SEC’s 2024 Exam Priorities: Registered Investment Advisers Still in the Spotlight

The Securities and Exchange Commission’s (SEC) Division of Examinations (Division of Exams) announced its 2024 examination priorities on October 16, 2023.¹

This marks the 12th year that the Division of Exams has published its exam priorities in a continuing effort to provide transparency about its activities. While additional priorities may be identified based on the Division’s ongoing findings and risk assessments, the advance announcement of exam priorities is intended to provide SEC-regulated entities insight into areas the agency believes warrant attention and constitute the most effective use of examination resources.

The Division of Exams noted that its work continues to be based on four “pillars:” promoting compliance, preventing fraud, identifying and monitoring risk, and informing policy.

The 2024 exam priorities are thematically similar to the 2023 priorities but reflect a more targeted focus on specific areas involving registered advisers. The announcement notes that the Division of Exams draws upon its regional outreach efforts and examiner presence in the field to generate the annual examination priorities. It is noted that these touchpoints supply a “critical connection” between the SEC and the capital markets as the SEC attempts to keep pace with evolving marketplace risks, including risks stemming from innovation in financial products and related technology.

This article will expand on the following exam priorities expected to have a powerful impact on investment advisers of private funds:

• Areas of focus in investment adviser examinations, generally
• Areas of focus in examinations of investment advisers to private funds
• Areas of focus in examinations of registered investment companies
• Other risk areas impacting various market participants (including investment advisers)

First, a look back at the fiscal year 2023.

The announcement reflects on the three years since the pandemic, noting the SEC’s transformation efforts concerning how it conducts examinations and communicates findings.

• Execution of exams. Citing “return to office” trends observed in 2023, the announcement discusses efforts by the Division of Exams to conduct more in-person fieldwork while providing virtual options to examiners and registrants throughout the examination life cycle.
• Sharing observations and findings. The announcement refers to the Risk Alerts published by the Division of Exams that relay common themes in examination observations as well as deliver transparency into exam scope. In 2023, the Division published seven risk alerts covering topics such as observations from newly registered investment advisers’ examinations and a planned examination focusing on firms’ compliance with the new Marketing Rule.

Exam Priority: Investment advisers, generally

1. Fiduciary Standard

The exam priorities announcement notes that, as a fiduciary, an investment adviser must “serve the best interest of its clients and not subordinate its clients’ interests to its own.” An adviser is, therefore, obligated to eliminate or make full and fair disclosure of all conflicts of interest. For the fiduciary standard, the Division intends to focus on the following in its 2024 examinations:

• Investment advice provided to clients. This covers all forms of recommendations, including recommendations of specific investment products, investment strategies, and account types. The SEC intends to apply special scrutiny to an adviser’s advice to clients if it involves complex products (specifically, derivatives and leveraged exchange-traded funds), high-cost and illiquid products (including variable annuities and non-traded real estate investment trusts) or unconventional strategies (for example, those that claim to mitigate the impact of rising interest rates). Examiner focus will also be a product of the types of clients the registrant advises (with a spotlight on older investors and those saving for retirement).
• Processes for evaluating whether investment advice is in a client’s best interest. Examiners will devote attention to an adviser’s methods for making investment suitability determinations (initial and ongoing determinations), achieving best execution, assessing costs and risks, and responding to conflicts of interest. With respect to conflicts of interest, the SEC will consider how an adviser eliminates (or mitigates) the conflict and how an adviser allocates investments to accounts where investors have more than one account (for example, when an adviser is allocating between accounts that are adviser fee-based, brokerage commission-based, or wrap fee, as well as between taxable and non-taxable accounts).
• Economic incentives of the adviser. Specifically, the SEC intends to review incentives an adviser may have to recommend products, services, or types of accounts. The SEC will consider the extent to which recommendations are influenced by the source and structure of the adviser’s compensation. On the SEC’s radar are economic incentives and conflicts of interest arising from an adviser’s dual registration as an RIA and a broker-dealer, an adviser’s use of affiliated firms to deliver services to clients, and advisers that have staff servicing both brokerage and advisory clients. The SEC’s goals include rooting out cases in which an adviser provided advice to acquire or hold onto certain types of investments or invest through certain account types when lower cost options were available or cases in which an adviser recommended proprietary products or affiliated service providers that resulted in higher overall costs to clients.
• Disclosures. Advisers selected for examination should anticipate that the SEC will review its investor disclosures for completeness and accuracy, including disclosures on conflicts of interest.

