By Nicholas Prentiss, Baker Tilly
The SEC’s Division of Examinations (“Division”) published an Alert, 2023 Examination Priorities, which detailed the significant focus areas that the SEC will prioritize during upcoming examinations. The four pillars of the Division’s Examinations policies include (1) promote compliance; (2) prevent fraud; (3) monitor risk; and (4) inform policy.
The Examination Priorities summarizes new and continuing focus areas, including an emphasis on the SEC’s “New Marketing Rule,” standards of conduct (specifically conflicts of interest and fiduciary duties), environmental, social and governance (ESG) investing, information security, and crypto investing with a focus on emerging technologies.
Focus areas on private fund managers
Private funds represent a significant portion of the Registered Investment Advisor (RIA) population. More than 5,500 RIAs manage approximately 50,000 private funds with gross assets exceeding $21 trillion. In the past five years, there has been an 80% increase in gross assets of private funds due to steady contributions through retirement plans. In response to the noted trend, the Division will continue to maintain its focus on private fund managers. The Division has detailed five specific focus areas:
- Conflicts of interest
- Calculation and allocation of fees and expenses, including the calculation of post-commitment period management fees and the impact of valuation practices at private equity funds
- Compliance with the New Marketing Rule – specifically reviewing performance advertising and compensated testimonials and endorsements such as solicitations
- Policies and practices regarding the use of alternative data and compliance with Advisors Act Section 204A
- Compliance with the Custody Rule – specifically the timely delivery of audited financials and selection of permissible auditors.
In addition to the five specific focus areas stated above, the Division will focus on managers of private funds that have the following risk characteristics:
- Highly leveraged
- Managed side-by-side with business development companies
- Using affiliated companies and advisory personnel to provide services to fund clients and underlying portfolio companies
- Holding certain hard-to-value investments, such as crypto assets or real-estate connected investments, with an emphasis on commercial real estate.
- Investing in or sponsoring Special Purpose Acquisition Companies
- Involved in adviser-led restructurings, including stapled secondary transactions and continuation funds.
Each of the above factors and risk areas are consistent with recent concerns posted by the Division. Private fund managers should assess their risk profile and approaches to these issues and make efforts to get ahead of potential examination scrutiny. See below for more detail related to new focus areas and risks as listed.