Rules, Risk Alerts, and Exam Priorities: A Reflection on 2023 and Preparation for 2024
Main Contributor: Elizabeth Cope, CPA, CSCP, CIPM, CEO & Lead Consultant
New Rules Adopted in 2023
The Securities and Exchange Commission (“SEC”) was busy in 2023 adopting several new rules, with private funds having the greatest impact as a result of the new private fund rule and changes to Form PF. Below is a quick summary of each rule impacting investment advisers:
Proxy Fund Reporting
The SEC adopted amendments to Form N-PX to require institutional investment managers (those that file 13F or are subject to filing 13F) to file Form N-PX annually through EDGAR to identify and report on executive compensation (“say-on-pay”) votes. For advisers that do not vote proxies, Form N-PX must be filed to indicate the Firm does not vote proxies. The first filing is due August 31, 2024, to include all votes made during the period July 1, 2023, through June 30, 2024. Note: Even if you do not vote proxies, you will need to file the form N-PX to indicate as such.
Shortening the Securities Transaction Settlement Cycle
The SEC amended Rule 15c6-1 to shorten the standard settlement cycle for most securities transactions from two business days after the trade date (T+2) to one (T+1). As a result of the transition, the SEC also adopted Rule 15c6-2 for broker-dealers and amended Rule 204-2 under the Advisers Act. On the compliance date of May 28, 2024, investment advisers subject to this type of securities trading must make and keep records of each confirmation received, and of any allocation and each affirmation sent or received, with a date and time stamp for each indicating when it was sent or received. Rule 15c6-1 includes all securities with the exception of a contract for an exempted security, government security, municipal security, commercial paper, bankers’ acceptance, or commercial bill.
Form PF Reporting Amendments
For this rule, there are two separate effective/compliance dates for the amendments to Form PF for private fund advisers. For new sections 5 and 6, the effective/compliance date is December 11, 2023. For the amended, existing sections, the effective/compliance date is June 11, 2024.
Large Hedge Fund Advisers – with at least $1.5 billion in hedge fund assets under management
Triggered Filing: Large Hedge Fund Advisers must file a current report within 72 hours from the occurrence of the following trigger events at a qualifying hedge fund (at least $500 million in net asset value): (a) certain extraordinary investment losses (defined as 20% or more); (b) significant margin and default events; (c) terminations or material restrictions of prime broker relationships; (d) critical operations events; and (e) events associated with withdrawals and redemptions. This will be completed in Section 5 of the new Form PF.
Private Equity Fund Advisers – with at least $150 million in private equity fund assets under management
Quarterly Filing: Within 60 days of the end of each fiscal quarter, each private equity fund adviser must file a private equity event report detailing: (a) the completion of an adviser-led secondary transaction (in which the adviser offered investors the choice to sell or exchange their interests in a private fund); or (b) investor election to remove a fund’s general partner, to terminate a fund’s investment period or to terminate the fund during the preceding quarter. This will be completed in Section 6 of the new Form PF.
Large Private Equity Fund Advisers – with at least $2 billion in private equity fund assets under management
Annual Filing: Large Private Equity Fund Advisers must disclose a range of new information in their annual updates to Form PF, including: (a) information about the implementation of general partner and certain significant limited partner clawbacks; (b) details about a fund’s investment strategies; (c) additional information about fund-level borrowings, including the average amount borrowed over the reporting period; (d) more granular information about the nature of reported events of default; (e) additional identifying information about institutions providing bridge financing; and (f) information about a fund’s greatest country exposures. This will be completed in Section 4 of the new Form PF.
Money Market Fund Reforms
The SEC has amended rules that govern money market funds under the Investment Company Act of 1940 as follows.
Increase of the Minimum Daily and Weekly Liquidity Requirements
The liquidity requirements will be increased to at least 25% of the fund’s total assets in daily liquid assets and at least 50% of the fund’s total assets in weekly liquid assets.
Firms must be in compliance with this requirement by April 2, 2024.
Removal of Temporary Redemption Gates
The amended rule will remove the money market funds’ ability to impose temporary gates to suspend redemptions and the regulatory tie that permits funds to impose liquidity fees if weekly liquid assets fall below the required threshold.
Firms must be in compliance with this requirement by October 2, 2023.
Liquidity Fee Requirement
Institutional prime and tax-exempt money market funds will be required to impose mandatory liquidity fees when the fund experiences daily net redemptions that exceed 5% of net assets unless the fund’s liquidity costs are de minimis. Non-government money market funds must impose a discretionary liquidity fee if the fund’s board determines that a fee is in the best interest of the fund.
Firms must be in compliance with the discretionary liquidity fee requirement by April 2, 2024, and the mandatory liquidity fee requirement by October 2, 2024.
Negative Interest Rates
To handle negative interest rates, retail and government money market funds may either convert from a stable share price to a floating share price or reduce the number of shares outstanding to maintain a stable net asset value per share, subject to board determinations and disclosures to investors.
Firms must be in compliance with this requirement by October 2, 2023.
