On February 7, 2023, the SEC’s Division of Examinations (“Division” or “EXAMS”) issued its examination priorities for 2023. The Division highlighted the following areas of focus relevant to private fund sponsors:
- Advisers Act Marketing Rule. EXAMS will focus on private fund advisers’ compliance with amended Rule 206(4)-1 (“Marketing Rule”) under the Investment Advisers Act of 1940 (“Advisers Act”), including whether advisers 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.
- Advisers to Private Funds. EXAMS will continue to focus on private fund advisers, emphasizing such advisers’ practices and polices related to conflicts of interest, custody, Marketing Rule compliance, fees and expenses and use of alternative data. The Division will also closely examine advisers that manage private funds with specific risk characteristics, including, but not limited to, those that: (i) are highly leveraged; (ii) use affiliated service providers; (iii) hold certain hard-to-value investments, such as crypto or real estate-connected investments; (iv) invest in or sponsor Special Purpose Acquisition Companies (SPACs); or (v) are involved in adviser-led restructurings, including stapled secondary transactions and continuation funds.
- Standards of Conduct. EXAMS will address standards of conduct issues for private fund advisers, with an emphasis on how such advisers are satisfying their fiduciary duties under the Advisers Act to act in the best interests of investors and not place their own interests ahead of such investors’ interests. Examiners will review whether conflicts of interest disclosures are sufficient such that a client or investor can provide informed consent to the conflict, whether express or implied.
- ESG. EXAMS will focus on ESG-related advisory services of private fund advisers, including whether such advisers are adhering to the ESG investing approaches outlined in their disclosures. The Division will also examine the accuracy of ESG products’ labeling.
- Information Security and Operational Resiliency. EXAMS will review private fund advisers’ practices designed to prevent interruptions to mission-critical services and to protect investor information, records and assets. The Division will specifically assess whether advisers have taken appropriate measures to: (i) safeguard investor accounts and prevent account intrusions; (ii) oversee third-party vendors, service providers and products; (iii) disclose the location of investor records and information to the SEC when required; (iv) respond to certain cybersecurity incidents; and (v) continue to manage operational risk as a result of a dispersed workforce. EXAMS will also review advisers’ operational resiliency plans, with a focus on specific topics such as the impact of climate-related risks.
- Emerging Technologies and Crypto Assets. The Division will examine private fund advisers that use developing financial technologies and on-line solutions to assess whether the unique attendant risks of such activities are addressed by such advisers’ compliance programs.
Specifically, examinations will review the custody arrangements of advisers engaged with crypto assets as well as the related offer, sale, recommendation, advice and trading of such assets. The Division will also focus on whether advisers involved with such assets (i) met and followed their respective standards of care when making recommendations, referrals, or providing investment advice, to the extent required, and (ii) routinely reviewed, updated, and enhanced their compliance, disclosure, and risk management practices.
Additionally, where private fund advisers employ “digital engagement practices” to make investment recommendations, the Division will review such advisers’ approach to disclosure and risk mitigation and whether such recommendations were in the recipient investors’ best interests.
In announcing its priorities for 2023, the Division underscored core aspects of typical examinations of private fund advisers, including: (i) custody and safekeeping of client assets; (ii) valuation methodologies; (iii) portfolio management; (iv) conflicts of interest; and (v) processes related to fees and expenses, retaining and monitoring electronic communications and selecting and using third-party service providers.
While the Division will allocate significant resources to the examination of the above themes, the scope of any examination is determined through a risk-based approach and may analyze a number of factors in addition to the aforementioned priorities and core aspects.
 The Division clarified that “digital engagement practices” include tools with behavioral prompts, differential marketing, game-like features (commonly referred to as gamification), and other design elements or features designed to engage with retail investors on digital platforms (e.g., websites, portals, and applications), as well as the analytical and technological tools and methods.