The Securities and Exchange Commission’s (SEC) Division of Examinations (Division) recently announced its 2023 examination priorities. The Division’s annual list sets out its priorities for its examinations of SEC registrants over the coming year and reflects areas it believes pose the most risk to investors and the health of U.S. capital markets. According to the Division of Examinations’ Director Richard Best, the Division “will emphasize compliance with the new SEC rules applicable to investment advisers and investment companies as well as continue [its] focus on emerging issues and rules aimed at protecting retail investors.” Id.
Being aware, and making sure your firm’s operations are in-line with the newly announced examination priorities and the underlying SEC rules and regulations is a must for registered investment advisers (RIAs), advisers of private funds, investment companies, and non-U.S. advisers not exempt under the Investment Advisers Act. If not, your firm runs the risk of being examined by the Division’s risk-based inspection program which, in turn, may result in a deficiency finding and penalties by the Division, and a possible referral to the SEC’s Division of Enforcement. This is particularly pertinent to non-US advisers with US clients who are unaware or forget that SEC rules and regulations can apply to them. This often occurs at firms that have inadequate compliance programs.
As set out in further detail below, the Division of Examinations in 2023, among other things, will increase its scrutiny of crypto-trading firms and investment advisors as well as Environmental, Social and Governance (ESG) funds. The Division released its examination priorities two months after the SEC’s Division of Corporation Finance issued new guidance, advising publicly traded companies to disclose their exposure to the cryptocurrency market after crypto exchange FTX filed for bankruptcy. The SEC was criticized by members of Congress, including U.S. Senator Elizabeth Warren, for “fall[ing] far behind” the crypto industry and for failing to use its regulatory powers to stop fraud and market manipulation in the crypto space. In addition, in May of 2022, the agency proposed new rules to prohibit misleading or deceptive claims on ESG fund names in the U.S. and enhanced their disclosure requirements.
The 2023 examination priorities highlight six areas that will draw increased scrutiny from the Division’s examination staff. They include:
1) New Investment Adviser and Investment Company Rules
On November 4, 2022 amendments to the Marketing Rule (Rule 206(4)-1) of the Advisers Act became effective for all registered investment advisers (RIAs). The Division will focus on the new Marketing Rule to ensure 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 new rule and its substantive requirements. The Division also intends to focus on investment companies’ compliance with the new Derivatives Rule (Investment Company Act Rule 18f-4) and the Fair Valuation Rule (Investment Company Act Rule 2a-5).
2) RIAs to Private Funds
The Examinations Division will review issues under the Advisers Act, including an adviser’s fiduciary duty, and will assess risks, including a focus on compliance programs, fees and expenses, custody, conflicts of interest, and the use of alternative data. The Division of Examinations will also review private fund advisers’ portfolio strategies, risk management, and investment recommendations and allocations, and will focus on RIAs to private funds with specific risk characteristics set out in the 2023 priorities list.
3) Retail Investors and Working Families
The Division will continue to review standards of conduct issues for broker-dealers and RIAs. According to the list, the Division will focus on, among other things, whether registrants are meeting their obligations under Regulation Best Interest and the Advisers Act fiduciary standard to act in the best interests of retail investors and not to place their own interests ahead of retail investors.
The Division will continue its focus on ESG-related advisory services and fund offerings, including whether funds are operating according to their disclosure documents. In addition, the Division will assess whether ESG products are appropriately labeled and whether recommendations of such products for retail investors are made in the investors’ best interests.
5) Information Security and Operational Resiliency
Among other things, the Division will review broker-dealers’, RIAs’, and other registrants’ practices to prevent interruptions to mission-critical services and to protect investor information, records, and assets. The review will also focus on the cybersecurity issues associated with registrants’ use of third-party vendors.
6) Emerging Technologies and Crypto-Assets
The Division indicated it will conduct examinations of broker-dealers and RIAs using emerging financial technologies or employing new practices, including technological and on-line solutions to meet the demands of compliance, marketing, and to service investor accounts. Examinations of registrants will focus on the offer, sale, recommendation of, or advice regarding trading in crypto or crypto-related assets.
The author of this alert is William C. Erb, Jr, of counsel at BMV International in Milan, Italy. Prior to joining BMV, Mr. Erb was a Senior Counsel at the U.S. Securities and Exchange Commission in the Division of Examinations where he led complex examinations of SEC registered domestic and foreign investment advisers.
This alert is provided for your convenience and does not constitute legal advice or create an attorney-client relationship. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
