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5 SEC Priorities for RIAs to Consider During Annual Reviews

By May 31, 2022No Comments

With Form ADV and Form PF filing seasons behind us, most registered investment advisers (“RIAs”), together with their compliance personnel and /or regulatory compliance consultants, are focusing their attention on conducting a gap analysis of compliance programs and preparing for Annual Reviews pursuant to Rule 206(4)-7 of the Investment Advisers Act of 1940, as amended (“Advisers Act”).

Using the U.S. Securities and Exchange Commission (“SEC” or the “Division”) 2022 exam priorities, which, not surprisingly, singles out private funds in its list of “Significant Areas of Focus,” Silver has assembled what we believe to be the key takeaways for private fund managers to keep in mind as they work to assess their policies and procedures; execution of their processes; and test the strength of their compliance controls to ensure that they remain out of the crosshairs of regulators.

  1. Private Funds are in the Hotseat – The rapid expansion of the private market has prompted the Division to continue to prioritize focus on RIAs of private funds. Private fund managers should note that SEC exams will continue to concentrate on, among many other areas, the: (i) calculation and allocation of fees and expenses; (ii) potential preferential treatment of certain investors by RIAs to private funds; (iii) compliance with the Advisers Act’s Custody Rule; (iv) adequacy of disclosure and compliance with any regulatory requirements for cross trades, principal transactions or distressed sales; and (v) conflicts around liquidity, such as RIA-led fund restructurings. We recommend that private fund managers ensure their policies and procedures are tailored to their investment strategy and are consistent with the governing documents of their private funds. A template or “off-the-shelf” policy with no executable procedures simply will not pass muster with the SEC so it is imperative that time is taken to review, test, revise and enhance the manager’s compliance program so the firm can adequately represent they have incorporated regulatory compliance principles into their investment advisory activities.
  2. ESG Investing Remains a Top Priority for Second Straight Year – The SEC will continue to scrutinize RIA disclosures regarding portfolio management practices that advertise ESG strategies or claim to incorporate certain ESG criteria to ensure they do not include false or misleading statements or omissions. In 2022, examiners will once again focus on adequate disclosure, false or misleading ESG practices and proxy voting policies. However, this year the SEC added specific language addressing use of standard ESG terminology, failure to address legal and compliance risks within ESG practices and a misrepresentation of ESG factors considered in portfolio construction. Private fund managers who do not have a specific ESG mandate can still incorporate ESG principles into their due diligence process.  They just need to be clear that it does not necessarily make them an “ESG Fund” or a “Sustainable Fund” so they need to be careful as to how they characterize these activities. Silver’s ESG Strategy Team can help private fund managers navigate the landscape while being mindful of the SEC’s scrutiny when it comes to ESG.
  3. Investors’ Best Interests are Front and Center for SEC – The Division will remain centered on RIAs’ compliance with fiduciary standards under the Advisers Act and examinations will look at both duties of care and loyalty, including best execution obligations, financial conflicts of interest and related impartiality of advice and any attendant client disclosures. It’s vital that RIAs who are private fund managers understand that their fiduciary duties are the foundation of all their investment advisory activities so they always need to test their actions through the lens of the best interest of their funds and, ultimately, their investors. Conflicts of interest can successfully be mitigated if managers execute their investment advice with the principle that the best interests of the client and investor must come first.
  4. Information Security and Cybersecurity Should be Closely Monitored –This year, examiners will be especially concerned about whether private fund managers have taken proper measures to: oversee vendors and service providers; address malicious email activities, such as phishing or account intrusions; respond to incidents like ransomware attacks; identify and detect red flags related to identity theft; and manage operational risk as a result of a dispersed workforce in a work-from-home environment. All of these areas represent components of a RIA’s information security/cybersecurity compliance program. Managers should work with their information security and/or cybersecurity experts to assess the state of such manager’s information security environment and overall cybersecurity program. Additionally, employees of the RIA should undergo cybersecurity-focused training on at least an annual basis.
  5. SEC Narrows in on Emerging Technologies and Crypto-Assets – To keep up with recent trends occurring around digital assets, the SEC makes clear that it will assess whether broker-dealers and RIAs involved with emerging technologies and crypto-assets have met their duty of care and standards of conduct with regard to advising clients of the risks associated with these products, and that their compliance procedures, risk disclosures and operational resiliency practices are being routinely reviewed and updated. This may indicate that crypto and digital asset managers, even quant fund managers, could be subject to additional scrutiny. Although the existing regulations do not specifically include digital assets or crypto currencies, investment managers trading these assets still have a fiduciary duty of care to their clients and thus need to follow these regulations as closely as possible in order to maintain a compliance program that mitigates those potential conflicts of interest and challenges applicable to their investment activity.

The SEC has also pointed out two additional areas of distinction that are essential for private fund managers to keep in mind as they evaluate their compliance protocols during Annual Reviews. The first relates to RIA disclosures and other issues concerning fees and expenses, such as advisory fee errors, inaccurate calculations of tiered fees and failures to refund prepaid fees for investors who have redeemed their interests or pro-rated fees for onboarding investors. By specifically calling out these fees, the SEC is warning private fund managers to take extra precautions when it comes to disclosing fees and expenses and to be overly inclusive when tracking and reporting them.

Second, the SEC mentions anti-money laundering (“AML”) policies, noting that if an investment adviser has adopted an AML program as part of its RIA compliance program, the adviser needs to ensure that the standards it has incorporated are in line with current regulations and the SEC’s focus.

The bottom line is that so far in 2022, the SEC has been clear that it intends to crack down on private fund managers, which is supported by the recent guidance published by the SEC earlier this year (see “SEC Proposes to Enhance Private Fund Investor Protection,” and “Observations from Examinations of Private Fund Advisers”) and underscored again with the SEC’s 2022 exam priorities. In response, a manager’s Annual Review is an important exercise that can and should be leveraged by compliance professionals.  Silver’s advice to clients is to stay vigilant in maintaining updated policies and procedures and to continue to test and analyze compliance programs to ensure they are prepared for an SEC exam. Silver’s compliance and risk team is available to review and evaluate your firm’s compliance program and advise on steps to take to strengthen protocols to ensure the compliance program can pass regulatory scrutiny and increasingly strict regulatory requirements.