The SEC’s Division of Examinations (the “Division”) announced its 2023 examination priorities earlier this month. These SEC exam priorities are announced each year to help promote and improve compliance and protect investors. The exam priorities also indicate what specific areas SEC examiners may be focusing on during upcoming examinations this year. The exam priorities cover not only RIAs but also broker-dealers and transfer agents.
The new Marketing Rule was named as one focus area. The Division will, among other things, assess whether RIAs have adopted and implemented written policies and procedures to help ensure compliance with the Marketing Rule. The Division stated that it 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.
Similar to last year, the Division will focus on RIAs to private funds. In particular, the Division stated that it will focus on private fund RIAs’: (1) conflicts of interest; (2) 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; (3) compliance with the new Marketing Rule, including performance advertising and compensated testimonials and endorsements, such as solicitations; (4) policies and practices regarding the use of alternative data and compliance with Advisers Act Section 204A; and (5) compliance with the Advisers Act Rule 206(4)-2 (Custody Rule), where applicable, including timely delivery of audited financials and selection of permissible auditors.
It was also announced that the Division will focus on RIAs to private funds with specific risk characteristics, such as: (1) highly-leveraged private funds; (2) private funds managed side-by-side with BDCs; (3) private equity funds that use affiliated companies and advisory personnel to provide services to their fund clients and underlying portfolio companies; (4) 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; (5) private funds that invest in or sponsor Special Purpose Acquisition Companies (SPACs); and (6) private funds involved in adviser-led restructurings, including stapled secondary transactions and continuation funds.
Another focus area will be whether RIAs have sufficiently disclosed conflicts of interest such that a client can provide informed consent to the conflict, whether express or implied. The Division will similarly 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, and product menu and customer base and are sufficient to support compliance with the standards. The Division during examinations will also review whether firms have customer or client agreements that purport to inappropriately waive or limit their standard of conduct, such as through the use of hedge clauses.
Form CRS, ESG investing, crypto assets, and cybersecurity were also areas that were mentioned by the Division. With regard to cybersecurity, the Division will continue to look at firms’ practices to prevent account intrusions and safeguard customer records and information, including personally identifiable information, while recognizing that personnel may continue to access information in a remote environment. Additional focus will be on the cybersecurity issues associated with the use of third-party vendors, including registrant visibility into the security and integrity of third-party products and services. The Division’s focus will also include reviewing whether there has been an unauthorized use of third-party providers, particularly for transition assistance when departing RIA personnel attempt to migrate client information to another firm.
Please click on the link below to access the full report issued by the Division.
https://www.sec.gov/files/2023-exam-priorities.pdf
Hayley Nelson is the President and Principal Consultant of NCA Compliance, Inc., a compliance consulting firm providing a wide range of customized compliance solutions for investment advisors. Ms. Nelson previously worked for the Securities and Exchange Commission and a large investment manager in New York.
