On October 16, 2023, the Division of Examinations (the “Division”) of the U.S. Securities and Exchange Commission (the “SEC”) announced its annual 2024 examination priorities (the “Examination Priorities”). In a break from its historical practice, the Division is aligning the Examination Priorities with the SEC’s fiscal year, releasing the Examination Priorities only eight months following the 2023 publication with the goal of better informing the industry of the current key risks, trends, and examination topics. This presumably should make it easier for industry participants to be properly prepared for examinations. Generally, the report highlights the Division’s continued focus on examination of advisers who have never been examined and those that have not been examined for several years. At the same time, by the Division’s own admission, given the shorter timeframe between publications, several priority areas from last year remain the same in 2024. In this regard, one noticeable absentee is ESG, which is not a specific priority for this year. We will focus our review on 2024 priorities affecting private fund advisers, followed by some other priority areas of note.
Investment Advisers to Private Funds
The Examination Priorities name several focus areas directly affecting private fund managers. Specifically, the report includes the following priority areas that the Division will review during private fund adviser examinations:
- Portfolio Management Risks. The SEC appears to be concerned with portfolio management risks present in an environment marked by market volatility and higher interest rates. The Division seems to suggest that private fund advisers experiencing poor performance, significant withdrawals, and valuation issues, and managing private funds with more leverage and illiquid assets may experience increased scrutiny under this focus area.
- LPAC and Similar Structures. The SEC will evaluate how private fund managers adhere to contractual requirements on limited partnership advisory committees (LPACs) and similar structures, including any notification and consent processes.
- Fees and Expenses. The Division intends to continue its historical focus on accurate calculation and allocation by private fund managers of fund fees and expenses at both the fund and investment level. In this regard, private fund managers should be mindful of the valuation of illiquid assets, post commitment period management fees, potential offsetting of fees and expenses, and the adequacy of fees and expenses disclosures.
- Due Diligence Practices. As part of its examination program, the SEC plans to assess private fund managers’ due diligence practices for consistency with their policies, procedures, and disclosures. In this regard, managers of private equity and venture capital funds should pay special attention to their assessments of prospective portfolio companies.
- Use of Affiliated Services Providers and Side-by-Side Management. The Division will review conflicts, controls, and disclosures around the use of affiliated services providers as well as with respect to private funds managed side-by-side with registered investment companies.
- Custody. With respect to compliance with the custody rule under the Investment Advisers Act of 1940 (“Advisers Act”), the SEC examination staff will focus on accurate Form ADV reporting and timely completion and distribution of private fund audits.
- Form PF. The Division plans to assess private fund managers’ adherence to policies and procedures for reporting on Form PF. The staff’s focus on Form PF is perhaps expected given the recent amendments to the form, specifically those related to reporting requirements after the occurrence of certain events.
Other Investment Adviser Priority Areas
- Fiduciary Standards. The Division will focus on fiduciary duties of all investment advisers. Advisers are required to abide by their duties of loyalty and care, and advice needs to be in the best interests of their clients. The SEC will assess these duties in various contexts such as complex products, high cost and illiquid products, and unconventional strategies. The staff will also evaluate how advisers address conflicts of interest, including whether disclosures made to investors include all material facts related to a conflict of interest and are sufficient to allow an investor to provide informed consent to the conflict.
- Economic Incentives for Adviser and Its Financial Professionals. The Division plans to evaluate competing economic incentives that advisers and their financial professionals may be subject to in light of revenue sharing and similar arrangements or when using affiliated firms for client services.
- Compliance Rule. The examinations remain focused on advisers’ compliance programs and annual reviews. In this respect, the Division may review one or more areas discussed in the adopting release of Rule 206(4)-7 under the Advisers Act (compliance rule): portfolio management processes; disclosures to investors and regulators; proprietary trading; safeguarding of client assets; accurate recordkeeping; privacy protection; trading practices; marketing advisory services; valuation practices; and business continuity plans. It appears that the SEC will pay particular attention to compliance with the new marketing rule, including such aspects of it as adoption and implementation of appropriate policies and procedures, accurate disclosures of marketing-related information on Form ADV, and proper maintenance of required books and records.
- Cybersecurity and Operational Resiliency. The SEC continues to be aware of the increase of the use of technology across the investment space and associated risks. The Examination Priorities lists cybersecurity as “a perennial focus area for all registrants.” Cybersecurity attacks, geopolitical concerns, and weather-related events remain areas of concern for the Division. The staff’s review will include registrants’ practices related to prevention of interruptions to mission-critical services; protection of investor information; maintenance of policies and procedures; internal controls; governance policies; oversight of third-party vendors; and provision of adequate training on identity theft prevention programs.
- Crypto Assets and Emerging Financial Technology. The SEC will continue to observe crypto assets and other emerging financial technology in the market. Examinations will assess such aspects as compliance with applicable standards of conduct, risk disclosures, operational resiliency, the custody rule, automated investment tools, and artificial intelligence.
This client alert is intended to serve only as a general overview and does not purport to be a full and complete discussion of the SEC’s 2024 examination priorities. Should you have any questions regarding the contents of this alert, please do not hesitate to contact anyone at Foley’s Fund Formation and Investment Management team.
 Sec. & Exchg. Comm’n Div. of Examinations, 2024 Examination Priorities (October 16, 2023), https://www.sec.gov/files/2024-exam-priorities.pdf.