Last week, the Securities and Exchange Commission (“SEC”) released the 2022 Division of Examinations priorities. In this post, I’ll focus on the three priorities that are most relevant for Vector’s private fund clients: (i) private funds, (ii) ESG investing, and (iii) emerging technologies and crypto assets. Note that there are other significant priorities listed, so registrants should certainly read the entire report.
A Significant Focus on Private Funds
In the report, the SEC notes that the total AUM of all RIAs is now over $113 trillion, a 70% increase from five years ago. More than 5,000 of those RIAs (over 35%) manage $18 trillion in private fund assets. It’s no big surprise that the SEC is focused on private funds, given the sheer volume of recent communications coming from the regulator on the topic. Some of my regulatory friends and colleagues have coined 2022 the “year of the private fund.”
Because of the growth of the private fund sector, increased complexity of strategies within the market, and the prevalence of significant investments from institutional LPs investing on behalf of retail investors, the SEC is continuing to focus on managers to such funds.
The big topics are: (i) fees and expenses (explicitly including valuation practices of illiquid strategies), (ii) preferential treatment of certain investors in private funds, (iii) private fund reporting and audit requirements, (iv) adequacy of disclosures, and (v) conflicts around liquidity. Again, none of this is particularly novel given the recent private fund proposal. Check out our post on the substantive impacts of that proposal from a fund administration perspective – it’s quite consistent with the comments in the 2022 priorities.
Environmental, Social, and Governance (ESG) Investing
In last year’s priorities, ESG got what I would call an “honorable mention,” in that it was included in the SEC’s broader focus on RIA compliance programs. This year, however, ESG gets its own “significant priority.” In the past couple years in the alternative investment space, we have seen ESG emerge as a common industry topic, largely driven by pressure from institutional LPs investing in private funds, an administration focused on ESG, the risk such topics pose to an investment strategy, and the SEC’s comments on the matter.
The SEC is focused specifically on (i) disclosures and policies, (ii) proxy voting, and (iii) “greenwashing” or overstating ESG factors in the investment process for marketing purposes. Managers of illiquid strategies should specifically be focused on what ESG factors the investment team considers in deal diligence, what framework is in place to document and report on those factors, how those factors are assessed over time, and what ESG story the firm tells in any fund documents or marketing materials. Consistency, thoughtfulness, and execution are key.
Emerging Technologies and Crypto-Assets
With the recent focus from the Biden administration, various comments from the SEC, a massive growing industry, and a healthy community of dialogue on the topic, it’s no surprise that emerging technologies and crypto-assets are a primary priority. Interestingly, the SEC priorities grouped advisers developing financial technologies and advisers investing in crypto assets into the same bucket – perhaps simply because it’s two emerging trends that the regulator has yet to fully understand.
On the technologies side, we have seen a trend in the alternative asset space around the development of mobile applications and technologies with an aim to democratize access to the space. While this isn’t explicitly mentioned, it will be interesting to see if and how the regulator focuses on such strategies. Also notable was the mention of the term “Finfluencers.” I foresee interesting dialogue around the murkiness of what exactly constitutes “investment advice,” and what additional controls the SEC may be expecting managers to put in place around their employees’ ever-growing use of social platforms.
We have daily conversations with our clients and prospective clients concerning investing into the digital asset space. On the crypto side, the SEC is explicitly focused on the adviser’s “duty of care” in selecting crypto-assets in their clients’ portfolios, compliance policies related to the assets (i.e. custody, AML, valuation), risk disclosures and resiliency controls, and overall portfolio management.
As more and more alternative investment managers expand into these spaces, I expect we will see more coming from the SEC as they get a deeper understanding of these products.
About Vector
Vector AIS is a next-generation fund administrator and technology company for closed-end investment funds.
At Vector, we strive to create an inspiring, inclusive, equitable workplace that celebrates and values employees. As we continue to scale, we do so with a responsibility to foster a culture of inclusivity and balance that allows teammates to thrive at work and in their personal lives.
Join the team, become a client, or follow us as we execute our mission.
