The SEC’s 2022 Examination Priorities: Key Takeaways for Private Fund Managers

On March 30, the SEC published its examination priorities for 2022. Every year, the SEC publishes a report discussing its areas of focus for examinations, providing industry participants a view into what the SEC considers to be the areas of heightened risk to investors, registered investment advisers (RIAs), broker-dealers and other market participants, as well as the markets generally. In this year’s report, some of the SEC’s key focus areas are: private funds; Environmental, Social and Governance (ESG) investing; retail investor protection; information security and operational resiliency; and emerging technologies and crypto-assets. We discuss the major takeaways from each of these focus areas below, as well as the SEC’s general concentration on RIAs, mainly as these points pertain to managers of private funds.

Private Funds: The SEC will continue to prioritize its focus on RIAs to private funds. Listed areas of priority include: adherence to fiduciary duties; compliance programs; 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; compliance with the “custody rule,” including the “audit exception” to the surprise examination requirements; conflicts of interest; preferential treatment of certain investors with respect to withdrawals; disclosures of investment risks; controls surrounding material nonpublic information; disclosure and compliance with regulatory requirements with respect to cross-trades, principal transactions or distressed sales; and conflicts around liquidity, such as adviser-led fund restructurings and stapled secondary transactions. The SEC also noted that its examinations will include reviewing the private fund’s investments in special purpose acquisition companies (SPACs), especially where the adviser is also the SPAC sponsor.

ESG Investing: In relation to ESG, the SEC will focus on whether the adviser is accurately disclosing its ESG investing approach, as well as whether the adviser has adopted and implemented policies, procedures and practices designed to prevent violations of the federal securities laws in connection with its ESG-related disclosures. The SEC will also look at whether advisers are voting client securities in accordance with their ESG-related disclosures and mandates, and whether advisers are engaging in “greenwashing” practices, which involve misrepresenting to investors the ESG factors considered or incorporated into the adviser’s portfolio selection.

Retail Investors and Standards of Conduct: Another area of focus will be “standards of conduct” issues for both RIAs and broker-dealers pertaining to retail investors. Specifically, with respect to RIAs, the SEC will review conflicts of interest and related impartiality of advice, adherence to RIA best execution obligations, disclosures provided in Form ADV and Form CRS, and account selection, conversions and rollovers in order to ensure that the interests of retail investors are being placed above the RIA’s. Private fund managers are generally not implicated by this priority.

Information Security: Protecting investors’ information is another key priority for the SEC this year. The SEC will review whether firms have appropriate (i) safeguards for customer accounts to prevent intrusions, (ii) responses to ransomware attacks and other incidents, (iii) oversight of vendors, (iv) means of addressing malicious email activity, (v) means of identifying and detecting red flags with respect to identity theft and (vi) management of operational risk as a result of employees working from home. Business continuity and disaster recovery plans will also be reviewed, with a particular emphasis on the impact of climate risk and substantial business disruptions.

Emerging Technologies and Crypto-Assets: The SEC will be taking a close look at firms claiming to be offering new products or services, or utilizing new practices, such as fractional shares, “finfluencers” and digital engagement practices. Examinations will focus on assessing whether these firms have controls in place that are consistent with their disclosures, whether they provide advice and recommendations that are consistent with the investors’ investment strategies and whether these firms are operating in line with their fiduciary duties.

The SEC will also be particularly focused on market participants engaged with crypto-assets, and will review the custody arrangements for crypto-assets, as well as the offer, sale, recommendation, advice and trading of crypto-assets. Private fund managers investing in crypto-assets should pay particular attention to their compliance policies and procedures relating to such assets.

Registered Investment Advisers

As expected, the SEC will continue to concentrate on the compliance programs, policies and procedures of RIAs, including with respect to long-standing areas of focus such as (i) marketing practices, (ii) custody of client assets, (iii) valuations, (iv) portfolio management, brokerage and execution and (v) conflicts of interest. The SEC also emphasized disclosures and other issues related to fees and expenses, such as advisory fee calculation errors, inaccurate calculations of tiered fees, and failures to refund prepaid fees for terminated accounts or prorated fees for onboarding clients.

Private fund managers should pay particular attention to the SEC’s areas of priority in order to best be prepared in case of an SEC examination. We are always available and happy to guide private fund managers in bolstering their compliance programs in light of these focus areas.

In addition to the takeaways discussed above, the SEC discussed priorities related to broker-dealers, registered investment companies, security-based swap dealers, municipal advisers, transfer agents, national securities exchanges, clearing agencies, and other systems compliance and integrity entities. The SEC release can be found here.