SEC Division of Examinations Priorities for 2023
February 24, 2023
By Dominic M. Hulse and Ray G. Lombardi
On February 7, 2023, the Division of Examinations (the Division) of the U.S. Securities and Exchange Commission (the SEC) issued its annual examination priorities.1 Consistent with its 2022 examination priorities and the SEC’s four pillars – promoting compliance, preventing fraud, monitoring risk, and informing policy – the 2023 examination priorities largely reflect a continuation of the Division’s focus areas for the past year.
This alert provides a summary of the Division’s priorities for 2023 with particular focus on those items that affect private funds. In 2023, the Division’s focus will remain consistent with its 2022 priorities on (i) registered investment advisers (RIAs), (ii) Environmental, Social, and Governance (ESG), (iii) retail investors and working families, (iv) information security and operational resiliency, and (v) emerging technologies and crypto assets. In addition, the Division will now also focus on new investment adviser and investment company rules. This year’s examinations prioritize areas that the SEC believes to pose unique or emerging risks to investors or the markets.
New Investment Adviser and Investment Company Rules
The SEC adopted various new rulemakings in its efforts to drive efficiency in the markets and modernize SEC rules applicable to the current economy and technologies. Significantly, the Division is prioritizing compliance with Rule 206(4)-1 (the Marketing Rule) promulgated under the Investment Advisers Act of 1940 (the Advisers Act), Rule 18f-4 (the Derivatives Rule), and the Fair Valuation Rule 2a-5 each promulgated under the Investment Company Act of 1940 (the 1940 Act).
The Marketing Rule presents a significant change for the SEC’s review of RIAs. RIAs should ensure that they have adopted written policies and procedures reasonably designed to prevent violations of the Marketing Rule. While primarily applicable to registered investment advisers, the provisions of the Marketing Rule are instructive to both advisers relying on exemptions from full registration (e.g., exempt reporting advisers) and unregistered advisers, particularly in light of the Division’s enhanced focus in 2023. The anti-fraud provisions of Rule 206(4)-8 of the Advisers Act, and Rule 10b-5 of the Securities Exchange Act of 1934 apply to unregistered entities. As the Marketing Rule sets out certain prohibited activities that the SEC deems fraudulent, market participants that are engaged in marketing funds or advisory services should familiarize themselves with these requirements.
For registered funds reliant on the Derivatives Rule, the Division will focus its examinations on whether the registered investment companies have adopted policies reasonably designed to manage its derivatives risk. The Division will further inquire as to compliance with the Derivatives Rule’s guidance on derivatives risk management program, including board oversight and whether disclosures of a fund’s use of derivatives is complete, accurate, or potentially misleading.
Lastly, regarding Rule 2a-5, the Division will focus its inquiries on compliance with the new requirements to determine fair value, board oversight, recordkeeping, recording requirements, and permitting a fund’s board to designate valuation designees subject to the board’s oversight.
RIAs to Private Funds
The Division, citing an 80 percent increase in the gross assets of private funds, will continue its focus on RIAs to private funds as private fund assets continue to grow. The Division will focus its examination on private fund RIA’s conflicts of interest, calculation and allocation of post-commitment period management fees, policies regarding the use of data under Section 204A of the Advisers Act, compliance with Advisers Act Rule 206(4)-2 (the Custody Rule), as well as the Marketing Rule discussed above.
The Division will focus its examinations on RIAs to private funds which are: (i) high-leveraged, (ii) managed side-by-side with BDCs, (iii) hold hard-to-value investments (e.g., crypto assets), (iv) invested in or sponsor Special Purpose Acquisition Companies, (v) involved in adviser led restructurings, and (vi) private equity funds using affiliated companies and advisory personnel to provide services.
Environmental, Social, and Governance (ESG)
On par with the Division’s 2022 priorities, ESG investments will continue to be an area of focus for the Division in 2023. The SEC found that registered funds are competing for the growing demand for ESG investments, resulting in the proliferation of more ESG related investments. As a result, the Division will continue its focus on reviewing whether funds are operating in a manner congruent with their disclosures, and whether ESG products are appropriately labeled.
Information Security and Operational Resiliency
Another continuation of the Division’s priorities from 2022 is its focus on Information Security and Operational Resiliency. The Division will focus its review on a firm’s practices to prevent interruptions to mission-critical services and protection of investor’s data and assets. The review will include inquiries on a firm’s practices to safeguard records, cybersecurity issues associated with the use of third-party providers, and a systematic assessment of significant registrants’ operational resiliency plans.
Emerging Technologies and Crypto-Assets
Lastly, the Division will continue its focus on crypto assets and emerging financial technology. As related investments in these areas continue to grow, the division intends to focus its examinations on broker-dealers and RIAs which offer new products and services or which deploy novel practices related to these areas. In light of recent controversies in crypto assets, the Division will review whether market participants, in each case, follow their standards of care in marketing recommendations, referrals, or in providing investment advice, in addition to whether practices regarding risk management, compliance, and disclosure are routinely updated. The Division will also focus its review on new registrants offering crypto related investments.
2023 SEC Division of Enforcement Examination Priorities. Available here.
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