In an important break from past practice, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) is reported to be conducting routine examinations of investment advisers to venture capital funds and certain other private funds. Such investment advisers, known as Exempt Reporting Advisers (ERAs), are not required to register with the SEC but they are required to file reports with the agency. Until now, OCIE had conducted examinations ERAs sparingly and only “for cause,” i.e. when the agency had a tip about wrongdoing or some other reason to believe that an examination was warranted. That has now changed. According to news reports, OCIE’s Acting Director Mark Wyatt recently remarked during an ABA panel that the agency is beginning to conduct routine examinations of ERAs. This means that the 3000+ ERAs may now face the risk of having SEC examiners show up at their doors for the kind of “routine” examination that registered investment advisers typically undergo. And, if such examinations uncover serious deficiencies, ERAs can expect that OCIE will refer the matter to the SEC’s Division of Enforcement for further investigation and possible enforcement proceedings.

Background. In the 2010 Dodd Frank Act, Congress amended the Investment Advisers Act of 1940 to remove a blanket exemption for private fund and venture fund advisers, replacing it with a more limited exemption and creating a new, narrow class of advisory firms: Exempt Reporting Advisers. ERAs include: (a) advisers to venture capital funds, and (b) advisers to private funds with less than $150 million in assets under management. Under SEC rules passed in 2011, ERAs must report certain information on Form ADV via the SEC’s IARD/FINRA system, and such information is publicly available. ERAs, like registered investment advisers, are subject to the anti-fraud provisions of the Advisers Act, as well as the requirement under Advisers Act Section 204 to implement policies and procedures designed to prevent the misuse of material nonpublic information. Further, the rules provide that ERAs are subject to SEC inspection by OCIE. Significantly, however, the SEC affirmed in the Implementing Release for the new rules that “we do not anticipate that our staff will conduct compliance examinations of these advisers on a regular basis,” and instead would conduct exams based only when there is an indication of wrongdoing. Implementing Release at 48. The June 22, 2011 Implementing Release for the rules is available here:

The Change in Course. During an ABA panel on hedge funds on November 20, 2015, Mr. Wyatt reportedly disclosed that OCIE is now conducting routine examinations of ERAs. Since then, practitioners have been waiting for more official confirmation from the SEC about this policy change, but no further comment has been forthcoming.

The expansion of OCIE’s examination practices towards ERAs should not come as a total surprise. In 2014 and 2015, the SEC increased the number of exams of registered private equity and other fund investors, signaling the agency’s increasing focus on private funds. Further, until he became acting OCIE director, Mr. Wyatt was co-head of OCIE’s specialized Private Funds Unit, which was created in 2014 to bring expertise and focus to examinations of private funds. Moreover, the 2011 rules were hotly debated and adopted by only a 3 to 2 vote, with the dissenting commissioners predicting that the SEC staff would gradually seek to collapse the distinction between registered advisers and ERAs, including expanding “the Form ADV and examination obligations.” See Statement by Commissioner Casey at June 22, 2011 Open Meeting, available here: and Statement by Commissioner Paredes at June 22, 2011 Open Meeting, available here: Finally, according to SEC Budget Request documents, OCIE staff has increased by over 17% since FY2012, and the SEC has asked Congress to grow OCIE by an additional 14% for FY2016. All of these new examiners need to be examining someone, and it appears that ERAs are one of the new targets.

What ERAs Can Expect. The SEC notes that OCIE decides what exams to conduct, and where to focus during exams, using “risk analysis.” See This contrasts with the OCIE approach prior to the Madoff scandal, in which examinations were scheduled based upon a pre-set cycle in which most registrants received the same number of routine SEC exams over time. Now, OCIE uses data analytics, market intelligence, and learnings from other examinations to drive which registrants are selected for routine examinations, and what to focus on during those inspections. Further, a sizeable number of examinations each year are part of “sweeps” aimed at particular issues, like the cybersecurity sweep conducted by OCIE in 2014 and 2015.

As OCIE begins adding ERAs to its routine examination list, we would expect that only a limited percentage of OCIE resources will be dedicated to such examinations. OCIE likely has particular ERAs or particular issues at ERAs already identified as its focus. As OCIE gets more resources and gains momentum in this area, ERAs will face an increasing risk of landing on OCIE’s examination list.

Bottom Line.  Exempt Reporting Advisers are at greater risk of examination and all its consequences—including referral to the enforcement arm of the SEC.  ERAs who are contacted by the SEC examination staff should get advice from experienced SEC counsel before engaging in the process in order to avoid common missteps, potential pitfalls, and collateral damage.  This is especially important because although the examination may be “routine,” SEC examination staff are increasingly working hand-in-glove with the specialized SEC enforcement attorneys in the Asset Management Unit.  Information uncovered in an SEC examination can—and is—quickly shared with enforcement attorneys.  And, while ERA’s will be on notice of an examination, they may not be on notice that the Enforcement Division is quietly conducting a parallel enforcement investigation of the entity undergoing an examination.  Given the severe and far-reaching remedies available to SEC enforcers, any entity undergoing an examination should devote resources and attention to help ensure that today’s “routine” examination does not turn into tomorrow’s unprecedented enforcement investigation.