Division of Examinations: 2024 Examination Priorities

   

Division of Examinations: 2024 Examination Priorities

Each year, the Division of Examinations (“the Division”) of the U.S. Securities and Exchange Commission (“SEC”) publishes its Examination Priorities for the upcoming year. This is the first year the Division has published their priorities to align with the beginning of the fiscal year, with the intent to inform new and current registrants of key risks, trends, and examination topics. Below are the key elements that we believe are of the utmost importance for registered investment advisors. Compliance Programs 

The Division remains focused on Advisors maintaining effective and compliant programs that align with the Advisor’s business model, the corresponding annual reviews that address the effectiveness of the compliance program, and any applicable conflicts related to the Advisor. A typical exam will include a review of program and disclosure documents focusing on such topics as:

• Custody
• Valuation
• Portfolio Management
• Brokerage and Execution
• Conflicts of Interest
• Compliance Issues
• Supervision and Oversight
• Compensation  

Currently, the Division has stated the following topics are deemed priority review items during an exam:

Communications and Marketing: It is critically important for Advisors to ensure that they have adopted and implemented written policies and procedures reasonably designed to prevent violations of the Marketing Rule, and have amended their Form ADV to appropriately disclose marketing related information. Advisors should review their current and prospective marketing material to ensure that they can substantiate statements made within their content, and that testimonials/endorsements, third party ratings, and performance advertising align with rule requirements. 

Compensation: The SEC will continue their focus on Advisor’s compensation structures. Examiners will review Advisor’s conflicts of interest and their related client disclosures, as seen in such regulatory initiatives as the Mutual Fund Share Class Sweep and Money Market Fund/Sweep Vehicles Initiative. The concern is whether an Advisor is adhering to their fiduciary obligations when attempting to maximize their revenue through forms of additional compensation via their advice, implementation of investment products, or how fee breakpoints are calculated and processed. 

Valuation: Advisors must ensure that there are compliant policies and procedures for the valuation of illiquid investments, such as commercial real-estate or private placements. When securities are not properly valued it will affect the billing of client assets, and affect performance considerations which can be detrimental and misleading to investors.

Safeguarding Client Information: Due to larger market events, geopolitical concerns, and the proliferation of cybersecurity attacks the Division will focus on Advisor’s policies and procedures (especially Regulations S-P and S-ID), governance practices, and cyber incident responses. Their reviews of policies and procedures will attempt to determine if controls are reasonably designed to safeguard customer records and information, whether the controls are implemented via a third party vendor or the Advisor itself.

Accurate and Timely Regulatory Filings: Regulatory filings, including the Form CRS, must be accurate, complete, and timely.  Client’s must be fully aware of the services, fees, disciplinary history, and conflicts of interest of an Advisor.  If not accurate, this would be deemed misleading.

Lastly, examiners will also be mindful in understanding the Advisors approach to initial and ongoing due diligence for third party vendors, branch oversight, electronic communications, and implementation procedures for material changes of  Advisor’s agreements with clients.

Private Fund Advisors

The SEC will continue their focus on Advisors to Private Funds and their policies and procedures, contractual requirements, calculation and allocation of fees and expenses, and custody. The Division will focus on Fund’s portfolio management techniques, especially when risks are present to the fund, for example inflation or withdrawal rate. Examiners will look for adequate controls, policies, and procedures regarding timely Form PF and Form ADV updates, especially in regard to Private Fund audits by an independent qualified auditor and distribution of Private Fund audited financial statements.

Standards of Conduct

The SEC continues to focus on fundamental principles of fiduciary responsibility and duty to clients. Examiners will evaluate the quality of investment advice provided, particularly in relation to various products and strategies. They will also review the Advisors robustness of their investment processes such as suitability assessments, cost and risk evaluations, and conflict of interest management.

Evaluation of Investment Advice: Examiners will focus on the evaluation of investment advice provided to clients. Specifically the concern around various products, investment strategies, and account types that are considered complex in nature. Complex products like derivatives and leveraged ETFs, high-cost and illiquid options such as variable annuities and non-traded REITs, and unconventional strategies targeting rising interest rates are a sample of mentioned items. There is an expectation that appropriate due diligence is performed before the investment advice is rendered. This allows the Advisor to substantiate the appropriateness of their investment recommendations, especially when considering certain client types such as seniors.

Client’s Best Interest: To ensure appropriateness of investment advice, the Advisor must have a process in place for making initial and ongoing suitability determinations, which should consider best execution, cost and risk evaluation, investment restrictions, and conflict of interest management. Further, the Advisor should adopt policies to evaluate reasonably available alternative products. Determining Client’s best interest should also include how an Advisor handles conflicts of interest by either mitigating or eliminating them.

Compensation Arrangements: Advisors have a fiduciary obligation to be transparent regarding their compensation arrangements with clients and affiliates. Disclosures are required for Advisor’s compensation for services provided to clients, including valuation methods, and alternative compensation arrangements such as cash sweep programs/mutual fund share classes.

Additionally, exams will include reviews of any economic incentives that an Advisor has to recommend products, services, or account types and how that affects investment advice, such as share class selection or proprietary products. This enhances last year’s priority where exams included conflict of interest disclosures and whether the disclosures are sufficient in scope that a client can provide informed consent to the conflict, whether express or implied. The inquiry will focus on whether the firm has tailored and established policies and procedures to identify and periodically review conflicts of interest, in alignment with the Firm’s business model, compensation structure, and product lineup

Crypto Assets and Emerging Financial Technologies

The Division will continue its focus and exams on certain types of investments such as crypto/crypto related products and services, along with emerging financial technology such as mobile apps, robo-advisors, and additional online solutions. Due to recent events in the crypto asset market the Division will continue to monitor and select applicable registrants for examination which will focus on the offer, sale, or recommendation of, advice regarding and trading in crypto or crypto-related assets. Furthermore, the Division will assess the following:

• The registrants’ requirements under the standards of care in crypto or crypto relates assets
• Whether the registrant reviews and updates their compliance and risk practices, and disclosures accordingly
• New or never examined registrants offering crypto or crypto-related assets

In particular, the Division will focus on the tools and methods offered via digital engagements through RIAs:

• Recommendations being provided via electronic channels such as social media or social trading platforms.
• Whether representations align with Marketing Rule requirements
• Are applicable disclosures and controls in place
• Are recommendations being made in the client’s Best Interest
• Risks that may be associated with this method of business practice

Please remember that the Division communicates these as PRIORITIES, and should not be relied upon as an all-inclusive list of all focus areas. To read the full report, click here: Division of Examinations 2024 Examination Priorities.

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