The SEC’s 2023 Examination Priorities: Key Takeaways for Private Fund Managers

On Feb. 7, the U.S. Securities and Exchange Commission’s (SEC) Division of Examinations (Division) published its examination priorities for 2023. Each year, the Division publishes a report detailing its areas of focus for upcoming examinations. This report provides industry participants insight into what the Division considers to be the areas of heightened risk to investors and other market participants, as well as to the integrity of the U.S. capital markets. In this year’s report, the Division identified several key areas of focus, which include registered investment advisers (RIAs) to private funds; the new Marketing Rule^[1] (Marketing Rule) under the Investment Advisers Act of 1940 (Advisers Act); adherence to standards of conduct; Form CRS; environmental, social and governance (ESG) investing; information security and operational resiliency; and emerging technologies and crypto-assets. We discuss the main takeaways from each of these focus areas below, mainly as these points pertain to managers of private funds.

RIAs to Private Funds: The Division will continue to focus on RIAs to private funds, with the following areas being emphasized in the report: conflicts of interest; calculation and allocation of fees and expenses, including the calculation of post-commitment period management fees and the impact of valuation practices on private equity funds; compliance with the Marketing Rule, as further discussed below; policies and practices concerning alternative data and compliance with Advisers Act Section 204A;^[2] and compliance with Advisers Act Rule 206(4)-2 (Custody Rule), including timely delivery of audited financials and auditor selection.

The report also indicates that the Division will have a particular focus on RIAs to private funds with certain risk characteristics, such as highly leveraged private funds (no detail was provided on what constitutes “highly leveraged”); private funds managed side by side with business development companies; RIAs that use affiliated companies and advisory personnel to provide services to their private equity funds and underlying portfolio companies; private funds that hold certain hard-to-value investments, such as crypto- and commercial real estate assets; private funds that invest in or sponsor special purpose acquisition companies; and private funds involved with adviser led-restructurings, including stapled secondary transactions and continuation funds.

Marketing Rule: The report noted a particular emphasis in upcoming examinations on the Marketing Rule. The Division will assess whether RIAs have adopted and implemented written policies and procedures that are reasonably designed to prevent violations of the Marketing Rule by the RIA and its supervised persons. The Division will also examine whether RIAs have complied with the Marketing Rule’s substantive requirements, such as the requirement that RIAs have a reasonable basis for believing they can substantiate material statements of fact and other requirements regarding performance advertising, testimonials, endorsements and third-party ratings.

Standard of Conduct: The Division will continue to prioritize reviewing whether RIAs are adhering to their standard of conduct and fiduciary duties. Examinations will focus on disclosures made to investors and whether they include all material facts relating to the associated conflicts of interest so that investors can provide informed consent. Compliance policies and procedures will also be reviewed with fiduciary standards in mind, and a focus will also be given to inappropriate attempts to waive or limit an investment adviser’s standard of conduct.

Form CRS: Compliance with Form CRS will continue to be a focal point in upcoming examinations as part of the general emphasis on retail investor protection.

ESG Investing: The Division will also continue its focus on ESG-related advisory services and fund offerings. Specifically, the Division will look at whether the funds are being operated in a manner that is consistent with the disclosures to investors, and whether ESG products are appropriately labeled.

Information Security and Operational Resiliency: Another area of continued review is RIAs’ practices designed to prevent interruptions of services and to protect investor information, records and assets. The Division will focus on policies and procedures, governance practices, responses to cyber-related incidents, and compliance with Regulations S-P and S-ID, where applicable. Focus will be given to cybersecurity issues associated with the use of third-party vendors. In addition, the Division will continue to assess RIAs’ operational resiliency planning, including efforts to consider and/or address climate-related risks.

Emerging Technologies and Crypto-Assets: The Division will examine RIAs offering new products and services, or employing new practices related to new technologies, such as internet advisers and robo-advisers. The Division will also examine, where appropriate, RIAs participating in the crypto-asset market. Such examinations will focus on whether the RIA has adhered to the appropriate standard of care in rendering its advisory services, and whether it has routinely reviewed, updated and enhanced its compliance, disclosure and risk management practices. Particular focus will be given to RIAs participating in the crypto-asset market that have never been previously examined by the Division. The report also discusses a focus on firms that employ digital engagement practices, such as tools that utilize features designed to engage with retail investors on digital platforms.

Going Forward

Private fund managers should be cognizant of the Division’s areas of priority to best be prepared in case of an SEC examination. We are always available and happy to guide private fund managers in strengthening their compliance programs in light of these focus areas.

The SEC release can be found here.

^[1] _{Rule 206(4)-1 of the Advisers Act.}

^[2] _{Section 204A of the Advisers Act requires RIAs to maintain and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information.}