The SEC’s recent risk alert on investment adviser annual compliance reviews provides a roadmap for what the Division of Examinations is focusing on when evaluating registered investment advisers. While the observations apply broadly to SEC-registered advisers, private fund managers should see the alert as a reminder that annual compliance reviews are increasingly being scrutinized as a substantive compliance function rather than a simple annual exercise.
The message is clear: annual compliance reviews should be thorough, risk-based, well documented and tied directly to the adviser’s actual business practices.
Why This Matters
The SEC’s examination staff identified deficiencies involving the timeliness of annual reviews, the adequacy of review procedures, alignment between policies and practices, documentation and remediation. Collectively, these observations suggest that regulators are focused not only on whether reviews occur, but also on how they are conducted and whether firms follow through on identified issues.
For private fund managers, annual reviews often become a focal point during SEC examinations because they provide insight into the overall effectiveness of the adviser’s compliance program.
Key Lessons for Private Fund Managers
1. Conduct the Review Every Year Without Exception
The SEC identified advisers that failed to perform annual reviews on a timely basis.
Examples included:
- Missing annual review periods entirely
- Conducting reviews more than 12 months apart
- Delays caused by CCO departures or organizational changes
- Assuming training programs or annual certifications satisfied the annual review requirement
Private fund managers should ensure annual reviews remain on schedule regardless of staffing changes, operational disruptions or growth periods.
2. Develop a Written Review Methodology
The SEC found that many advisers had policies requiring annual reviews but lacked procedures for conducting them. Common weaknesses included a lack of testing methodology, guidance on risk assessments, documentation standards and criteria for evaluating control effectiveness.
A review process should clearly define how testing will be performed, how results will be evaluated and how conclusions will be documented.
3. Review Areas the SEC Considers ‘High Risk’
Private fund managers often focus heavily on trading and portfolio management but may overlook compliance areas receiving significant regulatory attention.
The risk alert highlighted several areas where annual reviews failed to identify deficiencies, including:
- Fee and expense practices
- Marketing Rule compliance
- Custody compliance
- Regulatory filings and disclosures
- Oversight of delegated or outsourced responsibilities
Annual reviews should devote proper attention to the areas that present the greatest compliance risk based on the firm’s operations and business model.
4. Ensure Policies Match Actual Practices
A recurring SEC concern involved advisers whose policies did not reflect actual operations. Examples included proxy voting procedures that differed from actual practices, outdated marketing policies, missing oversight procedures for outsourced activities and regulatory filing procedures that no longer reflected current requirements.
The SEC’s observations suggest that examination findings often arise when policies, disclosures and business practices become misaligned. Annual reviews offer an opportunity to find and address those gaps before they become examination findings.
Best Practice: Perform a “policy-to-practice” comparison.
For each major compliance area, ask:
- What does the policy require?
- What does management do?
- What does Form ADV disclose?
- What do the fund documents disclose?
This exercise can be particularly valuable for private fund advisers that have experienced rapid growth, launched new strategies, expanded operations or made significant organizational changes.
5. Focus on Business Changes
The SEC emphasized that firms should evaluate changes in business activities when conducting annual reviews.
As firms introduce new products, modify fee arrangements or expand operations, compliance programs should evolve alongside those changes. Private fund managers should consider organizational, strategic, operational and regulatory changes when evaluating whether their compliance programs stay aligned with the business.
The annual review should document how these changes affected compliance risks and whether policies and procedures were revised accordingly.
6. Strengthen Documentation
The risk alert highlighted the importance of maintaining documentation that supports the annual review process.
The SEC observed advisers that conducted annual reviews but failed to maintain supporting documentation. In other instances, firms required reports, workpapers or templates under their own procedures but failed to complete or retain them.
When documenting testing, regulators should be able to understand:
- What was tested
- How it was tested
- What exceptions were identified
- How issues were resolved
If the SEC cannot see evidence of testing and conclusions, it may conclude the review was inadequate.
7. Track and Complete Remediation Efforts
The SEC’s observations made clear that identifying issues is only one part of the annual review process. The SEC observed advisers that identified deficiencies, recommended corrective actions and documented remediation plans, yet failed to implement those corrective actions or address the underlying issues.
Private fund managers should establish a process to assign ownership, monitor remediation efforts and confirm that corrective actions have been completed.
Practical Questions Every Private Fund Manager Should Ask
- Did we complete our last annual review within the required timeframe?
- Were all previously identified corrective actions completed?
- Do our policies and procedures accurately reflect our current business and operations?
- Did we perform sufficient testing to support our conclusions, and is that testing adequately documented?
- Do fee and expense allocations align with fund governing documents and disclosures, and have any exceptions occurred?
- Are marketing materials compliant with the Marketing Rule, and can performance claims be substantiated?
- Are valuation policies being applied consistently and supported by proper documentation?
- Are key service providers and outsourced functions subject to proper oversight?
- Is Form ADV accurate, and are all required regulatory filings current?
Final Thoughts
The SEC’s risk alert demonstrates that annual compliance reviews are more than a procedural requirement. Examiners are increasingly evaluating whether advisers conduct a meaningful, risk-based assessment of their compliance program and whether the review leads to action when issues are identified.
For private fund managers, the annual review should function as a compliance health check that examines key risk areas, evaluates whether policies align with actual practices and assesses whether identified issues are appropriately addressed. Firms that maintain strong documentation, align policies with operations and follow through on remediation efforts will be better positioned to demonstrate the effectiveness of their compliance programs during SEC examinations and manage regulatory risk as their organizations evolve.
Evaluating Your Annual Compliance Review Process?
Grassi’s Financial Services team works with investment advisers and private fund managers to evaluate annual compliance review frameworks and address areas of examination focus. To discuss how these considerations may apply to your organization, contact a Grassi advisor.
