by Robin M. Bergen, Elizabeth Lenas, Amber V. Phillips, and Anna Bintinger

The U.S. Securities and Exchange Commission (“SEC”) Division of Examinations (the “Division”) released its 2024 examination priorities on October 16, 2023 (the “2024 Priorities”), launching a new release schedule to align with the fiscal year. As in the 2023 examination priorities (the “2023 Priorities”), private fund advisers received special focus, with broad topic areas spanning both the existing Staff sweeps on custody, marketing and artificial intelligence, as well as renewed scrutiny of valuations and investment processes.  Despite its release causing much fanfare, there was surprisingly little overlap between the 2024 Priorities and the newly adopted Private Fund Adviser Rules; the focus on fees and expense allocation carried over from the Private Fund Adviser Rules, and the Division picks up a theme from its adopting release by taking a shot at limited partnership advisory committees (“LPACs”) and compliance with private fund governance procedures. 

The 2024 Priorities address private funds; standards of conduct (particularly fiduciary duties and conflicts of interest); information security and operational resiliency; emerging technologies and crypto; regulation systems compliance and integrity; broker dealers and exchanges; anti‑money laundering; oversight of the Financial Industry Regulatory Authority and Municipal Securities Rulemaking Board programs and policies; and oversight of municipal advisers, security-based swap dealers and transfer agents.

Key takeaways from the 2024 Priorities for investment advisers and fund sponsors include:

Are Fiduciary Duties Regarding Conflicts of Interest Expanding? 

The Division continues to focus on adviser conflicts of interest, stating that “an adviser is required to eliminate or make full and fair disclosure of all conflicts of interest which might incline the adviser—consciously or unconsciously—to render advice which is not disinterested such that a client can provide informed consent to the conflict.”  Notably, while the 2023 Priorities used the longstanding terminology of an adviser “managing” conflicts of interest (including by mitigating or eliminating the conflict, but also via disclosure), the Staff seems to have moved away from allowing mere management in favor of requiring mitigation or elimination  This stronger stance has been reflected in recent enforcement actions, and we expect further enforcement activity on this theme. Likewise, the recently proposed rules on the use of predictive data analytics and AI require that conflicts of interest in such models be eliminated (or the models be abandoned), with no option for management of such conflicts.

One conflict of particular focus is the economic incentives associated with advisers that are dually registered as broker-dealers, use affiliated firms to perform client services, and/or have financial professionals servicing both brokerage customers and advisory clients.  Investment advice regarding proprietary products and affiliated service providers that result in additional or higher fees to investors have been the subject of recent enforcement actions, and advisers should carefully review both their disclosures and compliance procedures with respect to the charging of such fees.

Where advisers rely on informed consent to clear conflicts, the Staff have indicated two avenues of scrutiny with respect to the adequacy of such consent.  First, they intend to examine whether disclosures made to investors include sufficient material facts relating to a conflict of interest to allow informed consent to be given.  Second, where consents are instead obtained from LPACs or similar structures (e.g., advisory boards), they intend to scrutinize adherence to any contractual notification and consent processes.

Compliance Programs Will be Scrutinized from all Angles

The adequacy of compliance programs is a perennial target, with the Staff providing a laundry list of focus areas: (1) portfolio management processes; (2) disclosures made to investors and regulators; (3) proprietary trading by the adviser and the personal trading activities of supervised advisory personnel; (4) safeguarding of client assets from conversion or inappropriate use by advisory personnel; (5) the accurate creation of required records and their maintenance in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction; (6) safeguards for the privacy protection of client records and information; (7) trading practices; (8) marketing advisory services; (9) processes to value client holdings and assess fees based on those valuations; and (10) business continuity plans.

Compliance program reviews will also more broadly assess whether policies and procedures are sufficient to support compliance with advisers’ fiduciary obligations, in particular with respect to conflicts created by the advisers’ business arrangements or affiliations and related to adviser fees and expenses.  Relatedly, and perhaps in response to recent high profile fraud cases like FTX, the Staff is focused on compensation arrangements, particularly with respect to the advisers’ receipt of compensation for services or other material payments made by clients and others.

Marketing Rule Sweeps will Continue 

Policies and procedures supporting compliance with the Marketing Rule, particularly with respect to disclosure, substantiation and maintenance of required records, were added as a focus in 2023 and remain a priority, suggesting that enforcement activity from the 2023 Marketing Rule sweeps will extend into 2024.  In addition to a general focus on disseminated advertisements, testimonials and endorsements, and marketing rule disclosures in Form ADV are also subject to scrutiny.  Given the overlap in performance metrics between many adviser advertisements and the quarterly statements required under the new Private Fund Adviser Rules, advisers should take care that their marketing practices incorporate Staff guidance from that adopting release.

