 Exam Priorities
The SEC identifies five “significant focus areas” in its recently released 2022 Examination Priorities report.
Assets managed by advisers to private funds have increased by 70% in the past five years, reaching $18 trillion, the SEC notes. Collectively, more than 5,000 SEC-registered investment advisers (RIAs), or over 35% of all RIAs, manage those assets.
“Given the significance of examination findings over the past several years, and the size, complexity, and significant growth of this market, the Division will continue to prioritize our focus on RIAs to private funds. Examinations will review issues under the Investment Advisers Act of 1940 (Advisers Act), including an adviser’s fiduciary duty, and will assess risks, including a focus on compliance programs, fees and expenses, custody, fund audits, valuation, conflicts of interest, disclosures of investment risks, and controls around material nonpublic information (MNPI),” the SEC states in its 2022 exam priorities report.
Environmental, Social, and Governance (ESG) Investing
The SEC notes, “RIAs and registered funds are increasingly offering and evaluating investments that employ ESG strategies or incorporate certain ESG criteria, in part to meet investor demand for such strategies and investments. There is a risk that disclosures regarding portfolio management practices could involve materially false and misleading statements or omissions, which can result in misinformed investors.”
In fiscal 2022, examiners will focus on whether RIAs and registered funds:
- Accurately disclose 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
- Vote client securities in accordance with proxy voting policies and procedures and whether the votes align with their ESG-related disclosures and mandates
- Overstate or misrepresent the ESG factors considered or incorporated into portfolio selection, such as in performance advertising and marketing
Standards of Conduct: Regulation Best Interest, Fiduciary Duty, and Form CRS
Examiners will also address standards of conduct issues for broker-dealers and RIAs, with fiscal 2022 reviews focused on how firms satisfy their obligations under Regulation Best Interest (Reg BI) and the Advisers Act fiduciary standard to act in the best interests of retail investors and not to place their interests ahead of retail investors’ interests.
Specifically, examiners will assess practices regarding consideration of alternatives, management of conflicts of interest, trading, disclosures, account selection, and account conversions and rollovers. “For both broker-dealers and RIAs, examinations will focus on the effectiveness of compliance programs, testing, and training that are designed to support retail investors and working families receiving recommendations and advice in their best interests,” the SEC states.
Information Security and Operational Resiliency
SEC examiners will also review broker-dealers’ and RIAs’ practices to prevent interruptions to mission-critical services and to protect investor information, records, and assets.
“Specifically, EXAMS will continue to review whether firms have taken appropriate measures to: (1) safeguard customer accounts and prevent account intrusions, including verifying an investor’s identity to prevent unauthorized account access; (2) oversee vendors and service providers; (3) address malicious email activities, such as phishing or account intrusions; (4) respond to incidents, including those related to ransomware attacks; (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,” according to the SEC’s exam priorities report.
Emerging Technologies and Crypto-Assets
Examiners have observed “a significant increase” in RIAs offering automated digital investment advice (so-called “robo-advisers”), as well as continued growth in the use of mobile apps by broker-dealers, and “a proliferation of the offer, sale, and trading of crypto-assets,” according to the SEC. When examining firms that use such developing financial technologies, the SEC will look at “whether the unique risks these activities present were considered by the firms when designing their regulatory compliance programs.”
Specifically, examiners will assess whether:
- Operations and controls in place are consistent with disclosures made and the standard of conduct required;
- Advice and recommendations, including by algorithms, are consistent with investors’ investment strategies and the relevant standard of conduct; and
- Controls account for “the unique risks associated with such practices.”
Furthermore, examiners will review whether firms that trade crypto-assets:
- Have met their respective standards of conduct when recommending to or advising investors with a focus on duty of care and the initial and ongoing understanding of the products
- Routinely review, update, and enhance their compliance practices, risk disclosures, and operational resiliency practices.
The SEC also included results from fiscal year 2021 examinations in its report on exam priorities for the upcoming year. In fiscal 2021, the Division of Examinations completed 3,040 examinations, 3% more than in fiscal 2020 and about the same as pre-COVID-19 pandemic examination totals in fiscal 2019. The SEC’s examination priorities for 2021 reflected the regulator’s continued concern for retail investors.
The SEC’s Division of Examinations issued more than 2,100 deficiency letters in fiscal 2021. Additionally, fiscal 2021 examinations prompted firms to return more than $45M to investors and examiners made more than 190 referrals to the SEC’s Division of Enforcement. “As we move further into FY22, we anticipate there will be more money returned to investors, and there will be additional referrals to Enforcement resulting from our FY21 examinations,” the SEC stated in its 2022 exam priorities report.
The SEC also noted that its exam priorities for 2022 could change. “These will not be the only issues the Division addresses in examinations, Risk Alerts, and industry and investor outreach,” it wrote of the issues raised in its report. “The Division continues to be flexible so that examinations may also cover new and exigent risks to investors and the marketplace as they arise.”
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