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2023 SEC Examination Priorities: New Rules, Private Funds, Retail Investors and Working Families, ESG, Information Security, and Digital Assets

2023 SEC Examination Priorities: New Rules, Private Funds, Retail Investors and Working Families, ESG, Information Security, and Digital Assets

What happened?

On February 7, 2023, the SEC’s Division of Examinations (“EXAMS”) published its 2023 Examination Priorities. These annual priorities highlight practices, products, and services that present potentially heightened risks to investors or to US capital markets.

The following are a selection of priorities EXAMS identified for 2023:

  1. Compliance with recently adopted rules. While the SEC has adopted multiple new rules in 2022, EXAMS is prioritizing assessment of compliance with the following rules:
    • Marketing Rule (Advisers Act Rule 206(4)-1). With its November 4, 2022 compliance date, the Marketing Rule now applies to all firms. Among other things, EXAMS will assess the following for compliance with the Rule:
      • “Whether RIAs have adopted and implemented written policies and procedures reasonably designed to prevent violations of the Marketing Rule by advisers and supervised persons”;
      • Compliance with the Rule’s substantive requirements, including those for substantiation of material statements of fact; performance advertising; testimonials and endorsements; and third-party ratings.
    • Derivatives Rule (Investment Company Act Rule 18f-4). For funds relying on the Derivatives Rule, EXAMS’s assessments will include the following:
      • Whether registered investment companies (RICs) have “adopted and implemented policies and procedures reasonably designed to manage the funds’ derivatives risk and to prevent violations of the Derivatives Rule
      • Whether RICs have complied with the Derivative Rule, including adopting and implementing a derivatives risk management program; board oversight; and avoiding disclosures that are “incomplete, inaccurate, or potentially misleading.”
    • Fair Valuation Rule (Investment Company Act Rule 2a-5). EXAMS will, among other things, assess the following:
      • Funds’ and fund boards’ compliance with the Rule’s requirements for determining fair value, implementing board oversight duties, forming recordkeeping and reporting requirements, and allowing the funds’ board, with the board’s oversight, to select valuation designees to perform fair value determinations
      • Whether funds have adjusted their “valuation methodologies, compliance policies and procedures, governance practices, service provider oversight, and/or reporting and recordkeeping”
  1. RIAs to private funds. Citing the continued growth of private fund assets, EXAMS will retain its 2022 focus on private funds into the new year. EXAMS will especially focus on the following for private fund advisers:
    • Conflicts of interest;
    • Calculation and allocation of fees and expenses, e.g. post-commitment period management fees and valuation practices at private equity funds
    • Compliance with the Marketing Rule, including items such as performance advertising and compensated testimonials and endorsements, e.g. solicitations.
    • Policies and practices concerning use of alternative data, as well as compliance with Advisers Act Section 204A
    • When applicable, compliance with the Custody Rule, including timely delivery of audited financials and selection of permissible auditors.

EXAMS will focus on examining the following types of private fund advisers:

  • Highly leveraged private funds
  • Private funds managed side-by-side with BDCs
  • Private equity funds using affiliated companies and advisory personnel to provide services to their fund clients and underlying portfolio companies
  • Private funds holding certain hard-to-value investments (e.g. crypto assets, real estate-connected investments, especially commercial real estate)
  • Funds that invest in or sponsor SPACs
  • Private funds involved in adviser-led restructurings, e.g. continuation funds and stapled secondary transactions
  1. Standards of Conduct. EXAMS will continue to focus on Reg BI (broker dealers) and the Fiduciary Standard (RIA). In particular, EXAMS will prioritize:
    • Examinations of broker-dealers, dually registered RIAs, affiliated firms with professional who service brokerage customers and advisory clients
    • Exams focusing on:
      • Investment advice and recommendations
      • Disclosures, particularly any omission of material facts about conflicts of interest
      • Processes for best interest evaluations
      • Factors considered based on an investor’s investment profile
      • For RIAs, if the disclosures enabled clients to provide informed consent to the conflict

Exams may focus on advice concerning specific products, such as complex products (e.g. derivatives and exchange-traded products), high cost and illiquid products; proprietary products; unconventional strategies claiming to address rising interest rates, and microcap strategies. The Priorities note that advice to senior investors, retirement investors, and specific account recommendations may receive special attention.

  • EXAMS will assess whether examined advisers have established, and periodically review and update (when appropriate), written policies and procedures to identify conflicts of interests. EXAMS will also assess how advisers manage conflicts of interest.
  • EXAMS will review any customer or client agreements claiming to inappropriately waive or limit a firm’s standard of conduct, e.g. hedge clauses
  • EXAMS will review compliance with Form CRS
  1. ESG investing. EXAMS will retain its focus on ESG-related advisory services and fund offerings. Among other things, EXAMS will assess:
    • Whether funds’ operations are consistent with their disclosures
    • Whether ESG products are properly labeled
    • Whether recommendations of ESG products for retail investors are made in their best interest
  1. Information security and operational resiliency. EXAMS will focus on reviewing firms’ practices to prevent service interruptions, and to protect investor information and assets. In particular, EXAMS will focus on:
    • Firms’ policies and procedures, including whether they are reasonably designed to protect customer records and information (whether stored internally or with a third party) and whether the records’ location has been properly disclosed to the SEC
    • Firms’ practices to protect customer information, particularly that stored with third-party vendors (security of third-party products, unauthorized use of third parties, etc.)
    • Firms’ operational resiliency planning, e.g. addressing climate-related risks
  1. Crypto assets and emerging financial technology. This focus area includes “crypto assets and their associated products and services,” as well as emerging financial technology such as automated investment advice and mobile apps. EXAMS will:
    • Examine firms offering new products, services, or practices, such as on-line solutions
    • Examine registrants that might have been impacted by recent issues in the crypto asset market, especially firms in this space that are new and/or have never been examined before. Specifically, EXAMS will investigate whether these firms:
      • Met and followed standards of care when providing investment advice
      • “Routinely reviewed, updated, and enhanced their compliance, disclosure, and risk management practices.”
    • Examine registrants that employ tools such as digital engagement practices. EXAMS will investigate whether these firms:
      • Made representations that are fair and accurate
      • Maintained operations and controls consistent with disclosures
      • Made advice in the investor’s best interest
      • Considered risks of such practices are considered, particularly investor-specific risks (e.g. senior investors)

Focus Areas for Examinations of RIAs. EXAMS noted that, in addition to core focus areas such as custody, valuation, fees and expenses, and portfolio management, 2023 exams of RIAs will also focus on “RIA policies and procedures for retaining and monitoring electronic communications and selecting and using third-party service providers.” 2023 exams will also focus on “fiduciary obligations of RIAs to registered investment companies, particularly with respect to their receipt of compensation for services.”

What does this mean for my firm?

Your firm may be more likely to be examined by the Division in 2023 if any of the focus areas above affect your firm. For the fiscal year 2022, EXAMS again meet the stated goal of examining at least 15% of RIAs annually. The priorities selected by EXAMS can help your firm improve its compliance program and prepare for the next, inevitable examination.

More risk alerts and in-depth information on the 2023 Examination Priorities will likely be released in the coming months, which will provide further details on who may be examined and how these focus areas will be reviewed.

Fairview provides comprehensive and ongoing compliance services, including complete examination support. Our Cyber practice specializes in the creation, testing, and meaningful cybersecurity programs for financial industry businesses, in compliance with SEC regulations. Contact us today if you have questions concerning the Division’s examination process or for additional information about the 2023 Examination Priorities.