Calculation of Weighted Average Maturity and Weighted Average Life
The amended rule specifies the calculations of “dollar-weighted average portfolio maturity” (“WAM”) and “dollar-weighted average life maturity” (“WAL”).
Firms must be in compliance with this requirement by April 2, 2024.
Reporting Requirements
Certain reporting forms have been amended to improve transparency, including Form N-CR, Form N-MFP, and Form PF.
Firms must be in compliance with these requirements by June 11, 2024.
Modernization of Beneficial Ownership Reporting
The SEC amended the rules for Schedule 13D to shorten the initial filing deadline from 10 days to 5 business days and all amendments to be filed within 2 business days of any material changes. For 13G filers who are qualified institutional investors and exempt investors in which the investor owns 5% of the covered class, the initial filing deadline has been shortened from 45 days following the calendar year to 45 days following the calendar quarter. For 13G filers who are passive investors, the filing deadline for the initial filing has been shortened from 10 days to 5 business days. Further, the filing deadline for 13G amendments changed from 45 days after year-end to 45 days after quarter-end and only “material” changes trigger an amendment instead of “any” changes. Compliance with this requirement is effective for Schedule 13D filers beginning February 5, 2024, and for Schedule 13G filers beginning September 30, 2024.
Private Fund Rule
The SEC adopted new rules specific to advisers of private funds. For private fund advisers registered with the SEC, the following new requirements apply:
Quarterly Statement Rule
A quarterly statement must be provided to all investors that includes, in table format, information on specific performance metrics and a detailed accounting of all fees and expenses incurred by and or allocated to the fund. It must also be accompanied by disclosures to assist the investor in understanding the calculations and methodologies applied.
Financial Statement Audit Rule
Advisers to SEC-registered private funds must cause the private funds to undergo a financial statement audit that meets the audit provisions of the current custody rule under the Investment Advisers Act. Surprise exams are no longer sufficient.
Adviser-Led Secondaries Rule
Advisers and their related parties who initiate transactions that offer the private fund investors the choice between (1) selling all or a portion of their interests in the fund and (2) converting or exchanging all or a portion of their interests in the fund for interest in another vehicle advised by the adviser or its related persons must obtain either a fairness opinion or valuation opinion that must be distributed to the investors. Further, disclosure of the material business relationships between the adviser and the independent opinion provider for a 2-year period must be provided to the investors.
All private fund advisers, whether registered with the SEC or not, must comply with the following requirements.
Restricted Activities Rule
Advisers to the funds must not engage in specific activities without disclosure and in some cases consent.
Preferential Treatment Rule
Advisers to the funds are prohibited from providing preferential treatment to any fund investor without notifying other fund investors. Additionally, advisers are explicitly prohibited from providing preferential treatment to investors regarding certain redemptions and preferential information on holdings or exposures.
Compliance Dates
For the Quarterly Statement Rule and the Financial Statement Audit Rule, the compliance date is March 14, 2025.
For the Adviser-Led Secondaries Rule, the Restricted Activities Rule, and the Preferential Treatment Rule, the compliance date for fund advisers with $1.5 billion or more in assets is September 14, 2024, and for fund advisers with less than $1.5 billion in assets is May 14, 2025.
SCS produced a 4-Part series on our Resources page, breaking down the requirements even further.
Written Documentation of Annual Review
Within the aforementioned private fund rule, the SEC imposed a requirement for all investment advisers to document a written annual review. The compliance date for this requirement was November 13, 2023.
Fund Name Rule
The Fund Name rule under the Investment Company Act of 1940 has been amended to expand the requirement that 80% of the investments are consistent with the Fund Name. The primary types of names anticipated to cover are ones with the terms “value,” “growth,” or any thematic focus, such as ESG. For Funds that hold derivatives, the notional amount rather than the market value must be used to determine compliance with the 80% rule. This determination must be reviewed no less than quarterly and if out of compliance, Firms generally have 90 days to get back into the 80% requirement. Finally, changes to their investment policies regarding the 80% rule require shareholder approval for closed-end funds and business development companies. The compliance date is December 11, 2025, for fund groups with net assets of $1 billion or more and June 11, 2026, for fund groups with net assets of less than $1 billion.
Short Position and Short Activity Reporting
The SEC has adopted Rule 13f-2 for Institutional Investment Managers (includes (i) an entity that invests in or buys and sells securities for its own account and (ii) an entity or a natural person that exercises investment discretion with respect to the account of any other entity or natural person) that meet or exceed certain reporting thresholds to file Form SHO through EDGAR within 14 calendar days after the end of each calendar month with regard to certain short position and short activity data for certain equity securities. Firms must be in compliance with this reporting requirement by January 2, 2025.
Investment Adviser Representative Continuing Education Requirements
Certain U.S. states have adopted a model rule for continuing education (“CE”) that was developed by the North American Securities Administrators Association (“NASAA”). The rule requires any investment adviser representative (“IAR”) registered in one of those states to complete continuing education requirements on an annual basis. The rule applies to IARs who work for both SEC-registered and state-registered Firms. The rule requires 12 credits to be completed annually, 6 in ethics and 6 in products and practices. You can read more about it in our article.
