The Securities and Exchange Commission (SEC) has recently released their examination priorities for the upcoming year, with a focus on the regulatory compliance of RIAs managing private funds. The new marketing rule, custody, conflicts of interest, and the growth of crypto assets and fintech are among the top priorities for the SEC’s Division of Examinations (EXAMS). Below, I’ve outlined the key areas of focus for the SEC’s examination for private fund managers.
A Significant Focus Area on the New Marketing Rule
The priorities note that the new Marketing Rule is a “significant change to a core examination review area” for RIAs. The new rule has significant requirements for fund managers pertaining to policies and procedures as well as substantive content requirements (i.e. performance, endorsements, etc.). The requirements have a significant impact on private fund managers, as they set new standards for the use of performance results and other information in marketing materials. Private equity fund managers are now required to provide additional disclosures about the basis for performance results, including the calculation method and the relevant period of time. For many, the new rule has required managers to invest in new systems and processes to ensure they have the necessary data to provide the required disclosures. The additional information can also be complex and difficult to communicate to investors in a clear and concise manner, which may require significant effort to ensure compliance with the new rule. These challenges highlight the importance of fund managers working closely with strong fund administration, legal, and compliance professionals to ensure that their marketing practices are in line with the new requirements.
RIAs to Private Funds
Private funds continue to grow, with over 5,500 RIAs managing approximately 50,000 private funds with gross assets exceeding $21 trillion. The SEC Division will focus on private fund managers, with a particular emphasis on conflicts of interest, calculation and allocation of fees and expenses, compliance with the new marketing rule, and compliance with the Custody Rule. They will also focus on private funds with specific risk characteristics, notably including private equity funds that use affiliated companies to provide services to funds and underlying portfolio companies and funds that hold difficult-to-value investments such as crypto and real estate investments.
To ensure accuracy in financial reporting and compliance with regulations, it is crucial for private fund managers to have a strong fund administration partner. This partner can help with the calculation and allocation of fees and expenses, including post-commitment period management fees, and assist with the timely delivery of audited financials. With the SEC’s continued focus on private funds, it is more important than ever to have a reliable and experienced fund administration partner to help navigate the complex regulatory environment.
Crypto Assets and Emerging Financial Technology
The SEC is keeping a close eye on the growth of investments in crypto assets and fintech, and will be conducting exams of RIAs offering new products and services or using “digital engagement practices,” which includes tools with behavioral prompts, differential marketing, gamification, features deigned to engage with retail investors on digital platforms (notably including portals and applications), and analytical tools. The focus of these exams will be on ensuring that these market participants have met and followed standards of care and have regularly reviewed, updated, and enhanced their compliance and risk management practices. With the recent turmoil among crypto market participants, the Division will also monitor and conduct exams of potentially impacted registrants. In short, crypto assets and digital investment practices will be under scrutiny, and it’s important for RIAs to have proper compliance and risk management procedures in place.
Focus Areas for Examination of RIAs
EXAMS remains focused on making sure that private fund managers are properly considering market factors that could impact the accuracy of their regulatory filings and operations. During an examination, the Division will review the compliance programs and disclosures of private fund managers in areas such as valuation, portfolio management, and brokerage and execution. They’ll also be looking for conflicts of interest and any compliance issues related to fees and expenses. In addition, they’ll review policies and procedures for retaining and monitoring electronic communications, as well as the selection and use of third-party service providers. The Division prioritizes private fund managers that have never been examined or those that haven’t been examined for a number of years. These exams typically focus on the firm’s compliance programs.
One of the key focus areas is Conflicts of Interest, which includes the examination of how firms identify, manage, and disclose conflicts that arise from the structure and operations of the funds they manage. The SEC will also review how firms handle conflicts arising from the use of affiliated service providers and the allocation of investment opportunities.
Another important area of focus for the SEC is Environmental, Social and Governance (ESG) practices. The SEC intends to examine firms’ ESG-related disclosures, including their compliance with SEC rules and regulations regarding ESG investment strategies. The examination will also focus on the accuracy of ESG-related performance claims and whether the firms have adequate controls and procedures in place to ensure that their ESG-related disclosures are accurate.
The SEC will also prioritize cybersecurity, examining firms’ protections against cyber threats and the effectiveness of their incident response plans. The SEC will evaluate firms’ information security policies and procedures, including how they protect against unauthorized access, theft, or misuse of confidential information.
With the SEC’s continued focus on alternative investments, fund managers should ensure they are informed and updated on regulatory changes. Having strong finance, legal, and compliance partners to assist is essential. With the robust changes to performance calculation and disclosures and with the upcoming sweeping Private Funds rule, having a strong fund administrator that understands the nuances of the regulatory environment and has the expertise to adapt is more important than ever.
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