Consistent with recent speeches and other public statements, on October 9, 2012, the Office of Compliance Inspections and Examinations National Exam Program ("NEP") of the U.S. Securities and Exchange Commission published formal notification of its new "Presence Examination" initiative. The notification is addressed to the senior executives of private investment fund advisers that have recently registered with the SEC as a result of Dodd-Frank. The notification states that the initiative will take place over the next two years and has three primary phases: engagement, examination and reporting.
The engagement phase involves the outreach to private fund firms to inform them of applicable laws and regulations as well as the availability of NEP resources such as the SEC's website, NEP publications and NEP compliance-outreach meetings and seminars.
The examination phase addresses the various areas the NEP staff will likely look at during the course of the exam. This is also useful information for investment advisers that have been registered with the SEC for a while, because it reflects the staff's sense of what the major risk areas are within a private fund adviser. The notification states that the staff will review "one or more" of the following areas:
- Review materials for false or misleading statements about firm or performance
- Review materials for fraud
- Review how investors are solicited, including the use of placement agents
- Review and evaluate portfolio decision-making practices
- Review allocation of investment opportunities
- Review whether practices are consistent with disclosures
Conflicts of Interest
- Review allocation of investments, fees and expenses
- Review sources of revenue
- Review fund payments to the adviser and related persons
- Review employees' outside business activities
- Review employees' personal securities trading
- Review transactions by the adviser with affiliated parties
Safety of Client Assets
- Review advisers' compliance with rules that are designed to prevent the loss or theft of client assets
- Review independent audits of private funds
- Review valuation policies and procedures
- Review methodology for fair valuing illiquid or difficult to value investments
- Review procedures for calculating management and performance fees
- Review procedures for allocating expenses to the funds
The reporting phase involves the NEP reporting its observations to the SEC and to the public. Such observations may include common practices, industry trends and significant issues. The NEP hopes that by sharing its observations from the examination phase, all firms will review their practices in the applicable areas and, if necessary, be able to improve their compliance programs.
The notification also includes a list of additional reference materials, including the Investment Advisers Act of 1940, as amended, information about the NEP and examinations, information about higher-risk compliance areas, and the role of senior management in compliance. A copy of the notification is available on the SEC's website.