SEC Division of Examinations Releases its 2023 Examination Priorities

Who may be interested: Registered Investment Companies; Directors of Registered Investment Companies; and Investment Advisers.

Quick Take: Registered funds should expect the staff of the Division of Examinations (Staff) of the Securities and Exchange Commission (SEC) to focus on the following during its examinations:

• ESG offerings;
• mutual fund-to-ETF conversions; and
• compliance with the new Derivatives Rule (Rule 18f-4) and Fair Valuation Rule (Rule 2a-5).

Registered advisers should expect the Staff to focus on:

• compliance with the new Marketing Rule (Rule 206(4)-1); and
• adherence to their fiduciary duty to act in clients’ best interest.

Private fund advisers remain in the cross-hairs of heightened attention.

Note: Hyperlinked below are S&K materials that may be helpful in considering the topics identified by the Staff in its release.

The Staff published its annual list of examination priorities for 2023. In its release, the Staff identified a broad range of examination priorities, which covered a number of different types of market participants. The Staff highlighted four subject areas as “Notable New and Significant Focus Areas” for 2023:

1. compliance with recently adopted Advisers Act and Investment Company Act rules (including the new Marketing Rule, Derivatives Rule, and Fair Valuation Rule);
2. registered investment advisers to private funds;
3. adherence to applicable standards of conduct, including Regulation Best Interest and the fiduciary standard for investment advisers; and
4. environmental, social, and governance (ESG) investing. 

Registered Funds

The Staff will prioritize multiple focus areas specific to registered investment companies (funds). As in previous years, the Staff will continue its “perennial” focus on compliance programs, governance practices, disclosures to investors and accuracy of reporting to the SEC. This year, the Staff will again evaluate the adequacy of fund boards’ processes for evaluating and approving advisory and other fund fees. The Staff specifically noted the importance of this area for funds with weaker performance relative to peers. The Staff will also assess the effectiveness of funds’ derivatives and liquidity risk management programs.  

The Staff will continue to focus on ESG-related advisory services and fund offerings, including whether a fund is operating in the manner set forth in the fund’s disclosures, as well as whether ESG-related products are appropriately labeled. The Staff also noted that it will be monitoring the growth of volatility-linked and single-stock ETFs, reviewing those funds’ disclosures, marketing, conflicts, and compliance with portfolio management disclosures.

Further, the Staff indicated that it would prioritize examining funds that fall into the following categories: 

1. turnkey funds;¹
2. mutual funds that converted to ETFs;
3. non-transparent ETFs;
4. loan-focused funds, such as leveraged loan funds and funds focused on collateralized loan obligations; and
5. medium and small fund complexes that have experienced excessive staff attrition. 

Registered Investment Advisers

The Staff will also continue to focus examinations on core areas of an investment adviser’s disclosure and compliance programs – such as custody and safekeeping of client assets, valuation, portfolio management, and brokerage and execution. Similarly, the Staff will continue to prioritize review of advisers’ fee calculations, alternative methods for generating revenue (such as bank sweep deposit programs) and collection of excessive fees.

In addition to the core focus areas listed above, the Staff will focus on an adviser’s implementation of policies relating to, and compliance with, the new Marketing Rule, as well as whether an adviser’s recommendations of ESG-related investments are made in the investor’s best interest. The Staff will also prioritize reviewing an adviser’s policies and procedures to determine whether they adequately provide for monitoring and retention of electronic communications, and whether they are reasonably designed to safeguard customer records and information from a cybersecurity perspective.

As in previous years, the Staff will prioritize advisers that have never been examined, including recently registered firms, and those that have not been examined for a number of years. These examinations typically focus on the firm’s compliance program.

Private Fund Advisers

For private fund advisers, examinations will focus on an adviser’s conflicts of interest; calculation and allocation of fees and expenses, including post-commitment period management fees and the impact of valuation practices on fees; compliance with the new Marketing Rule; policies regarding the use of alternative data and compliance with Section 204A (which is directed at preventing insider trading); and compliance with the Custody Rule (Rule 206(4)-2). The Staff confirmed it will continue to focus on the following types of private funds:

1. highly-leveraged private funds;
2. funds managed side-by-side with business development companies;
3. private equity funds that use affiliated companies or personnel to serve both the fund and its portfolio companies;
4. funds holding hard-to-value investments, such as crypto assets and real estate-connected investments (specifically, commercial real estate);
5. funds investing in or sponsoring Special Purpose Acquisition Companies (SPACs); and
6. funds participating in adviser-led restructurings, including stapled secondary transactions and continuation funds.

For more detailed information on the Staff’s 2023 examination priorities, please see the 2023 Examination Priorities release here as well as the SEC press release here. 

¹ The term “turnkey funds” references funds that utilize a turnkey solutions provider for infrastructure purposes (i.e., to organize, operate, and service the funds, such as governance and compliance services).