SEC Division of Examinations’ 2021 examination priorities and focus

| Max Ledger

Important for investors and private fund sponsors alike, below are certain highlights from the Security and Exchange Commission’s (SEC) Division of Examinations (the Division) 2021 examination priorities and the SEC’s newly established Climate and ESG Task Force.

While private funds are not a specific target in the Division’s examination priorities for 20211, the Division shows a continued focus on themes affecting the private funds industry. The Division also indicates that as the SEC looks beyond the pandemic, although uncertainties remain, they will continue to adapt, innovate, and work to ensure strong compliance and investor protection.

  • Private fund advisers. The Division will continue to review the compliance programs of registered investment advisers (RIAs), including whether those programs and their policies and procedures are reasonably designed, implemented, and maintained. The Division will continue to prioritize examinations of RIAs that have not been examined for a number of years and focus on whether the compliance programs of RIAs have been appropriately adapted in light of any substantial growth or change in their business models.

    The Division will focus on how private fund sponsors are complying with the newly adopted definition of accredited investor and will continue to focus on liquidity and disclosures of investment risks and conflicts of interest. Specifically, the Division will review for, among other things: preferential treatment of certain investors by advisers to private funds that have experienced issues with liquidity, including imposing gates or suspensions on fund withdrawals; portfolio valuations and the resulting impact on management fees; adequacy of disclosure and compliance with any regulatory requirements of cross trades, principal investments, or distressed sales; and conflicts around liquidity, such as GP-led secondary transactions and stapled secondaries.
  • Private fund assets. The Division will focus on advisers to private funds that have a higher concentration of structured products, such as collateralized loan obligations and mortgage backed securities, to assess whether the funds are at a higher risk for holding non-performing loans and having loans with higher default risk than that disclosed to investors. In addition, the Division will examine advisers to private funds where there may have been material impacts on portfolio companies owned by the private fund (e.g., real estate related investments) due to recent economic conditions.
  • Emerging investing strategies, ESG. Due to investor demand, private fund sponsors are increasingly offering investment strategies that focus on sustainability. These strategies may include products and services that are referred to by a variety of terms such as sustainable, socially responsible, impact, and ESG conscious. The Division will review the consistency and adequacy of the disclosures provided by private fund sponsors regarding these strategies, determine whether the firms’ processes and practices match their disclosures, review fund advertising for false or misleading statements, and review proxy voting policies and procedures and votes to assess whether they align with the strategies.  In addition, the SEC announced the creation of a Climate and ESG Task Force that will focus on disclose and compliance issues relating to private funds’ ESG strategies and proactively identify ESG related misconduct, i.e., material disclosure gaps and misstatements. 
  • Information security. The increase in remote operations in response to the pandemic has increased concerns about, among other things, endpoint security, data loss, remote access, use of third-party communication systems, and vendor management. As such, the Division has undertaken to review whether firms have taken appropriate measures to: safeguard customer accounts and prevent account intrusions, including verifying an investor’s identity to prevent unauthorized account access; oversee vendors and service providers; address malicious email activities, such as phishing or account intrusions; respond to incidents, including those related to ransomware attacks; and manage operational risk as a result of dispersed employees in a work-from-home environment.
  • Dual registrants. The Division will continue to prioritize examinations of RIAs that are dually registered as, or are affiliated with, broker-dealers, or have supervised persons who are registered representatives of unaffiliated broker-dealers. Areas of focus will include whether RIAs maintain effective compliance programs to address the risks associated with these business models, including conflicts of interest that arise from certain compensation arrangements and outside business activities, best execution, and prohibited transactions.
  • Additional notes. While the priorities drive many of the Division’s examinations, firms are selected for examination according to a risk-based analysis, which varies depending on the type of firm and its business activities. Although not directly addressed in the 2021 examination priorities, during examinations, examiners continue to focus on valuation practices, performance presentations and calculations, presentations of internal rates of return and the effect of subscription credit facilities on such returns, pay to play practices, the testimonial rule and the custody rule. We expect that the Division will shift its focus to the newly adopted advertising rule as well.

Investment advisers should review their existing practices, policies and procedures to ensure consistency with the SEC’s examination priorities and areas of focus. Investors should be aware and take into account these specific areas of SEC focus when conducting their diligence with respect to a potential investment.

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1 The Division’s 2021 Examination Priorities can be found at https://www.sec.gov/files/2021-exam-priorities.pdf

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