SEC Division of Examinations - 2024 Examination Priorities
SEC DIVISION OF EXAMINATIONS – 2024 EXAMINATION PRIORITIES
As it has for more than ten years, on October 16, 2023, the U.S. Securities and Exchange Commission (“SEC”) Division of Examinations (the “Division”) published its fiscal year 2024 examination priorities for market participants. This memorandum focuses on the 2024 examination priorities applicable to investment advisers, particularly advisers to private funds. In general, the examination priorities are largely similar to the 2023 priorities, but with a heightened focus on the following:
Complex products and risk management in a high interest rate environment
The Division will focus its attention in three principal areas: (1) complex products, such as derivatives and leveraged exchange-traded funds (ETFs); (2) high cost and illiquid products, such as variable annuities and non-traded real estate investment trusts (REITs); and (3) unconventional strategies, including those that purport to address rising interest rates.
Conflicts of Interest
A continual focus in exams will be advisers elimination or full and fair disclosure of all conflicts of interest which might incline the adviser—consciously or unconsciously—to render advice which is not disinterested such that a client can provide informed consent to the conflict. Examinations will review how advisers address conflicts of interest, including (1) mitigating or eliminating the conflicts of interest, when appropriate, and (2) allocating investments to accounts where investors have more than one account (e.g., allocating between accounts that are adviser fee-based, brokerage commission-based, and wrap fee, as well as between taxable and non-taxable accounts).
Disclosures
The Division will also focus on disclosures made to investors and whether they include all material facts relating to conflicts of interest associated with the investment advice sufficient to allow a client to provide informed consent to the conflict.
Compliance Programs
Advisers are advised to engage in comprehensive annual reviews of their compliance programs as the Division has emphasized review of advisers’ annual reviews of the effectiveness of their compliance programs as an important part of assessing whether the advisers’ conflicts of interests are addressed in the advisers’ compliance programs, including those conflicts created by the advisers’ business arrangements or affiliations and related to adviser fees and expenses.
The Marketing Rule (i.e., Advisers Act Rule 206 (4)-1)
The Division has stated that it will assess whether advisers have: (1) adopted and implemented written policies and procedures to conform with the Marketing Rule; (2) appropriately disclosed their marketing related information on the Form ADV; and (3) maintained substantiation of their processes and other required books and records. Items (1) and (3) are of particular importance as it is not enough to demonstrate that there were no violations of the Marketing Rule during the examination period. Advisers must show that they have written policies and procedures reasonably designed to ensure compliance with the Marketing Rule and have maintained in their books and records for any assertions made in the marketing materials.
The Division will also assess whether disseminated advertisements: (1) include any untrue statements of a material fact, (2) are materially misleading, or are otherwise deceptiveand, (3) as applicable, comply with the requirements for performance (including hypothetical and predecessor performance), third-party ratings, and testimonials and endorsements.
Compensation Arrangements
The Division will assess the adviser’s compensation arrangements with its clients, and will focus on: (1) fiduciary obligations of advisers to their clients, including registered investment companies, particularly with respect to the advisers’ receipt of compensation for services or other material payments made by clients and others; (2) alternative ways that advisers try to maximize revenue, such as revenue earned on clients’ bank deposit sweep programs; and (3) fee breakpoint calculation processes, particularly when fee billing systems are not automated.
Valuation Assessments
Adviser’s recommendations to clients, including private fund clients, to purchase illiquid or difficult to value assets, such as commercial real-estate or private placements, must be accompanied by rigorous valuation processes in order to pass muster with the Division.
LPAC and Advisory Board Contracts
Advisers should take care that they follow all disclosed and agreed procedures around the operation of their LPACs and advisory boards.
Fees and Expenses and Due Diligence
Of particular interest this year to the Division will be checking how an adviser calculates post-commitment period management fees. Also of interest to PE managers will be a focus on the quality of the due diligence they have done on portfolio company investments. If you disclose a diligence process, you must follow it.
Custody Rule
Care must be taken that assets required to be held at qualified custodians are so held and that advisers relying on the private fund audit exception complete and deliver timely audits to fund investors.
Form PF reporting
In light of the enhancements made by the SEC to Form PF, the advisers must have policies and procedures in place to ensure reporting events are timely reported.
Other Focus Areas:
Monitoring third party service providers and branch offices, particular the cybersecurity risks they pose and their policies and procedures for protecting client data.
Cybersecurity generally.
Protection of client’s material non-public information, particularly when multiple advisers share office locations, have significant turnover of investment adviser representatives, or use expert networks.
As with previous years, the Division continues to prioritize examinations of: (i) advisers that have never been examined, including recently registered advisers; and (ii) advisers that have not been examined for a number of years. If you have any questions about this alert, or any other regulatory matters, do not hesitate to reach out to: Mark Strefling (Partner) at 212.573.8159 or via email at mstrefling@sadis.com, David Fitzgerald (Partner) at 212.573.8428 or via email at dfitzgerald@sadis.comor Vartika Naithani at 212.573.8148 or via email at vnaithani@sadis.com.