Risk Alerts from 2023
Each year the SEC provides us with Risk Alerts, which are generally the result of their examinations and, in my opinion, a warning for advisers to address these risk areas proactively. Below is a summary of the risk alerts impacting investment advisers in 2023:
Observations from Examinations of Newly Registered Advisers
On March 27, 2023, EXAMS published a risk alert providing a summary of focus areas reviewed during examinations of newly-registered investment advisers and a summary of the observations made regarding compliance policies, disclosures and marketing practices. You can read our article here.
Safeguarding Customer Records and Information at Branch Offices
On April 26, 2023, EXAMS published a risk alert providing a summary of observations from exams of investment advisers that had multiple offices, particularly around the safeguarding of customer records and information. You can read our article here.
Examinations Focused on Additional Areas of the Adviser Marketing Rule
On June 8, 2023, EXAMS published a risk alert to summarize the additional areas of focus during examinations related to adherence to the Marketing Rule. This risk alert does not summarize findings or areas of potential improvement.
Assessing Risks, Scoping Examinations, and Requesting Documents
On September 6, 2023, EXAM published a risk alert describing its process for selecting advisers for examination and determining risk areas to examine. This risk alert does not summarize findings or areas of potential improvement.
Exam Priorities for 2024
Annually, the SEC publishes its exam priorities, which includes its focus areas for investment advisers, with this version coming a bit earlier than usual, in November of 2023. Within the priorities report, the SEC provided the following focus areas for investment advisers. This is a good opportunity to circle back to your Firm’s policies and procedures and annual review testing to identify any potential changes, improvements, or training as it relates to the following topics.
Investment Advice
They will focus on the investment advice provided to clients specifically as it relates to complex, high cost, illiquid products, and unconventional strategies. The emphasis will be on older investors and those saving for retirement. They do not indicate what they are looking for or what the adviser needs to do in regard to this area of focus, but in our opinion, Firms must have solid documentation to support that the investment advice is in the client’s best interest, with clear and distinct disclosures on the risks and fees associated. Further, the staff will focus on suitability documentation, how advisers seek and document best execution, how advisers evaluate costs and risks associated with their investment advice, and how the firm is identifying and either disclosing and mitigating or avoiding conflicts of interest. If the Firm has a financial incentive to recommend particular products or services, the SEC will also address with heightened concern given the additional conflict presented.
Marketing Practices
The SEC will continue to focus on the Firm’s marketing practices as it relates to adherence to the Marketing Rule. You can receive a copy of our eBook on the Marketing Rule here. They are focusing on the marketing policies and whether they are tailored to the Firm’s practices, consistent with ADV Part 1, Item 5, and whether advisers have the documentation to substantiate material statements of fact.
Valuation
If your firm recommends securities that are illiquid or difficult to price, the staff is going to focus on your Firm’s valuation procedures for reasonably designed policies and consistency with actual practice.
Insider Information
They will continue to review the Firm’s procedures for monitoring and detecting material non-public information. If the firm has multiple advisers sharing offices, significant turnover, or expert network use, a higher focus will most likely be made in this area.
Private Fund Managers
We have seen firsthand that the SEC is focusing on private fund managers, and with the new private fund rule recently adopted, we suspect that will only increase. In the exam priorities, they specifically called out the areas they plan to focus on when examining private fund managers. This includes the Firm’s portfolio management process, specifically in volatile markets; adherence to contractual requirements; the accurate calculation and allocations of private fund expenses; the adviser’s due diligence process with respect to underlying portfolio companies of private equity and venture capital Firms; the proper identification and disclosure of conflicts; compliance with the custody rule; and procedures on accurately and timely completing Form PF.
Other Areas
Other areas addressed for investment advisers include the Firm’s controls and practices around cybersecurity threats. Given the heightened risk in this area for the entire financial services industry, the SEC is going to focus on the Firm’s written procedures, internal controls, due diligence of third-party service providers, and governance practices.
Further, the SEC will continue to pay more attention to Firms that recommend digital assets given the continuing volatility in the market.
Conclusion
While 2023 was a busy year with several new rules, risk alerts, and exam priorities, the potential overwhelm can be overcome by focusing on the consistency of the SEC’s message. Over-disclose, make timely filings, ensure your policies match your practices, complete your due diligence, and act as a fiduciary around every corner. Advisers are in the business of assisting their clients and ensuring investor protection, which results in a slew of regulations and a great responsibility to be transparent and detail-oriented in every aspect of your compliance program. This yearly round-up is a good opportunity to circle back to your Firm’s policies and procedures and annual review testing to identify any potential changes, improvements, or training. It’s not a matter of if, but rather when you will be examined by the SEC. Keeping yourself abreast of these updates in the industry is a critical aspect of keeping your compliance program current and adequate. SCS is always here to assist advisers in implementing these new rules, risk alerts, and exam priorities – reach out with any questions you and your team may have!