New focus on valuations for the SEC in 2024 exam priorities
The U.S. Securities and Exchange Commission’s (SEC) Division of Examinations (DOE) recently announced its examination priorities for 2024.
With the release of new priorities, organizations are encouraged to revisit their operational and compliance frameworks and ensure that they are robust enough to withstand scrutiny in areas such as information security, crypto assets and anti-money laundering practices. In particular, the exam priorities highlight the SEC’s commitment to maintaining integrity and transparency, with an increased focus on compliance and fair valuations.
Here’s what your organization should know to help prepare for scrutiny on valuation practices:
Overview of exam priorities
Regarding valuations, the DOE will focus on:
- Examination of investment advisors: The DOE will be paying careful attention to the procedures and compliance policies of investment advisors for several areas, including portfolio management processes, disclosures to investors and regulators, trading practices, market advisory services and the processes used to value client holdings and assess fees based on those valuations. There will also be a focus on valuation assessments used by advisors recommending illiquid or difficult-to-value assets such as commercial real estate or private placements.
- Examination of investment advisors to private funds: Topics of interest for private funds include portfolio management risks — particularly in the context of recent market volatility and higher interest rates — and the accurate calculation and allocation of private fund fees and expenses, including valuation of illiquid assets and adequacy of disclosures.
- Crypto assets and emerging financial technology: The DOE will focus on the offer, sale, recommendation of, advice regarding, trading in, and other activities in crypto assets or related products.
- Investment companies: Registered investment companies, including mutual funds and ETFs, will continue to be a priority. The DOE will review registered investment company valuation practices, with additional focus on those addressing fair valuation practices and compliance with the derivatives rule, including derivatives risk management programs and board oversight.
Fair value determinations
With the focus on valuation practices, it’s important for companies to review their 2a-5 rule compliance.
Rule 2a-5 outlines four key functions for determining fair value in good faith:
- Periodically assessing and managing valuation risks: This first function requires periodic assessment and management of valuation risks, including conflicts of interest. Although the rule does not prescribe a minimum frequency for re-assessing valuation risks, it suggests that changes in fund investments, investment strategies, market events and other relevant factors should be considered.
- Establishing and applying fair-value methodologies: Organizations are required to establish and apply appropriate fair-value methodologies. The rule also requires periodic review of the appropriateness and accuracy of these methodologies and making necessary adjustments.
- Testing fair-value methodologies for accuracy and appropriateness: The rule does not prescribe any specific testing method or frequency, leaving it up to the fund or the valuation designee to determine the best approach.
- Overseeing and evaluating pricing services used: Organizations need established processes for approving, monitoring, evaluating pricing service providers, and initiating pricing challenges when appropriate.
The board of directors of a fund has the primary responsibility to adhere to the valuation framework outlined in rule 2a-5. They can either perform these functions themselves or designate them to a “valuation designee.” When a valuation designee performs these functions, active oversight is required by the board.
The designee is required to present both annual and quarterly written reports to the board. The reports should cover items related to the fair value of investments, the valuation process and any significant changes in valuation risks and methodologies.
Preparing for new exam priorities
Proactively addressing compliance risks and aligning practices with regulatory expectations can help your organization avoid potential penalties and maintain growth in a heavily regulated business environment.
Here are some steps you can take to be more proactive about compliance:
- Review your existing practices and policies: Identify gaps or weaknesses in your current compliance framework before they cause concerns. To help ensure a thorough assessment, involve key stakeholders in this process, such as legal and compliance teams.
- Enhance internal controls and compliance processes: Robust internal controls can help detect and prevent potential noncompliance issues before they escalate. It’s also important to establish clear lines of communication and reporting within your internal control framework.
- Review documentation and recordkeeping processes: Establish robust practices to document all relevant information regarding investment contracts and your compliance efforts, including maintaining comprehensive records of contractual terms, financial information and any other relevant documentation. It’s also important to establish clear guidelines and procedures for document retention and retrieval.
- Refresh employee training and education: Regular training sessions can help reinforce compliance knowledge and raise awareness about potential compliance risks. Your organization can also establish channels for ongoing communication and dialogue with employees. This helps to foster a culture of compliance, where employees feel comfortable raising concerns, seeking clarification and taking an active role in maintaining compliance.
How Wipfli can help
Wipfli brings deep knowledge and experience in a wide range of industries to helping your organization with either third-party valuations or fund audits.
Our valuation services go beyond determining a value, helping you identify risks and providing actionable recommendations for how you can achieve your goals. And our fund services team is ready to deliver answers and insights to help you stay confident in your decisions. Contact us today to learn more about how we can support you in defining your organization’s future.
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