The SEC has unveiled its 2024 Exam Priorities, signposting where attention is likely to be focused during the year ahead. Typically circulated towards the start of the calendar year, the regulator has published early to ensure investors and registrants are better informed of the risks, trends, and examination topics for the upcoming year.
As always, the SEC will focus examinations on organizations yet to be examined (including recently registered organizations), and those that have not been examined in several years. The examinations focus on the adequacy of an advisers’ policies and procedures, and the ability to implement, follow, and disclose (as applicable) those written requirements.
Examinations of Investment Advisers
Advisers should be prepared for examinations to focus on the 10 key areas detailed in the Adviser’s Act of 1940, but in the announcement the SEC called out the following areas in particular:
- marketing practices of advisers, including advisers to private funds, focusing specifically on adoption of the new Marketing Rule and appropriate disclosure of Marketing practices in Form ADV;
- substantiation of processes and other required books and records;
- assessment of disseminated advertisements that may include untrue statements, are materially misleading, or are otherwise deceptive;
- compliance with the requirement for performance reporting, third-party ratings, and testimonials and endorsements;
- valuation assessments regarding advisers’ recommendations to clients, particularly in illiquid or difficult-to-value assets;
- safeguarding assessments for advisers’ ability to protect client’s material non-public information, particularly in firms with shared office locations, that have high turnover, and/or use expert networks;
- disclosure assessments to review the accuracy and completeness of regulatory filings. The announcement called out Form CRS in particular.
The Commission is also focused on adviser’s policies and procedures for selecting and using third-party service providers, overseeing branch offices in advisers with numerous or geographically dispersed offices and obtaining informed consent from clients when an adviser implements material changes to advisory agreements.
Examinations of investment advisers to private funds
An expected area of focus considering the release of the Private Fund Rule this September, the SEC called out some specific topics for these organizations:
- portfolio management risks that are present when there is high volatility and higher interest rates, particularly for private funds experiencing poor returns, significant withdrawals, valuation issues and/or fends with more leverage and illiquid assets;
- adherence to contractual requirements regarding limited partnership adviser committees or similar structures;
- accurate calculation and allocation of private fund fees and expenses;
- due diligence practices with respect to private equity and venture capital fund assessments of prospective portfolio companies;
- conflicts, controls, and disclosures regarding private funds managed side-by-side with registered investment companies and use of affiliated service providers;
- compliance with Adviser Act custody requirements;
- policies and procedures for Form PF.
The Division continues to prioritize examinations of registered investment companies (RIC), including mutual funds and ETFs, due to their importance to retail investors. The SEC has signalled that it will focus on fees, expenses, and whether registered investment companies have adopted effective policies, with a particular focus on:
- charging different fees to different share classes of the same fund;
- identical strategies offered by the same sponsor through different distribution channels that charge differing fee structures;
- high advisory fees relative to peers;
- high RIC fees and expenses, particularly those of RIC’s with weaker performance relative to their peers;
- derivatives risk management assessment to review whether registered investment companies as well as business development companies have adopted and implemented written policies and procedures reasonably designed to prevent violations of the Commission’s fund derivatives rule (Investment Company Act Rule 18f-4).
In addition, the Division will review for compliance with the terms of exemptive order conditions and the issues associated with recent market dislocations and volatility, such as whether registered investment companies in liquidation are following liquidation procedures.
Regulation Best Interest
Regulation Best Interest is what establishes the standard of conduct for broker-dealers at the time they recommend to a retail customer a securities transaction or investment strategy. There are many key aspects to this rule, but the Divison have particularly called out:
- recommendations regarding products, investments strategies, and account types;
- disclosures made to investors regarding conflicts of interest;
- conflict mitigation practices;
- process for reviewing reasonably available alternatives;
- factors considered in light of the investor’s investment profile.
Examinations will focus on products that are:
- complex, such as derivatives and leveraged ETFs;
- high cost, such as variable annuities;
- illiquid, such as non-traded REITS and private placements;
- microcap securities;
- recommendations to certain types of investors, such as older investors or those saving for retirement or college.