Use of Service Providers and Expert Networks Scrutinized for both Conflicts and Supervision 

The Division is continuing its focus on an adviser’s policies and procedures for selecting and using third-party and affiliated service providers. These arrangements are being viewed from several angles – for management of related conflicts (as discussed above) when engaging such service providers, as part of a focus on fees and expenses, and (new this year) as part of a more general review of the adviser’s supervision of the provided services and maintenance of appropriate technology infrastructure.  This examination activity will likely serve as data gathering to inform the final version of the SEC’s proposed Outsourcing Rule.

More broadly, the Division has introduced a focus on advisers’ controls to protect clients’ material non-public information and other sensitive data, particularly when multiple advisers share office locations, have significant turnover of investment adviser representatives, or use expert networks.  The Division has also introduced a focus on overseeing branch offices when advisers operate from numerous or geographically dispersed locations (likely to be a headache for advisers with extensive “work from home” policies).  When taken together, these topics speak to the adviser’s role as supervisor, responsible for monitoring (and documenting) compliance of all service providers, consultants and employees with the securities laws wherever and however services are provided.

Private Funds Adviser Focus Areas Expand

• The Division has increased its attention on the rising interest rate environment, and is focusing in particular on the portfolio management risks present when there is exposure to recent market volatility and higher interest rates, including funds experiencing poor performance, significant withdrawals, and valuation issues around illiquid or difficult to value assets. Staff also intend to focus on the due diligence process for investments (particularly private equity and venture capital investments) to ensure portfolio company assessments are consistent with fund policies, procedures and disclosures.
• The Division added a new focus on the adherence to contractual notice and consent requirements for LPACs and similar bodies. The inadequacy of LPACs as a fund governance body was a primary theme in the Private Fund Adviser Rules adopting release, and is likely to be used by the SEC in defending those rules against recently filed legal challenges.  This exam area may be intended to gather information on LPAC practices to bolster those efforts.
• In addition to a general focus on fees and expenses for all advisers, the Staff have zeroed in on accurate calculation and allocation of private fund fees and expenses (both fund-level and investment-level), including valuation of illiquid assets, calculation of post commitment period management fees, adequacy of disclosures, and potential offsetting of such fees and expenses.  Again, given the overlap with the quarterly statements that will be required under the Private Fund Adviser Rules, advisers should take note of that adopting release guidance with respect to the calculation and disclosure of such fees and expenses.
• The Division is carrying forward its Custody Rule sweep, likely to add support for the upcoming final Safeguarding Rule.
• The Division added a focus on policies and procedures for reporting on Form PF, which will be a headache for compliance teams working to implement recent revisions to Form PF reporting while keeping an eye on additional amendments in the pipeline.

Information Security and Operational Resiliency Remain a Focus 

The Staff noted that given the continued risks for cyberattacks, cybersecurity in particular is a focus area for all registrants, particularly the adequacy of policies and procedures, oversight of third‑party vendors, and internal controls. The SEC has enhanced cybersecurity proposals waiting in the wings for both advisers and broker-dealers, and we expect that examination activity with respect to information security will be used to bolster the case for those rules when adopted.

Crypto Focus Broadens into Custody 

The Division is continuing its focus on the crypto area, as well as other emerging financial technology. Examinations in this area, like in the 2023 Priorities, will focus on the offer sale, recommendations of, advice regarding, trading in, and other activities in crypto assets or related products, with a specific focus on meeting standards of care and routinely reviewing and updating compliance procedures regarding these activities. The Division also added a related focus on assessing whether any technological risks associated with the use of blockchain and distributed ledger policy have been addressed in compliance policies and disclosures. This priority, coupled with the continuing focus on custody, may suggest a more aggressive stance from Staff in exams.  Finally, the Division remains focused on emerging technologies generally, including automated investment tools, artificial intelligence, trading algorithms or platforms, and alternative sources of data.

Anti-Money Laundering 

Anti-money laundering was a significant priority in 2023. Following several recent enforcement actions, the Division is extending this focus into 2024. The Division will review policies and procedures for oversight of applicable financial intermediaries, and look for documentation that broker-dealers and advisers are monitoring Office of Foreign Assets Control sanctions and ensuring compliance with such sanctions.  While not mentioned in the 2024 Priorities, advisers should ensure their policies and procedures address compliance with the Corporate Transparency Act, which comes into effect in the new year.

As with previous years, the Division stated its intention to prioritize examinations of advisers that have never been examined, including recently registered advisers, and those that have not been examined for a number of years.

Robin M. Bergen and Elizabeth Lenas are Partners, Amber V. Phillips is an Associate, and Anna Bintinger is an incoming Associate at Cleary Gottlieb Steen & Hamilton LLP. This post first appeared on the firm’s blog.

The views, opinions and positions expressed within all posts are those of the author(s) alone and do not represent those of the Program on Corporate Compliance and Enforcement (PCCE) or of the New York University School of Law. PCCE makes no representations as to the accuracy, completeness and validity or any statements made on this site and will not be liable any errors, omissions or representations. The copyright or this content belongs to the author(s) and any liability with regards to infringement of intellectual property rights remains with the author(s).