SEC Division of Examinations Announces 2021 Examination Priorities
Every year, the SEC’s Division of Examinations (the “Division”) publishes its examination priorities to provide insight and transparency into its risk-based approach. While the recently published 2021 Examination Priorities confirm that the SEC will continue its long-standing focus on advisers to private funds, we do, however, see some relatively new themes being addressed and we anticipate these will further evolve with time.
In line with what we’ve observed during examinations of our clients in prior years, the Division will remain focused on the overall strength of advisers’ policies and procedures and how they address firm risks and conflicts of interest.
The Division will continue to review for, inter alia, preferential treatment of certain investors where a private fund has experienced liquidity issues, portfolio valuations and their impact on advisory fees, adequacy of disclosures with respect to cross trades, principal investments or distressed sales and any other conflicts brought about by adviser led fund restructurings.
An emerging theme this year centers around the focus on advisers to private funds that have a higher concentration of structured products, such as CLOs and mortgage-backed securities, to assess whether the funds are at “a higher risk for holding non-performing loans and having loans with higher default risk than that disclosed to investors”. Further, the Division will examine advisers to private funds where there may have been material impacts on underlying portfolio companies due to recent economic conditions.
As the COVID-19 pandemic unfolded, the Division’s examination focus shifted to whether advisers’ business continuity plans were updated, operational and effective, and addressing the increased cybersecurity risks facing firms and investors.
The Division published a number of Risk Alerts during 2020, emphasizing the importance of information security to the operation of financial markets. Specifically, the Division released its examination observations related to cybersecurity and operational resiliency practices taken by market participants
Given the increase in remote working operations, the Division has increased concerns about, among other things, endpoint security, data loss, remote access, use of third-party communication systems, and vendor management. Firms must ensure implementation of sufficient policies and procedures to safeguard customer accounts, oversee service providers, address malicious email activities, such as phishing or account intrusions, and manage operational risk as a result of dispersed employees in a work-from-home environment.
Not surprisingly, there will be focus not only on procedures, but also controls relating to investor information, firm books and records, and third-party cloud providers. If your firm did not provide cybersecurity training to staff in 2020, we highly recommend you do so now.
ESG and Climate Change
The Division notes that advisers are increasingly offering investment strategies that focus on sustainability, a trend that we too have observed amongst our clients. With a focus on the ESG arena the Division intends to review for commonly known private funds deficiency areas including consistency and adequacy of investor disclosure and false or misleading statements in marketing. Interestingly and going further, reviews will include proxy voting policies and procedures and votes “to assess whether they align with the strategies.”
This new focus area is significant if we consider that other regulatory jurisdictions have already taken steps to codify ESG-related rules, and how briefly the topic has been covered in prior years. The recently announced creation of a Climate and ESG Task Force by the Division further emphasizes the importance of the new initiative.
Another focus area of the Division, for which a Risk Alert detailing recent examination observations was published in February 2021, is digital assets. Timely to the release of the examination priorities and intended to assist advisers in enhancing their compliance policies, the Alert provides transparency into the Division’s approach to these examinations. While not new, additional color is provided in certain areas of focus such as portfolio management, maintenance of appropriate books and records, custody, disclosures to clients and investors and valuation. The Division will also consider issues more focused on staff, such as key person policies and outside business activities.
If you are interested in hearing more about what we are seeing in SEC exams, please do reach out. We remind all registered investment advisers of the importance of assessing compliance-based risks on an ongoing basis and are happy to assist our clients in this review.
Furthermore, we recognize the importance of empowering the industry with the tools to mitigate against the latest SEC Division of Examinations priorities, by providing cost-effective and scalable SEC Compliance and Cyber Security e-Learning courses – click here if you’d like access to our Free Demo courses.