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10 February 20237 minute read

SEC announces 2023 examination priorities: Key takeaways

This week, the Securities and Exchange Commission announced the 2023 examination priorities for its Division of Examinations.  The priorities seek to support the SEC’s “four pillars”: (i) promoting compliance; (ii) preventing fraud; (iii) monitoring risk; and (iv) informing policy. 

The priorities also reflect new and evolving threats identified by the Commission as presenting potentially heightened risks to investors or the US markets.  Overall, the examination priorities serve as a reminder for firms and companies to address compliance gaps the Division of Examinations recently has observed.

Examination priorities

The Division identified six priorities for examinations this year:

  1. New investment adviser and investment company rules: The Division will focus on the new Marketing Rule (Investment Advisers Act Rule 206(4)-1) to determine whether registered investment advisers have adopted and implemented written policies and procedures to prevent violations by the advisers and whether they have complied with their substantive requirements.  The Division also will focus on the Derivatives Rule (Investment Company Act Rule 18f-4) and Fair Valuation Rule (Investment Company Act Rule 2a-5), which apply to investment companies.

  2. Investment advisers to private funds: The Division also will focus on the Investment Advisers Act to examine issues including an adviser’s fiduciary duty and assess risks relating to compliance programs, fees and expenses, custody, the new Marketing Rule, conflicts of interest, and the use of alternative data.  The Division will review conflicts and disclosures relating to private fund advisers’ portfolio strategies, risk management, and investment recommendations and allocations.  In addition, the Division will review registered investment advisers to private funds having specific risk characteristics, including the following:

    1. Highly leveraged private funds

    2. private funds managed side-by-side with Business Development Companies (BDCs)

    3. private equity funds that use affiliated companies and advisory personnel to provide services to their fund clients and underlying portfolio companies

    4. private funds that hold certain hard-to-value investments, such as crypto assets or real estate-connected investments, with an emphasis on commercial real estate

    5. private funds that invest in or sponsor Special Purpose Acquisition Companies (SPACs) and

    6. private funds involved in adviser-led restructurings, including stapled secondary transactions and continuation funds.

  3. Retail investors and working families: The Division will concentrate on Regulation Best Interest (Reg BI) and the Investment Advisers Act to ensure that broker-dealers and registered investment advisers are providing advice that is in the best interest of retail investors and working families.  Reg BI requires investment advisers to act in a retail investor’s best interest and not to place the interests of the firm or its financial professionals ahead of investors’ interests.  The fiduciary duty of investment advisers broadly applies to all advisory clients and the entire adviser-client relationship.  The Division’s January 30, 2023, Risk Alert addressing broker-dealer examinations related to Reg BI provides a useful roadmap for areas on which the Division will focus.  The Division will also examine practices regarding review of investment alternatives, management of conflicts of interest, and consideration of investment goals and account characteristics.

  4. Environmental, social, and governance: The Division will look at ESG-related advisory services and fund offerings, which includes ensuring that funds are operating in the manner set forth in their disclosures.  The Division also will evaluate whether ESG products are appropriately labeled and whether product recommendations are made in investors’ best interests.  This dovetails with recent ESG-related enforcement efforts.  In its end of fiscal year 2022 summary of enforcement actions, the SEC focused on three ESG enforcement actions, including:

    1. Charging a robo-adviser with making misleading statements that its advisory business complied with Shari’ah where it did not adopt and implement written policies and procedures addressing how it would assure compliance with that law on an ongoing basis

    2. Charging one of the world’s largest iron ore producers with allegedly making false and misleading claims to local governments, communities, and investors about the safety of its dams prior to the collapse of a particular dam in South America and

    3. Charging a registered investment adviser for materially misleading statements and omissions about ESG considerations in making investment decisions for certain mutual funds.

  5. Information security and operational resiliency: To avoid interruptions to mission-critical services and protect investor information, the Division will focus on the practices of broker-dealers, registered investment advisers, and other registrants.  The Division will concentrate on cybersecurity issues associated with the use of third-party vendors.

  6. Emerging technologies and crypto-assets:  Lastly, the Division will focus on broker-dealers and registered investment advisers that are using emerging financial technologies or employing new practices.  The Division will conduct examinations of registrants regarding “the offer, sale, recommendation of, or advice regarding trading in crypto or crypto-related assets and include whether the firm (1) met and followed their respective standards of care when making recommendations, referrals, or providing investment advice; and (2) routinely reviewed, updated, and enhanced their compliance, disclosure, and risk management practices.”

Key takeaways

The priorities reflect the principal goals of the Division, which are to continue to incentivize investment advisers and broker-dealers to provide accurate and complete disclosure to investors and to maintain effective compliance programs.  Specifically, the priorities focus on the latest industry trends and emerging risks to investment management.

The Division of Examinations routinely refers perceived deficiencies in a registrant’s books-and-records or its controls to the Commission’s Division of Enforcement (“Enforcement”), which can lead to disruptive, costly investigations.  Statements made during the course of an examination are routinely used to further Enforcement investigations.  Registrants should be particularly mindful of the overlapping priorities of these Divisions because these are the areas that are most likely to draw scrutiny.  They include (i) cybersecurity; (ii) digital assets; (iii) ESG; (iv) insider trading and the protection of material, non-public information; and (v) gatekeepers and whether effective gatekeeping systems, policies, and procedures are in place.

To minimize the risk of Enforcement referrals, registrants should consider proactively testing and auditing their policies and procedures and to consult with counsel before engaging with Examinations staff.

It is important to note that the published priorities are not exhaustive.  The Division is likely to cover issues not listed here in the course of an examination.  For example, the Division still will examine an entity’s history, operations, services, products offered, and other risk factors. 

If you have any questions regarding the Division’s examination priorities, the Commission’s enforcement activities, or the impact these matters could have on your business, please contact any of the authors or your DLA Piper relationship attorney.