SEC’s Division of Exams 2022 Priorities

On March 29th, 2022, the SEC’s Division of Examinations released their 2022 Examination Priorities.  This note will focus on the priorities relevant to private equity, hedge fund, real estate and other private fund managers.

Statistics:

• Total assets under management of registered investment advisers increased 70% in five years and the number of registered investment advisers with AUM over $10 billion has increased 30% in five years.  Similarly, private fund AUM has increased 70% over five years.
• In 2021, the Division of Examinations completed 3,040 examinations with 2,100 deficiency letters issued¹.  According to these statics, only 69% of examinations resulted in any deficiencies at all, which to us appears to be a number which is lower than the historical average for the program.   Note, however, that private fund exams tend to have a higher rate of deficiencies than the program average.
• Similarly, the Division recovered $41 million for investors.  While this number is significant, it likewise appears to be lower than we would have expected.

Leadership Turnover and Gaps:

• The priorities highlighted significant management turnover in the Division with several key senior roles – including Division Director, Deputy Director – being held by “Acting” or temporary leaders.

Compliance Philosophy:

• EXAMS highlighted the three components it believes should be present in good compliance programs:
  1. Inclusivity – meaning that the CCO and the compliance program should be integrated into the business.
  2. Change Management  – meaning that compliance programs need to be able to change to accommodate business and market changes.
  3. Testing – meaning that compliance programs should be continually tested for efficacy.

Key Priorities:

• Private Funds – This year, private funds are the first priority listed by EXAMS.  This highlights the importance of private fund examinations for this administration. However, the actual priorities listed for private funds appear to be similar ‐to those for previous years and include:
  1. Fees and Expenses: 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;
  2. Preferential Liquidity: 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;
  3. Custody Rule Compliance: Particularly compliance with the audit exemption;
  4. Cross and Principal Trades: The adequacy of disclosure and compliance with any regulatory requirements for cross trades, principal transactions, or distressed sales;
  5. GP‐Leds: 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;
  6. SPACS: Special Purpose Acquisition Companies (SPACs), particularly where the private fund adviser is also the SPAC sponsor;
  7. Alternative Data: Whether or not advisers are implementing appropriate compliance and controls around the creation, receipt, and use of potentially MNPI when alternative data is utilized;
  8. Oversight of service providers; and
  9. Sufficient resources available for compliance.

• Environmental, Social, And Governance (ESG) Investing – Significantly, EXAMS listed ESG as being its second exam priority and is signaling a focus on:
  • Accurate disclosure of ESG investing approaches;
  • ESG aligned proxy voting; and
  • Greenwashing: overstating the incorporation of ESG into an investment program.

• Information Security – Cybersecurity has been a perennial and important priority for the Commission and this year’s priorities highlight that the Commission will leverage Regulations S‐P and S‐ID while focusing on the appropriate measures have been taken to:
  1. Privacy: Safeguard customer accounts and prevent account intrusions, including verifying an investor’s identity to prevent unauthorized account access;
  2. Vendor and Service Provider Providers: Properly vet vendors and service providers.
  3. Intrusion:  Detect malicious email activities, such as phishing or account intrusions;
  4. Incident Response: Respond to incidents, including those related to ransomware attacks;
  5. Reg S‐ID Compliance: Identify and detect red flags related to identity theft; and
  6. WFH: Control operational risk as a result of a dispersed workforce in a work‐from‐home environment.

• Emerging Technologies and Crypto Assets – EXAMS is honing their approach to new products and crypto assets.  Many of these priorities appear to be focused on general compliance matters including disclosure, duty of care and the duty of loyalty.  These include:
  1. Duty of Care:  Ensure advisers 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 (e.g., blockchain and crypto‐asset feature analysis);
  2. Compliance and Controls: Ensure advisers routinely review, update, and enhance their compliance practices (e.g., crypto‐asset wallet reviews, custody practices, anti‐money laundering reviews, and valuation procedures), risk disclosures, and operational resiliency practices (i.e., data integrity and business continuity plans).

¹ Includes all examinations across all programs, not just investment adviser exams.