The SEC just recently announced its 2022 Exam priorities. We have reviewed them, compared them with 2021, and included some trends we have seen over the past year.
Published annually, (albeit a bit late this year) The SEC Exam Priorities outlines the SEC examination focus for the coming year. Largely followed by compliance professionals, the publication gives investment advisors & broker dealers a view of what the SEC is concerned with when conducting examinations over the coming year. There is also an outlook for changes in the publication year-over-year. This relative view gives a broader trend of where the SEC is looking to focus its examinations for the years to come.
One of the key metrics that caught our eye was in the Registered Investment Adviser (“RIA”) segment. The SEC has been transparent about the growth of new RIAs. In 2022, they made a clear statement that RIA growth is likely to far outpace SEC staffing increase. The rolling 5-year rate changed from a 15.8% to a 20.8% increase in RIAs, from last year. Not only is the annual growth in RIAs large, but it is also speeding up. The SEC made clear that the percentage of RIAs that get examined each year going forward will likely decrease.
We have seen evidence of, (and expect more) shorter, targeted exams. The information requests we have seen are much more concise and tend to focus on a handful of key areas where RIAs have the greatest risk. Given the substantial growth of RIAs, this strategy makes sense, as the SEC is trying to keep pace with growth yet ensure the exam priorities are achieved.
In this light, we are breaking out the topics we view as distinct enhancements over the 2021 Exam Priorities. Our goal is to highlight updated key areas for firms to focus their efforts for the coming year.
Digital Assets & Emerging Technologies
In 2021, the SEC broke out the following topics for firms engaging in digital asset services: (1) whether investments are in the best interests of investors; (2) portfolio management and trading practices; (3) safety of client funds and assets; (4) pricing and valuation; (5) effectiveness of compliance programs and controls; and, (6) supervision of representatives outside business activities.
In 2022, the SEC seems to have narrowed its focus on firms offering digital asset services, namely digital asset robo-advisors. The Examination Priorities mentions an uptick in these firms, something we have seen on the consulting side as well. We can expect the SEC to focus their examination efforts on Firms that conduct this type of business. The examinations will likely focus on the items outlined in the 2021 Exam Priorities letter, specifically:
- Digital asset recommendations;
- Compliance programs items covering:
- wallet reviews;
- custody;
- anti money laundering; and,
- valuation.
- Risk disclosures
- Operational resiliency plans
While many of these concepts were presented in last year’s Exam Priorities Letter, we can see an obvious focus in what type of firms the SEC is interested in and what they will be looking for.
Private Funds
Much of the RIA growth discussed above came to private fund managers. This segment makes up 35% of the RIA population and makes up about 16% of RIA AUM. The key figure here is the growth – Private fund assets have increased by 70% over the past five years. This growth has spurred not just a focus on examinations but new regulations as well. The SEC specifically highlighted the following areas that they intend to focus on:
- Fees and Expenses
- Preferential treatment of certain clients when liquidity is limited.
- Custody rule, specifically the exception to the surprise audit requirement.
- Disclosure & compliance with cross trades, principal transactions or distressed sales.
- Conflicts related to liquidity, RIA-led fund restructuring.
- Portfolio strategies, risk management, recommendations, and conflict disclosure, particularly for funds that sponsor and/ or invest in SPACs.
Environmental, Social, & Governance (“ESG”)
As with digital assets, this priority was mentioned briefly in the 2021 exam priorities but received much more detail in 2022. The focus in 2022 targets disclosure around ESG, noting the lack of standardization or clarity in ESG classifications. We expect the heightened review of all ESG related disclosures, proxy voting procedures that align with management mandates, and any advertising that mentions ESG strategies or products.
Regulation Best Interest
As a newer rule, last year was the announcement of the SEC’s intention to focus on Regulation Best Interest compliance. Last year, the guidance mainly targeted the treatment of retail investors, naming several retail investor groups and addressing rollovers and other strategies involving saving for retirement. Mutual Funds, ETFs, Municipal Securities, and Microcap securities were highlighted as products the SEC was most concerned with.
This year, the SEC provided similar guidance on what types of firms, products, and strategies they intend to focus on. Here again, we see a focus on the type of account being recommended (brokerage, advisory, wrap, rollover, etc) In comparing to last year, there seems to be a greater broker-dealer focus on SPACs, structured and other complex products, REITs, and Private Investments. On the advisory side, the SEC specially calls out revenue sharing practices, share class recommendations, wrap account recommendations (specifically calling out the industry trend to zero commission charges), and proprietary product recommendations.
The biggest enhancement under the Regulation BI priority is the focus on dual registrants (or affiliates that act in both capacities) In 2022, this topic was broken out and addressed separately, highlighting the focus on recommendations of high-fee and / or proprietary products and conflicts related to financial advisor sales incentives. This guidance to us seems exceeding clear what the SEC is looking for.
In general, we see a trend of the SEC being more specific in their guidance, as they are being more targeted in their exams. We feel that this will likely continue, and the value of the Exam Priorities guidance will continue to grow for RIA and broker-dealer market participants.
The analysis above only represents the areas we have chosen to highlight. Please see the complete 2022 Examination Priorities for a full assessment of the SECs focus for 2022.