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2023 SEC Examination Priorities – Highlights for Investment Advisers

United Atlantic Legal Services

Hopefully you are not as excited as we are about this, but 2023 SEC Examination Priorities (the “2023 Priorities”) are out. Many of the areas of focus were expected and, with respect to investment advisers, are things United Atlantic Legal Services has been working with clients to prepare for.

In this post we cover a lookback at the SEC’s 2022 Examination Priorities for investment advisers and what the SEC will be focused on in 2023.

The 2023 Examination Priorities – Looking Forward

We turn our attention to the SEC’s 2023 Examination Priorities (the “2023 Priorities”) and discuss how your firm can be proactive in ensuring its compliance program will pass muster. For investment advisers, we look at the following:

  • Advisers Act Rule 206(4)-1 (Marketing Rule)
  • Client Fees
  • Policies and Procedures
  • Electronic Communications
  • Third-Party Service Providers

Advisers Act Rule 206(4)-1 (Marketing Rule)

If you are unaware that a new Marketing Rule went into effect late last year, then reach out to your compliance consulting firm or a law firm that understands the ramifications to your business. The SEC, as stated in its 2023 Priorities will be looking for investment adviser compliance with the new Marketing Rule.

Under the “Notable New and Significant Focus Areas” of the 2023 Priorities, the SEC led off with

The new Marketing Rule is a significant change to a core examination review area for registered investment advisers (RIAs). As such, the Division will, among other things, assess whether 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 Marketing Rule. The Division will also review whether RIAs have complied with the substantive requirements of the Marketing Rule, including the requirement that RIAs have a reasonable basis for believing they will be able to substantiate material statements of fact and requirements for performance, testimonials, endorsements and third-party ratings.

United Atlantic Legal Services worked with its clients throughout 2022 to ensure compliance with the new marketing rule.

  • How well do your firm’s policies and procedures reflect the requirements of the new marketing rule?
  • Has your firm undergone specific training on the new marketing rule?
  • Are you able to tell/show the story of how your firm has worked to come into compliance with the new marketing rule?
  • Have there been any violations of the new marketing rule and how did your firm respond?

Client Fees

The SEC noted in the 2023 Priorities that:

Often examinations also include a review for conflicts, compliance issues and the oversight and approval process related to RIA fees and expenses, including: (1) the calculation of fees; (2) alternative ways that RIAs may try to maximize revenue, including revenue earned on clients’ bank deposit sweep programs; and (3) excessive fees.

Fees are such an important part of SEC examinations that they are rarely not tested. In fact, we cannot recall a single examination that we supported where there wasn’t at least some testing of fee calculations.

  • When was the last time your firm compared/contrasted fee language in client agreements with the language of the firm’s ADV Disclosure Brochure?
  • What is the scope/depth of ongoing fee testing? What percentage of clients have their fees tested each billing period? How are these clients selected?
  • Is the same individual (or team) responsible for constantly testing fees? When was the last time a third-party or other individual tested fees?
  • What is your firm’s process for testing fees? How does this process compare to your peer group?

Policies and Procedures

Most firms have policies and procedures, and many investment advisers even have good policies and procedures, unfortunately most firms do not actually implement these good policies and procedures. One of the biggest asks that your compliance department has of senior management is buy in on following through with all the hard work that goes into creating policies and procedures by insisting on compliance.

Electronic Commutations

As most investment advisers already know, the SEC is taking this issue seriously. There have been fines and other disciplinary action brought for failures around the monitoring of electronic communications, and it appears the SEC is running out of patience on this issue.

  • Does your investment adviser firm even have a policy on electronic communications?
  • What training is your firm conducting on electronic communications?
  • Do employees understand the ramifications of using “off channel” communications with client?

Third-Party Service Providers

This is an up-and-coming hot button issue for the SEC. Last year, the SEC proposed new rules around how investment advisers use and monitor service providers.

  • Has your firm established a comprehensive list of all service providers?
  • Has your firm identified and ranked the risks associated with these service providers? In other words, how critical would a breach of that service provider be to your firm’s ability to provide services to its clients?
  • What is your firm’s process for monitoring service providers? How would you be aware of significant issues arising with your service providers?

The 2022 Examination Priorities – Looking Back

Let us take a moment to look back at the SEC’s 2022 Priorities (the “2022 Priorities”) to see if there are any trends.

Significant Focus Areas

Private Funds – The 2022 Priorities kicked off its areas of focus discussion with private funds (private duns are also an area of focus for 2023 – a trend). The SEC noted that it will continue to review investment advisers’ fiduciary obligations, compliance programs, disclosures of risks, and controls around material nonpublic information. More specifically, the SEC stated that it will continue to review:

  • the calculation and allocation of fees and expenses, including the calculation of the post-commitment period management fees and the impact of valuation practices at private equity funds;
  • the potential preferential treatment of certain investors by RIAs to private funds that have experienced issues with liquidity, including imposing gates or suspensions on fund withdrawals;
  • compliance with the Advisers Act Custody Rule, including the “audit exception” to the surprise examination requirement;
  • the related reporting and updating of Form ADV regarding the audit and auditors that serve as important gate-keepers for private fund investors;
  • the adequacy of disclosure and compliance with any regulatory requirements for cross trades, principal transactions, or distressed sales; and
  • conflicts around liquidity, such as RIA-led fund restructurings, including stapled secondary transactions where new investors purchase the interests of existing investors while also agreeing to invest in a new fund.

If that wasn’t enough, the SEC stated that it would also be reviewing private fund advisers’ portfolio strategies, risk management strategies, and investment recommendations and allocations with a focus on conflicts and disclosures around these areas.

