What the SEC Plans for Next Year: 2024 SEC Examination Priorities Are Already Published
October 17, 2023
On October 16, 2023, the SEC’s Division of Examinations (“EXAMS”) published its 2024 Examination Priorities. These annual priorities highlight certain practices, products, and services that present potentially heightened risks to investors or the integrity of US capital markets. For 2024, the SEC’s examinations priorities are in areas that pose emerging risks to investors or the markets, as well as examinations of core and perennial risk areas.
The following is a selection of areas EXAMS identified for 2024 that affect registered investment advisers, particularly those that manage private funds and employ complex and illiquid strategies.
EXAMS remains focused on investment advisers’ fiduciary duty of care and of loyalty to their clients. In reviewing advisers’ adherence to this fiduciary standard, EXAMS continues to focus on:
- Investment advice provided to clients related to products, investment strategies, and account types, particularly:
- Complex products, such as derivatives and leveraged exchanged-traded funds (ETFs);
- High cost and illiquid products, such as variable annuities and non-traded real estate investment trusts (REITs); and
- Unconventional strategies, including those that purport to address rising high interest rates.
EXAMS indicated that examination focus may be emphasized for investment advice provided to certain types of clients, such as older investors and those saving for retirement.
- Processes for determining that investment advice is in clients’ best interest, including those processes for:
- Making initial and ongoing suitability determinations;
- Seeking best execution;
- Evaluating costs and risks; and
- Identifying and addressing conflicts of interest.
- Economic incentives that an adviser and its financial professionals may have to recommend products, services, or account types, such as the source and structure of compensation, revenue, or other benefits.
- Disclosures made to current and prospective clients and whether they include all material facts relating to conflicts of interest associated with the investment advice sufficient to allow a client to provide informed consent to the conflict.
EXAMS will focus on:
- Compliance policies and procedures and whether they accommodate the adviser’s specific practices, client types, operations, and risk.
- Annual reviews performed and documented by advisers with an expectation that conflicts of interests related to fees, and affiliations are addressed in compliance programs.
- Compliance with the Marketing Rule, shining a light on advisers to private funds in this area. Have advisers, in general:
- Adopted and implemented reasonably designed written policies and procedures to prevent violations of the Advisers Act and the rules thereunder including reforms to the Marketing Rule;
- Appropriately disclosed their marketing-related information on Form ADV; and
- Maintained substantiation of their processes and other required books and records.
- Compensation arrangements in circumstances related to:
- Clients, including registered investment companies, particularly with respect to the advisers’ receipt of compensation for services or other material payments made by clients and others;
- Alternative ways to maximize revenue, such as revenue earned on clients’ bank deposit sweep programs; and
- Fee breakpoint calculation procedures, particularly when fee billing systems are not automated.
- Valuation of client investments in illiquid or difficult to value assets, such as commercial real-estate or private placements.
- Controls in place to protect clients’ material non-public information (MNPI), particularly when multiple advisers share office space, have significant turnover of investment adviser representatives, or use expert networks.
- Accuracy and completeness of disclosures made in regulatory filings, including Form CRS, with a particular focus on inadequate or misleading disclosures and, registration eligibility.
Selection of Service Providers:
- Policies and procedure that cover:
- Selection and use of third-party and affiliated services providers;
- Branch office oversight when advisers operate from numerous offices across multiple geographic locations; and
- Informed consent from clients when advisers implement material changes to their advisory agreements.
Advisers to Private Funds
EXAMS will continue to focus on advisers to private funds and prioritize specific topics, such as:
- Portfolio management risks present when there is exposure to recent market volatility and higher interest rates.
- This may include private funds experiencing poor performance, significant withdrawals and valuation issues and private funds with more leverage and illiquid assets.
- Adherence to contractual requirements regarding limited partnership advisory committees or similar structures (e.g., advisory boards), including adhering to any contractual notification and consent processes.
- Accurate calculation and allocation of private fund fees and expenses (both fund-level and investment-level), including valuation of illiquid assets, calculation of post commitment period management fees, adequacy of disclosures, and potential offsetting of such fees and expenses.
- Due diligence practices for consistency with policies, procedures, and disclosures, particularly with respect to private equity and venture capital fund extent and documentation of diligence on 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 Advisers Act requirements regarding:
- Custody disclosures and reporting in Form ADV, timely completion of private fund audits by a qualified auditor and the distribution of private fund audited financial statements to fund investors within deadlines.
- Policies and procedures for reporting on Form PF, including upon the occurrence of certain reporting events.
- Registration status and history: EXAMS will prioritize:
- Newly registered advisers
- Advisers who have never been examined
- Advisers who have not been examined in a number of years
Broad-based Risk Areas
EXAMS will evaluate:
- Information Security and Operational Resiliency: How are advisers practices preventing interruptions to mission-critical services and protecting investor information, records, and assets.
- With cybersecurity attacks on the rise and becoming more sophisticated, cybersecurity remains a focus for all registrants.
- Particular areas include:
- Policies and procedures
- Internal controls
- Oversight of third-party vendors
- Responses to cyber-related incidents, including those related to ransomware attacks
- Identification of risks to critical business operations and how those risks will be mitigated
- Concentrated reliance on certain service providers how advisers are managing this risk.
- Crypto Assets and Emerging Financial Technology: EXAMS will focus on the offer, sale, recommendation of, advice regarding, trading in, and other activities in crypto assets or related products.
What does this mean for my firm?
Fairview provides comprehensive and ongoing compliance administration services for registered advisers, including complete SEC examination support. Our Cyber Solutions practice specializes in the creation, testing, and meaningful cybersecurity and vendor due diligence programs for financial industry businesses, in compliance with SEC regulations, including the proposed Cybersecurity Risk Management Rule, which is expected to be finalized in Fall 2023.
Contact us today if you have questions concerning the Division’s examination process, 2024 Examination priorities, or if you’re interested in support for your firm.