Articles & Alerts
The SEC Division of Examinations Announces 2023 Priorities
On February 7, 2023, the Securities and Exchange Commission’s Division of Examinations (the “Division”) released its 2023 Examination Priorities. The Division publishes its examination priorities annually to provide insights into its risk-based approach, including the areas believed to present potential risks to investors and the integrity of the U.S. capital markets.
We have presented below some areas that we believe are significant. We suggest that all advisers review the full report (available by clicking here).
Registered Investment Advisers (RIAs) to Private Funds
Considering that RIAs to Private Funds continue to represent a significant number of total Advisors, the SEC will continue to increase its scrutiny on such RIAs. Areas of focus identified in the Exam Priorities include:
- conflicts of interest;
- the calculation and allocation of fees and expenses, including the calculation of post-commitment period management fees and the impact of valuation practices at private equity funds;
- compliance with the new Marketing Rule, including performance advertising and compensated testimonials and endorsements, such as solicitations;
- policies and practices regarding the use of alternative data and compliance with Advisers Act Section 204A; and
- compliance with the Advisers Act Rule 206(4)-2 (Custody Rule), where applicable, including timely delivery of audited financials and selection of permissible auditors.
The Examination Priorities report also noted that there will be a specific focus on advisers to private funds with the following risk characteristics:
- highly leveraged private funds;
- private funds managed side-by-side with Business Development Companies (BDCs);
- private equity funds that use affiliated companies and advisory personnel to provide services to their fund clients and underlying portfolio companies;
- private funds that hold certain hard-to-value investments, such as crypto assets and real estate-connected investments, with an emphasis on commercial real estate;
- private funds that invest in or sponsor Special Purpose Acquisition Companies (SPACs); and
- private funds involved in adviser-led restructurings, including stapled secondary transactions and continuation funds.
Compliance with Recently Adopted Rules
Advisers Act Rule 206(4)-1 (Marketing Rule)
The new Marketing Rule is a significant change to a core examination review area for registered investment advisers (RIAs). The Division will assess whether RIAs have adopted and implemented written policies and procedures that are reasonably designed to prevent violations by the advisers and their supervised persons of the Marketing Rule. The Division will also review whether RIAs have complied with the substantive requirements of the Marketing Rule, including the requirement that RIAs have a reasonable basis for believing they will be able to substantiate material statements of fact and requirements for performance advertising, testimonials, endorsements and third-party ratings.
Investment Company Act Rule 18f-4 (Derivatives Rule)
If a fund relies on the Derivatives Rule, the Division will, among other things:
- assess whether registered investment companies, including mutual funds (other than money market funds), exchange-traded funds (ETFs) and closed-end funds, as well as business development companies (BDCs), have adopted and implemented policies and procedures reasonably designed to manage the funds’ derivatives risks and to prevent violations of the Derivatives Rule pursuant to Investment Company Act Rule 38a-1; and
- review for compliance with Rule 18f-4, including the adoption and implementation of a derivatives risk management program, board oversight, and whether disclosures concerning the fund’s use of derivatives are incomplete, inaccurate or potentially misleading.
Investment Company Act Fair Valuation Rule 2a-5
The Division will, among other things:
- assess funds’ and fund boards’ compliance with the new requirements for determining fair value, implementing board oversight duties, setting recordkeeping and reporting requirements, and permitting the funds’ board to designate valuation designees to perform fair value determinations subject to oversight by the board; and
- review whether adjustments have been made to valuation methodologies, compliance policies and procedures, governance practices, service provider oversight, and/or reporting and recordkeeping.
Standards of Conduct: Regulation Best Interest, Fiduciary Duty, and Form CRS
The Division will continue to prioritize examinations of broker-dealers and RIAs for compliance with their applicable standard of conduct. Broker-dealers and dually registered RIAs are an area of continued interest for the Division, as are affiliated firms with financial professionals who service both brokerage customers and advisory clients.
All broker-dealers and investment advisers have at least some conflicts of interest with retail investors. The nature and extent of those conflicts of interest will depend on various factors, including a firm’s business model. The Division will seek to identify and understand the economic incentives that a firm and its financial professionals have to recommend products, services, or account types, such as the source and structure of compensation, revenue, or other benefits. Part of this inquiry will look at whether the firm has established written policies and procedures to identify such conflicts of interest, and periodically reviewed and updated their policies and procedures, as appropriate. The Division will also review whether compliance policies and procedures are tailored to the firm’s particular business model, compensation structure, product menu and customer base.
Environmental, Social and Governance Investing
RIAs and registered funds are competing for the rising investor demand for ESG-related investments and strategies that incorporate certain ESG criteria. The Division will continue its focus on ESG-related advisory services and fund offerings, including whether the funds are operating in the manner set forth in their disclosures. In addition, the Division will assess whether ESG products are appropriately labeled and whether recommendations of such products for retail investors are made in investors’ best interests.
The published priorities are not an exhaustive list of the focus areas of the Division in its examinations, risk alerts, and outreach. The collaborative effort to formulate the annual examination priorities starts with feedback from examination staff who can identify the practices and other factors that may pose risks to investors.