On February 7th, the SEC released its list of exam priorities for 2023, providing helpful insight to compliance staff at investment advisory firms and broker-dealers. The 30-page release outlines a significant number of priorities, which comes at no surprise considering the amount of plans the SEC aims to finalize before the end of the year. To help narrow down the list, we’ve pulled the top six exam priorities from the announcement that you should focus on for the year.
1. New Investment Adviser and Investment Company Rules
New Marketing Rule. The Division will, among other things, assess whether 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. The Division will also focus on new rules applicable to investment companies, including the Derivatives Rule (Investment Company Act Rule 18f-4) and Fair Valuation Rule (Investment Company Act Rule 2a-5).
Derivatives Rule (for funds that rely on the Derivatives Rule). The Division will focus on whether registered investment companies, mutual funds (not money market funds), ETFs, closed-end funds, business development companies (“BDC”), and other relevant actors have adopted and implemented policies and procedures designed to manage funds’ derivates risk and prevent violations of the Derivatives Rule. The Division will also look for compliance with Rule 18f-4 including the implementation of a derivates risk management program with board oversight. Additionally, disclosures about the fund’s use of derivates should be complete, accurate, and without misleading statements.
Fair Valuation Rule. The Division will assess funds’ and fund boards’ compliance with determining fair value, implementing board oversight duties, setting recordkeeping, and reporting requirements. The Division will also focus on whether adjustments have been made to valuation methodologies, compliance policies and procedures, governance, service provider oversight, and reporting/recordkeeping.
2. Investment Advisers and Investment Companies
Focus Areas for Examinations of RIAs. During examinations, the following areas are typically reviewed for a RIAs Compliance Program and related Disclosures:
- Custody and Safekeeping of Client Assets
- Portfolio Management
- Brokerage and Execution
- Compliance Issues
- Oversight and Approval Process related to RIA fees and expenses
On top of the above core focus areas, the Division will review RIA policies and procedures for retaining and monitoring electronic communications and selecting and using third-party service providers. With no surprise in this aspect, the Division will prioritize examining the following RIAs below:
- RIAs that have never been examined (including recently Registered Firms).
- RIAs that have not been examined for multiple years.
3. RIAs to Private Funds
Private Fund RIAs will be examined for:
- Conflicts of Interest;
- Calculation and allocation of fees and expenses;
- Compliance with new Marketing Rule;
- Use of alternative data and compliance; and
- Compliance with the Custody Rule where applicable.
The Division will focus on Private Funds with specific risk characteristics below:
- Highly-Leveraged Private Funds.
- Private Funds are managed side-by-side with BDCs.
- Private Equity Funds holding hard-to-value investments (emphasis on commercial real estate).
- Private Funds involved in adviser-led restructurings including stapled secondary transactions and continuation funds.
- Private Equity Funds use affiliated companies and advisory personnel to provide services to their clients.
- Private Funds that invest in or sponsor SPACs.
4. Adviser Fiduciary Duty and Regulation Best Interest
BD and RIA examinations will prioritize compliance with the applicable standard of conduct.
BDs and dually registered RIAs are “an area of continued interest”.
Examinations may focus on the RIAs:
- Portfolio strategies.
- Risk management for retail investors
- Investment recommendations and allocations.
- Disclosures of financial information and all material conflicts of interest.
- Advice or Recommendations that may draw additional attention:
- Complex products (Leveraged ETFs, Derivatives, ETNs, and ETPs).
- High-cost and illiquid products (Variable Annuities and REITs).
- Proprietary Products.
- Unconventional strategies to address rising interest rates.
- Microcap securities.
The Division will review if Firms have active policies and procedures to address potential conflicts of interest stemming from economic incentives for financial professionals to recommend specific products, services, or account types.
5. ESG Investing
The Division will continue to evaluate and review whether ESG RIAs and Registered Funds advisory services and fund offerings are operating as outlined in their disclosures.
ESG products being appropriately labeled and if recommendations are being made in the investor’s best interest for retail investors are also key areas the Division will assess.
6. Information Security and Operational Resiliency
There will be a focus on Firm’s policies and procedures, governance practices, and response to cyber-related incidents.
Having policies and procedures reasonably designed to safeguard customer records and information will be an additional focus area, among many more.