These are all areas that are also covered in the 2023 Priorities.

  • Environmental, Social, And Governance (ESG) Investing – ESG investing has become a hot button issue in both compliance and politics and is not likely to be going away anytime soon. We have noted that investment adviser firms offering these types of services have seen document requests from the SEC focused on the topic. Some of the requests include:
    • stating what is the registrant’s internal definition of any terms that relate to ESG that are also used in disclosure or marketing materials provided to prospective or current clients or investors;
    • listing and providing a description for each ESG factor utilized (e.g., environmental, social, governance, etc.); and
    • providing copies of any written policies and procedures relating to the application of such factors in determining whether an investment qualifies as an appropriate ESG Investment or receives an ESG score.
  • Standards of Conduct: Regulation Best Interest, Fiduciary Duty, and Form CRS – When we start working with a new investment adviser’s Chief Compliance Officer, one of the foundational elements we focus on is the investment adviser’s fiduciary obligations owed to clients. We ask our new Chief Compliance Officers to look at every problem or issue that arises first through the prism of the firm’s fiduciary obligations. Is the firm’s conduct in the client’s best interest? After that, we move on to the specific rule, if one exists. Form CRS, while being a ridiculous piece of nonsense, has been front and center for regulators since becoming effective a couple years ago. Review the delivery instructions for the Form CRS and test to ensure your firm has been following them.
  • Information Security and Operational Resiliency – To no surprise, the 2022 Priorities highlighted the need for investment advisers to increase scrutiny around their information’s security and operational resiliency. When talking with our Chief Compliance Officers about these issues, we try to get them to conduct an honest assessment of their strengths and weaknesses and most of the time their IT capabilities is not a strength. It is very rare that an investment adviser’s Chief Compliance Officer is good at both regulatory compliance and information technology. This is almost always an area that needs to be outsourced or where an IT professional needs to be brought in-house.
  • Emerging Technologies and Crypto-Assets – Have we mentioned that an investment adviser’s Chief Compliance Officers need to stay proactive and engaged with their business and operational counterparts? Crypto is turning into a mess, and it appears that this is because of a lack of a compliance culture in the industry. How would a Chief Compliance Officer be able to stay on top of these issues if he or she is not involved and learning?

Investment Adviser Examination Program

The SEC stated in its 2022 Priorities that it would be looking at whether an investment adviser firm’s (1) investment advice is in each client’s best interest; (2) oversight of service providers is adequate; and (3) sufficient resources exist to perform compliance duties. We will cover each of these in turn.

  • Investment Advice – Again, we are looking at our investment adviser’s fiduciary obligations to ensure that investment advice is in each client’s best interest. There are typically two perspectives in which one can tackle this issue. First, from the perspective of the client. What are the client’s investment objectives, investment time horizon, and risk tolerance? The second perspective involves the modeling and rating of portfolios. Looking at these two perspectives and making them match is critical. Does “high risk” on the client’s investment policy statement mean the same thing as your firm’s “high risk” portfolio?
  • Service Provider Oversight – Service provider oversight is the next train coming down the track. As many of you are likely aware, the SEC has proposed a new rule around service provider due diligence. Given this topic’s importance, we will discuss this at length in a future post and likely create an entire course on the matter. Take the time to look at the proposed rule and compare it you your firm’s current practices. How much work will you have to do?
  • Compliance Resources – We will close our discussion of this section reviewing an issue identified in the 2022 Priorities that is near and dear to my heart: Compliance Resources. We discuss with our new Chief Compliance Officers the importance of recognizing that they are responsible for an entire compliance program, including that program’s budget. A Chief Compliance Officer should have a deep understanding of the resource needs of the compliance department and what firm growth means for those resources.

Closing Thoughts

It is now time to review the 2023 Priorities and consider how well your firm would respond to an SEC inquiry focused on any (or all) of these areas. We use these examination priorities to create ongoing testing requests. This helps the mock testing more accurately reflect actual examination testing. You do not, however, need to rely on an outside party to conduct such testing, if compliance is responsible for conducting ongoing testing of fees, for example, as your accounting department to take a look a sample of client and the process being used to see if they can leverage their expertise to tighten things up.

  • Are there ways for more than the compliance department to leverage vendor due diligence?
  • For example, are there questions relating to operations that should be addressed in an annual, semi-annual, or quarterly review of a certain service provider?

Take the time to really contemplate these 2023 Priorities with your firm’s compliance department. The SEC considers how investment advisers adapt to the information provided in these types of public releases and will often discuss the specific issues identified in the Priorities with investment advisers under examination.

Michael Rasmussen

About the Author

Michael Rasmussen is the founder of United Atlantic Legal Services. He is a licensed attorney in Florida and registered solicitor in the United Kingdom. Michael has acted as General Counsel and Chief Compliance Officer to several investment advisers, including private fund managers, responsible for the management of billions of dollars in client assets.  

Michael is also the founder of FinProLaw, an online learning platform where Michael has created courses designed for investment adviser compliance professionals. These courses include: 

  • Investment Adviser Compliance Essential for Chief Compliance Officers 
  • Foundations of Investment Adviser Compliance 
  • What is a “Security”? 
  • Investment Adviser Marketing Rule 
  • Regulation A – Exemption from Registration 
  • Regulation Crowdfunding – Exemption from Registration 
  • Regulation D – Exemption from Registration 

Investment adviser firms who are also clients of United Atlantic Legal Services can receive many of these courses at a significantly reduced fee or, in some cases, at no expense. Contact us today or visit the FinProLaw to learn more.  Please visit Michael’s website to learn more about Michael and his insights into the investment adviser industry. He can also be found on LinkedIn.