SEC publishes 2023 examination priorities

On February 7, 2023, the Securities and Exchange Commission’s (SEC) Division of Examinations (EXAMS) announced its 2023 examination priorities. The SEC reaffirmed that it will continue to emphasize compliance with new SEC rules applicable to investment advisers, as well as continue its focus on emerging issues and rules aimed at protecting retail investors. 

What you need to know

• Examinations of registered investment advisers (RIAs) will focus on conflicts of interest, fee allocation and compliance with the Marketing Rule and the Custody Rule.
• The SEC continues to focus on compliance with standard of care and ESG commitments.
• RIAs that manage funds that invest in crypto-assets and emerging technologies will be a primary focus for the SEC’s Division of Examinations.

2023 examination priorities in brief

Marketing Rule (Advisers Act Rule 206(4)-1)

Given that the new Marketing Rule significantly changes a core examination review area for RIAs, EXAMS will be looking to confirm that 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. EXAMS will also be focused on whether RIAs have substantively complied with the Marketing Rule, including whether they can substantiate information that has been disseminated to investors.

RIAs to private funds

EXAMS identified the following focus areas in conducting examinations of RIAs to private funds:

• Conflicts of interest;
• Calculation and allocation of fees and expenses (including valuation practices);
• Compliance with the Marketing Rule (as detailed above);
• Policies and practices regarding the use of alternative data (i.e., material non-public information); and
• Compliance with the Custody Rule (including selection of auditors and timely delivery of audited financials).

EXAMS will be focused on RIAs to private funds with specific risk characteristics, including (i) highly leveraged funds, (ii) funds managed side-by-side with BDCs, (iii) funds that are serviced by affiliated companies and advisory personnel (who also service portfolio companies of such funds), (iv) funds holding hard-to-value investments (i.e., crypto and commercial real estate), (v) funds that invest in or sponsor SPACs, and (vi) funds involved in GP-led secondaries, including continuation funds and other similar transactions.

Best interest and fiduciary duties

EXAMs will focus on how RIAs are satisfying their obligations to act in the best interests of the private funds they manage. Examinations will include assessments of (i) investment advice regarding certain products, strategies and account types (including advice regarding complex products, illiquids, proprietary products, strategies purporting to address rising interest rates and microcap securities), (ii) investor disclosures, including whether all material facts relating to conflicts of interest have been disclosed (specifically relative to RIAs, EXAMS will be focused on whether investors are able to provide informed consent to a conflict, express or implied), (iii) processes for making best interest evaluations, and (iv) consideration of an investor’s profile, including investment goals. Lastly, EXAMS will review whether firms have investor agreements that inappropriately waive or limit their standard of conduct.

Environmental, Social, and Governance (ESG)

EXAMS specifically notes a focus on ESG-related advisory services and fund offerings, including compliance with disclosures relative to ESG, whether ESG products are appropriately labeled and whether recommendations of such products for retail investors are made in the investors’ best interests.

Information security and operational resiliency

EXAMS will continue to review cybersecurity and operational practices that have been put in place to prevent interruptions to mission-critical services and to protect investor information, records and assets. Reviews will focus on the cybersecurity issues associated with the use of third-party vendors, including visibility into the security and integrity of third-party products and services and whether there has been an unauthorized use of third-party providers. EXAMS will also continue to assess operational resiliency planning, such as efforts to address climate-related risks.

Crypto-assets and emerging technologies

EXAMS will be specifically attuned to RIAs that are using emerging financial technologies (i.e., technological solutions to compliance and marketing and to service investor accounts) or investing in crypto assets (especially those new to the market). Examinations will focus on the offer, sale, recommendation of, or advice regarding trading in crypto or crypto-related assets and include whether the firm (1) met and followed its respective standards of care when making recommendations, referrals, or providing investment advice; and (2) routinely reviewed, updated, and enhanced its compliance, disclosure, and risk management practices.

Next steps for investment advisers

Although many of the newly adopted SEC rules apply specifically to RIAs, exempt reporting advisers are subject to the anti-fraud provisions of the Advisers Act, which require that information included in marketing materials not be misleading. As a general matter, investment advisers should conduct ongoing reviews of their policies and procedures to ensure ongoing compliance with the SEC’s enumerated priorities. We will continue to monitor these and any other updates.