As in years past, the SEC is taking a risk-based approach to the 2024 examination priorities. The Commission continues to use its “four pillars” (1. promote compliance; 2. prevent fraud; 3. monitor risk; 4. inform policy) as the foundation on which the examination priorities are built. By using a risk-based approach, the SEC has put forth examination priorities for investment advisers (including advisers to private funds), investment companies, broker-dealers, self-regulatory organizations, clearing agencies and other market participants. In addition, the SEC has noted additional “Risk Areas Impacting Various Market Participants.
This summary will focus on investment advisers, investment companies, broker-dealers and the “Various Market Participants” risk factors identified in the Commission’s release.
Exam Priorities by Firm Type
Beginning with investment advisers, the SEC’s examination priorities are broken down into two categories: fiduciary duty and compliance program. The priorities for each category are as follows:
Fiduciary duty
- Advice provided regarding complex products (derivatives & leveraged ETFs), high cost & illiquid products (VAs & non-traded REITs) and unconventional strategies. Also, advice to certain types of clients (older clients, retirement savers).
- Client best interests: initial & ongoing suitability; best execution; evaluation of cost & risk; addressing conflicts of interest (mitigating/eliminating conflicts; allocation of investments between account types).
- Compensation: Revenue sharing, mark-ups or incentivizing arrangements. Continued additional scrutiny on advice where lower cost options are available and proprietary products.
- Disclosure of conflicts of interest sufficient to allow a client to provide informed consent.
Compliance Program
- Marketing Practices: appropriate policies and procedures; disclosure; substantiation documentation (performance, including hypothetical); testimonials/endorsements/third-party ratings.
- Compensation assessments: Fiduciary obligations re: receipt of compensation for products/services; alternative ways advisers maximize revenue; fee breakpoint calculations.
- Valuation of illiquid or difficult to value assets.
- Assessment of controls to protect client MNPI (privacy & cybersecurity policy testing)
- Processes to ensure accuracy of regulatory filings.
For investment advisers to private funds, the SEC articulates the following examination priorities in addition to the above:
- Portfolio management risks:
- performance,
- significant withdrawals,
- leverage, &
- illiquid assets.
- Contractual requirements:
- notification/consent process,
- advisory committee structures.
- Calculation of private fund fees and expenses, including valuation of assets.
- Due diligence process for portfolio companies
- Controls & disclosure to mitigate conflicts when private funds are managed side-by-side with registered investment companies.
- Custody rule compliance.
- Form PF policies and procedures.
Regarding investment companies, the two primary SEC examination focus areas are:
- Fees & Expenses:
- share classes; identical strategies w/ differing fee structures;
- high fees relative to peers;
- review of board’s approval of advisory contracts & fees.
- Derivative risk management processes & derivative rule (Rule 18f-4 of the Investment Company Act) compliance.
Additionally, the SEC says it will continue to prioritize examinations of registered investment companies that have never been examined as well as firms that have not been examined “in a number of years”.
The Commission lists four primary areas of examination priorities for broker-dealers, which encompass several areas of compliance risk.
- Reg BI:
- disclosure obligations;
- care obligations;
- conflict of interest obligations;
- compliance obligation.
- Form CRS:
- relationships and services;
- fees and costs;
- conflicts of interest disclosure;
- filing and delivery obligations.
- Financial Responsibility Rules:
- Net Capital Rule;
- Customer Protection Rule;
- internal controls
- Trading practices:
- Reg SHO;
- Reg ATS (including disclosures in Forms ATS & ATS-N);
- Exchange Act Rule 15c2-11;
Exam Priorities Expected to Impact Various Market Participants
The SEC has identified risk areas impacting various market participants that span multiple categories of firms. These areas of risk are common to advisers, broker-dealers and other firms who participate in the securities marketplace.
- Information Security & Operational Resiliency:
- risk assessment;
- policies & procedures;
- internal controls;
- vendor management;
- branch offices;
- response/recovery plans.
- Crypto Assets & Emerging Financial Technology:
- blockchain;
- automated investment tools;
- artificial intelligence (AI);
- trading algorithms;
- custody issues presented by crypto assets.
- Regulation Systems Compliance & Integrity (SCI):
- adequate systems’ capacity, integrity, resiliency, availability and security;
- policies and procedures reasonably designed to ensure the security of the SCI systems.
- Anti-Money Laundering (AML):
- broker-dealer & registered investment companies have tailored AML program to business model & risks;
- independent testing; adequate customer identification program;
- SAR filing obligations;
- OFAC monitoring.
The SEC’s complete release can be found here.
Addressing the SEC Exam Priorities: How the COMPLY™ brand can help you achieve compliance with confidence
While the Exam Priorities list is not exhaustive in nature, it does provide firms with a roadmap for expected focus areas in the coming year. By providing the 2024 Exam Priorities well in advance of the calendar year, the regulatory body has given firms the chance to proactively prepare their compliance programs for a potential exam – addressing processes and procedures which may not stand up to regulatory scrutiny.
In doing so, firms may look to perform certain audits or assessments to test the dexterity and capability of its program. These can include:
Having worked with thousands of SEC-registered firms, the COMPLY team is extremely adept at enabling compliance programs to adapt and adjust to meet regulatory requirements and review. With solutions spanning from compliance technology automation to Mock Exam services, we provide compliance professionals with the resources to COMPLY with confidence.
Interested in learning more about how COMPLY can empower your compliance program? Schedule time to speak with an expert today!