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To complement a series of quarter-end announcements from the U.S. Securities and Exchange Commission (SEC), the Examinations Division (Examinations) announcement its review priorities for 2022 on March 30, 2022. These priorities reflect SEC Chairman Gary Gensler’s stated view that the review agenda is critical to the SEC’s work to protect investors and build confidence in the markets. The reviews will cover, among others, (i) private funds, (ii) brokers, (iii) environmental, social and governance (ESG) or impact investing, (iv) financial technology (FinTech) and crypto-assets, and (v) information security (InfoSec) and operational resilience. Additionally, a week before the 2022 exam priorities were announced, Richard Best was appointed as the new Acting Director of Exams. Mr. Best most recently served as Regional Director of the SEC in New York after holding similar positions in Salt Lake City and Atlanta, where he led both the review and enforcement efforts of these three regional offices. We expect the number of review referrals to the Enforcement (Enforcement) Division to be likely to increase, as today’s review priorities are likely a preview of tomorrow’s enforcement actions. .
Private funds: The reviews observed that more than 5,000 registered investment advisers (RIAs) manage approximately $18 trillion in private fund assets across strategies that include hedge funds, private equity funds and real estate funds, whose investors include state and local pensions, family beneficiaries, charities, and endowments. Given the size, complexity and growth of this market, the reviews will focus on various issues under the Investment Advisers Act 1940, including (i) fiduciary duties, (ii) compliance with custodial rule, (iii) disclosure and compliance for cross trades, principal trades and distressed trades, and (iv) disputes around liquidity, such as RIA-led fund restructurings. The reviews are intended to examine advisor conflicts and disclosures regarding portfolio strategies, risk management, and investment recommendations and allocations, including investments in Special Purpose Acquisition Companies (SPACs) and particularly where the private fund adviser is also the sponsor of the SPAC. The reviews will also examine all aspects of trading private funds with systemically important indicia, such as excessive counterparty exposure or gross notional exposure relative to similarly situated firms.
Brokers-Dealers: Reviews will continue to focus on brokerage activity involving microcap, municipal, fixed income and over-the-counter securities, as well as brokerage transactions. The reviews will also monitor broker sales practices and compliance with BI regulations, particularly with respect to SPACs, structured products, leveraged and inverse exchange-traded products (ETPs), investment trusts real estate (REIT), private placements, annuities, municipal bonds and others. income securities and microcap securities. In addition, the reviews will monitor broker compliance with the whereabouts requirement of Regulation SHO, penny stock disclosure rules, monitoring and reporting of suspicious anti-money laundering (AML) activity, and compliance with the safeguards of the Client Protection Rule and the Net Capital Rule by firms that hold client cash and securities. Exams acknowledged its continued interest in RIAs and dual-listed brokers, as well as companies that service both brokerage and advisory clients.
ESG or impact investing: The reviews recognized that RIAs and registered funds increasingly offer and assess investments that use ESG strategies or criteria, and noted the risk that disclosures regarding portfolio management practices may involve statements or materially false and misleading omissions. The reviews will focus on disclosures by RIAs and registered funds regarding their approaches to ESG investing and their policies and procedures to ensure appropriate disclosures to clients and investors, including portfolio management processes and practices, as well as only to check whether the voting of client stocks aligns with ESG. disclosures and warrants.
FinTech and crypto-assets: Exams has observed that RIAs are increasingly providing automated digital investment advice to clients, which RIAs are often referred to as ‘robo-advisors’, with continued growth in the use of mobile apps by brokers. The reviews will focus on the use of developing technologies to assess whether RIAs and brokers have considered “the unique risks these activities present” when designing their regulatory compliance programs, and whether firms have implemented implement the operations and controls necessary to meet their regulatory obligations. , statements to clients and the standard of conduct due to investors. The reviews also noted “a proliferation of the offering, selling and trading of crypto-assets” and said its review of market participants engaged with crypto-assets will include custodial agreements and communications in the offer, sale, recommendation, advice and trading of such assets. The reviews said it will review mutual funds and ETFs that offer exposure to crypto-assets to assess, among other things, compliance, liquidity and operational controls around portfolio management and market risk. .
InfoSec and operational resilience: The reviews pointed out that the consequences of information security failures by RIAs and brokers can extend to other market participants and retail investors, making “vigilant data protection. . . essential to the functioning of financial markets and to the confidence of its participants. The reviews will continue to look at companies’ efforts to prevent disruptions to critical services, protect investor information, protect customer accounts and prevent account breaches, both internally and through vendor and vendor monitoring. Services. The reviews will also examine companies’ efforts to address and respond to malicious email activity and ransomware attacks, identify and detect red flags related to identity theft, and manage operational risk due to a hand -dispersed work. In addition, reviews will examine business continuity and disaster recovery plans with a focus on the impact of climate risk and substantial disruptions to business operations and the maturation of plans over the years.
The 2022 Review Priorities Report marks the tenth anniversary of Exams (formerly the Office of Compliance Inspections and Examinations) publishing its review priorities. As in previous years, the report provides a roadmap for brokers, RIAs and other market participants as to which specific areas reviews will focus on in the coming year. Given the strong regulatory and enforcement stance of the current SEC leadership, companies would be well advised to study review priorities, review their policies and procedures, and be prepared to address these priority areas for future reviews. Proactively ensuring compliance from the start will help avoid what could otherwise become a referral to law enforcement in the future.
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