SEC Issues 2022 Examination Priorities
Commentary by Steven Lofchie
The SEC Division of Examinations issued its annual priorities, which include an increased focus on private investment funds, ESG risks, cybersecurity and operational redundancy, and crypto assets.
In the report, the Division stated that it will focus on, among other things:
Private Investment Funds
- ensuring registered investment advisers’ comply with fiduciary duties;
- evaluating risks related to (i) compliance guidelines, (ii) management fees and expenditures, (iii) custody of assets, (iv) financial audits, (v) asset appraisal, (vi) conflicts of interest, (vii) investment risk disclosure, and (viii) safeguards pertaining to important nonpublic information; and
- reviewing investment strategies, risk management controls, and customer recommendation practices to identify "conflicts and disclosures" in areas of "systemic importance."
ESG
- ensuring that ESG investing methodologies are properly disclosed and that policies, procedures, and practices are implemented to avoid breaches of federal securities law;
- reviewing how client securities are voted to determine if voting is in line with ESG mandates; and
- examining portfolio selections to find ESG misrepresentations or inconsistencies.
Retail Investors
- confirming compliance with the Advisers Act and Regulation Best Interest by evaluating investment strategies, conflict management, and account management (e.g., account selection, conversions and rollovers) to determine actions taken are in the "best interests of retail investors[.]"
Information Security and Operational Redundancy
- reviewing how firms protect customer information, prevent breaches, and address threats from (i) malicious email schemes, (ii) ransomware attacks and (iii) identity theft;
- assessing firm controls over vendor and service provider selection; and
- ensuring firms have business continuity plans that adequately consider climate-related risks.
New Technology and Crypto Assets
- evaluating new products, services, or practices to determine whether the "operations and controls" used are in line with the claims made to investors and meet the "standard of conduct owed to investors and other regulatory obligations";
- reviewing investments recommendations including those made by algorithms, to ensure they reflect investors' chosen strategy and meet the "standard of conduct owed to such investors";
- ensuring firm controls adequately consider the "unique risks" associated with emerging technology; and
- assessing investments in crypto including as to (i) trading activities, (ii) recommendations and (iii) custodial arrangements.
Commentary
This issue has not attracted as much attention as the SEC's numerous other rule proposals. That said, the SEC's monitoring of proxy voting, and its ongoing warnings of enforcement action for what it determines to be improper voting, seem to be a potentially significant expansion of regulatory authority.
As suggested by this report, if the SEC deems a proxy vote to be out of line with ESG mandates, it may take enforcement action against an adviser. Given that position, how is the adviser going to vote on such a matter where the adviser believes that a no vote is in the best economic interests of the adviser's clients, but that such a vote creates the risk of an SEC inquiry or enforcement action?