The Division will also focus on dual registrants, specifically how those firm’s encompass conflicts of interest, account allocation practices and account selection practices. Examinations are expected to assess broker-dealers’ supervision of branch office locations.
The Division’s examinations will review the content of a broker-dealer’s relationship summary, such as how the broker-dealer describes:
- the relationships and services that it offers to retail customers;
- fees and costs;
- conflicts of interest;
- whether the broker-dealer discloses any disciplinary history;
- if broker-dealers have met their obligations to file their relationship summary;
- if broker-dealers have met their obligations to deliver their relationship summary to retail customers.
Broker-Dealer financial responsibility rules
Examinations will focus on broker-dealer compliance with the Net Capital Rule, the Customer Protection Rule and related internal processes, procedures and controls. Areas of review will include fully-paid lending programs and broker-dealer accounting for certain types of liabilities, such as reward programs, point programs, gift cards and non-brokerage services, and will also assess broker-dealer credit, interest rate, market, and liquidity risk management controls to assess whether broker-dealers have sufficient liquidity to manage stress events.
Broker-Dealer trading practices
Examinations will cover broker-dealer equity and fixed income trading practices. In particular, reviewing compliance with:
- Regulation SHO, including the rules regarding aggregation units and locate requirements;
- Regulation ATS, and whether the operations of alternative trading systems are consistent with the disclosures provided in Forms ATS and ATS-N; and (3) Exchange Act Rule 15c2-11.
Risk areas affecting various market participants
Finally, the Division provided clarity on some general areas of the market they will be focusing on that affect various types of market participants. These areas of focus include:
Information security and operational resiliency
Cybersecurity remains a perennial focus area for all registrants. The SEC will review practices related to mission-critical services, specifically how interruptions may be handled and how investor information is protected.
The SEC will also focus on policies, procedures, and controls related to the use of third-party vendors. Part of this review will consider whether registrants adequately train staff regarding their identity theft prevention program and their policies and procedures designed to protect customer records and information.
For firms with multiple offices, examinations will look at firms’ practices to prevent account intrusions and safeguard customer records and information, including personally identifiable information.
The SEC will also assess broker-dealer preparedness for the upcoming shortening of the settlement cycle, which has a compliance date of May 28, 2024.
Crypto assets and emerging financial technology
The Division continues to observe the proliferation of certain types of investments (including crypto assets and their associated products and services), emerging financial technology (such as broker-dealer mobile applications), and advisers choosing to provide automated investment advice to their clients. Focus will be on organizations that:
- offer new products and services, particularly technological and online solutions that service online accounts aimed at meeting the demands of compliance and marketing;
- use automated investment tools, artificial intelligence, and trading algorithms or platforms, and alternative sources of data.
Given the continued volatility and activity around the crypto markets, organizations that operate in that part of the market can expect exams to focus on:
- ability to meet and follow their respective standards of conduct when recommending or advising customers and clients regarding crypto assets, with a focus on the client’s ability to understand the investment and the appropriateness of the investment for the individual;
- reviewing whether organizations are able to routinely review, update, and enhance their compliance practices, risk disclosures, and operational resiliency practices.
With respect to crypto assets that are funds or securities, the Division will consider whether advisers are complying with the custody requirements under the Advisers Act (Rule 206(4)-2)
In addition, the Division will assess whether any technological risks associated with the use of blockchain and distributed ledger technology have been addressed.
Anti Money Laundering
The Division will continue to focus on AML programs to review whether broker-dealers and certain registered investment companies are:
- appropriately tailoring their AML program to their business model and associated AML risks;
- conducting independent testing;
- establishing an adequate customer identification program, including for beneficial owners of legal entity customers;
- meeting their SAR filing obligations.
Examinations of certain registered investment companies will also review policies and procedures for oversight of applicable financial intermediaries.
Valerie Ruppel advises investment advisers and wealth managers on daily operational matters that need to comply with US regulatory requirements. Before joining Bovill, Valerie was an Attorney-Adviser at the US SEC in the Division of Examinations. Ryan Stibich s a consultant, he supports investment advisers and broker-dealers on daily operations matters in order to comply with US regulatory requirements.