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Securities and Exchange Commission (SEC) Identifies Investment Adviser, Investment Company Examination Priorities for 2013

On Feb. 21, 2013, the SEC’s National Examination Program (“NEP”) published its examination priorities for 2013. This annual memorandum informs investors and registrants on the “areas that are perceived by the staff to have heightened risk” of examination and supports “the SEC’s mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”

Although the comprehensive NEP memorandum addresses each of the its four distinct program areas – investment advisers and investment companies, broker-dealers, clearing and transfer agents, and market oversight – this client alert addresses only the examination priorities relating to the approximately 11,000 registered investment advisers and 800 registered investment company complexes for which the NEP has primary examination authority.

The NEP has identified several priorities for investment advisers and investment companies, organized under the categories of “Ongoing Risks,” “New and Emerging Issues,” and “Policy Topics,” utilizing a number of risk analytics and information sources.


  • Safety of Assets: Not surprisingly, the staff will continue to make a priority of confirming the safety of client assets and compliance with custody requirements, and will review the measures undertaken to secure client assets from loss or theft, audits of private funds, and the effectiveness of policies and procedures. Regarding the Custody Rule (Rule 206(4)-2), the staff will be making at least the following inquiries:
  1. Are you recognizing situations in which you in fact have “custody” as defined by the Custody Rule?
  2. Are you arranging independent “surprise exams” as required?
  3. Have you complied with the Custody Rule’s “qualified custodian” provision?
  4. Have you complied fully with the terms of the exception to the independent verification requirements for pooled investment vehicles?
  • Conflicts of Interest Related to Compensation Arrangements: Are there undisclosed compensation arrangements in existence resulting in conflicts of interest?
  • Marketing/Performance: In examining this “inherently high-risk area…,” the staff will focus on the accuracy of advertised performance, the assumptions or methodology utilized, and related disclosures and compliance with record-keeping requirements.
  • Conflicts of Interest Related to Allocation of Investment Opportunities: The staff intends to test controls in place to monitor the allocation of investment opportunities in circumstances where advisers are managing accounts that do not pay performance fees alongside accounts that do pay performance-based fees.
  • Fund Governance: What is the “tone at the top” at your investment company? Are your fund directors conducting reasonable reviews of information forwarded by advisers relating to contract approvals, oversight of service providers, valuation of fund assets, and assessment of expenses?


  • New Registrants-Hedge Funds and Private Equity: The NEP notes that the vast majority of the approximately 2,000 new investment adviser registrants are advisers to hedge funds and private equity funds, and have never been subject to SEC regulation or examination. As such, the NEP will launch a two-year, coordinated national examination initiative consisting of four phases:
  1. Engage with the new registrants;
  2. examine a substantial percentage of the new registrants;
  3. analyze examination findings;
  4. report observations to the industry.
  • Dually Registered IA/BD: The NEP memorandum highlights the conflicts of interest inherent in the dual registrant firms – the staff will review, among other things, how registered representatives and firms satisfy their suitability obligations when determining whether to recommend a brokerage or advisory account, what financial incentives are present and whether all conflicts are fully and accurately disclosed. A dual registrant firm must make inquiry on whether its policies and procedures provide adequate guidelines for when a registered representative makes a securities recommendation to a client with a brokerage account, as opposed to an advisory account.
  • “Alternative” Investment Companies: The SEC continues to emphasize its focus on sales of complex securities. The staff will focus here on the growing use of alternative and hedge fund investment strategies in open-end funds, ETFs and variable annuity structures.
  • Payments for Distribution in Guise: The staff intends to review the disclosure and propriety of the “wide variety…” of payments made by advisers and funds to distributors and intermediaries. Is your fund board aware of all such payments, and how does it review the propriety of such payments?


  • Money Market Funds: The staff will review whether investment companies are conducting appropriate stress testing to determine their ability to maintain a stable share price of money market funds in response to hypothetical scenarios, including changes in short-term interest rates, increased redemptions, downgrades and defaults and changes in spreads from selected benchmarks.
  • Compliance with Exemptive Orders: The staff will review compliance with previously granted exemptive orders, including for example those related to closed-end funds and managed distribution plans, employee securities companies, ETFs and the use of custom baskets and those granted to fund advisers and affiliates permitting co-investment with the funds.
  • Compliance with the “Pay to Play” Rule: Advisers are prohibited from securing government business in return for political “contributions.” Compliance with this rule will be tested.


As we have discussed with our investment adviser, investment company and dual registrant clients and friends, examination deficiencies can have serious ramifications, particularly in situations where the deficiencies at issue had previously been identified to the registrant for remediation. Indeed, several recent enforcement actions involving such registrants included (and emphasized) the facts that certain compliance failures had previously been flagged by examination staff. In light of the foregoing, it bears asking at minimum:

  • Have we conducted – and re-evaluated, as necessary – an effective risk assessment of our business activities?
  • Are our compliance policies and procedures designed to manage and control effectively the items identified by our risk assessment?
  • Have we remediated – and confirmed such remediation – any and all prior deficiencies pointed out by examination staff or found in our own review?
© 2022 Neal, Gerber & Eisenberg LLP.National Law Review, Volume III, Number 58

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