RISK MANAGEMENT—SEC’s 2023 exam priorities include investment industry, crypto, and ESG issues - 09 February 2023

Division of Examinations announced its priorities to help regulated entities assess whether they need to improve their compliance programs.

The SEC’s Division of Examinations released its 2023 examination priorities which emphasize, among other things, compliance with new rules applicable to investment advisers and investment companies, ESG-related advisory services and fund offerings, and offers and recommendations of crypto assets. The report is one of the ways the staff communicates about the deficiencies it has observed during examinations to help firms proactively assess the current state of their compliance programs.

The report is based on observations in fiscal 2022 when the staff examined 15 percent of the more than 15,000 registered investment advisers who oversee $125 trillion in assets under management. With respect to broker-dealers, the staff conducted more than 360 examinations and, together with FINRA, examined nearly half of the 3,500 registered firms.

The staff also devoted substantial time in 2022 to responding to significant risk events such as market volatility, cyber-events, and market disruptions caused by bankruptcies and financial distress in the crypto asset markets. Based on its work in 2022, the Division identified the following priorities for 2023.

Investment advisers and investment companies. The staff indicated that it will focus on the new marketing rule (Investment Advisers Act Rule 206(4)-1), whether registered advisers have complied with its substantive requirements, and whether they have adopted and implemented written procedures to prevent violations by their supervised persons of the new rule. The staff also will review efforts surrounding new rules for investment companies such as the derivatives rule (Investment Company Act Rule 18f-4) and the fair valuation rule (Investment Company Act Rule 2a-5).

The Division said that examinations will include the review of other Advisers Act issues such as an adviser’s fiduciary duty, and will assess risks associated with compliance programs, fees and expenses, custody, conflicts of interest, and the use of alternative data. The staff also intends to review conflicts and disclosures related to private fund advisers’ portfolio strategies, risk management, and investment recommendations and allocations. Advisers to private funds will also come under review in 2023, including those advising highly leveraged private funds and private funds managed side-by-side with business development companies.

Crypto and emerging technologies. Citing the recent disruption of the crypto asset markets, the staff said that it will monitor and, when appropriate, conduct examinations of potentially impacted registrants. The exams will focus on the offer, sale, or recommendation of crypto assets, as well as investment advice regarding trading in crypto.

The staff plans to assess whether crypto market participants met and followed their respective standards of care when making recommendations or providing investment advice, and whether they routinely reviewed, updated, and enhanced their compliance, disclosure, and risk management practices. The Division also will prioritize new or never before examined registrants offering crypto assets.

More broadly, the staff intends to examine brokers and advisers that are using emerging financial technologies or employing new practices, including technological and online solutions to meet the demands of compliance and marketing and to service investor accounts. These will include online brokerage services, internet advisers, and automated investment tools and trading platforms such as robo-advisers, the staff said.

ESG issues. The Division noted the rising investor demand for ESG-related investments and stated that it will continue its focus on ESG advisory services and fund offerings. The staff intends to assess whether funds are operating in the manner set forth in their disclosures, and whether ESG products are appropriately labeled. In addition, the Division will review whether recommendations of ESG products for retail investors are made in the investors’ best interests.

Cyber risks and information security. The Division also identified information security as an area it will prioritize in 2023. The staff intends to review brokers’ and advisers’ practices to prevent interruptions to critical services and to protect investor information, records, and assets. The staff expects that those reviews will focus on the cybersecurity issues associated with the use of third-party vendors, including registrant visibility into the security and integrity of third-party products and services, and whether there has been an unauthorized use of third-party providers.

The Division will review firms’ policies and procedures, governance practices, and response to cyber-related incidents, including those related to ransomware attacks, and brokers’ and advisers’ compliance with Regulations S-P and S-ID. The staff said that it also plans to continue to assess systemically significant registrants’ operational resiliency planning, such as their efforts to consider and/or address climate-related risks.

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