2. Compliance

The exam priorities announcement notes that investment advisers’ compliance programs will be subjected to particular attention in 2024, including the following:

• Marketing practices. This encompasses whether advisers have:
  • Adopted and implemented written policies and procedures sufficient to prevent violations of the Advisers Act (including recent updates to the Marketing Rule).
  • Included required disclosures of their marketing-related information on Form ADV.
  • Maintained required support and documentation concerning marketing activities.
  • Complied with Marketing Rule requirements for advertisements.
• Adviser compensation arrangements. Examiners will review whether the adviser’s receipt of compensation is consistent with its fiduciary obligation to clients.
• Investment valuations. Examiners will consider whether an adviser’s recommendations to clients to invest in illiquid or difficult-to-value assets (the announcement explicitly mentions commercial real estate and private placements) are backed by appropriate valuation assessments.
• Safeguarding of client assets. The Division will review an adviser’s controls to safeguard clients’ material non-public information, especially in cases of multiple advisers sharing office locations, having significant turnover, or using expert networks.
• Regulatory filings. Examiners will conduct disclosure assessments to review the accuracy and completeness of regulatory filings, including Form CRS.
• Other focus areas. The SEC also intends to focus resources on evaluating an adviser’s policies and procedures for selecting third-party and affiliated service providers, overseeing branch offices when advisers operate from numerous or geographically dispersed offices, and obtaining informed consent from clients when advisers implement material changes to their advisory agreements.

Exam Priority: Investment advisers to private funds

With respect to advisers to private funds, the announcement imparted the following 2024 examination priorities:

• Risks created by recent market volatility and higher interest rates. Examples provided in the announcement include private funds that are underperforming, experiencing valuation issues and a high volume of withdrawals, and private funds that are highly leveraged and illiquid.
• LPAC requirements. The Division will focus on compliance concerning limited partnership advisory committees or similar structures, including whether advisers have complied with contractual notification and consent processes.
• Fees and expenses. The Division will review whether advisers have computed and allocated fund expenses accurately, with particular attention given to valuation of illiquid investments, calculation of post-commitment period management fees, adequacy of disclosures, and expense offsetting arrangements.
• Adherence to policies, procedures, and disclosures. The announcement specifically mentions assessments of prospective portfolio companies by private equity and venture capital funds.
• Private funds managed side-by-side with registered investment companies and use of affiliated service providers. The announcement relays the SEC’s planned focus on conflicts, controls, and disclosures related to these scenarios.
• Compliance with Advisers Act requirements regarding custody. This includes accurate Form ADV reporting, completion of private fund audits in a timely manner by a qualified auditor, and the distribution of private fund audited financial statements.
• Policies and procedures for reporting on Form PF. This encompasses policies and procedures for reporting upon the occurrence of certain reporting events.

Exam Priority: Registered Investment Companies

The announcement notes the importance of registered investment companies (RICs), including mutual funds and ETFs, to retail investors, especially those saving for retirement. The SEC will incorporate the following examination priorities in 2024 with respect to this subpopulation of registrants:

• RIC compliance programs and fund governance. Pursuant to this, the Staff will review boards’ processes for assessing and approving advisory and other fund fees (particularly funds that are underperforming relative to their peers).
• Valuation practices. Emphasis will be placed on board oversight duties concerning fair valuations.
• Risk management. The announcement explicitly mentions a targeted focus on derivatives risk management and liquidity risk management programs.
• Fees and expenses. The Division will review the board’s approval of the advisory contract and other fees. The following scenarios will draw particular focus from examiners:
  • Charging different advisory fees to other share classes of the same fund
  • Identical strategies offered by the same sponsor through different distribution channels but that charge differing fee structures
  • High advisory fees relative to peers
  • High fees and expenses, especially for RICs that are underperforming relative to their peers
• Compliance with the terms of exemptive orders. This includes exemptive orders related to recent market conditions, including whether RICs in liquidation follow liquidation procedures.

Additional Examination Priorities

The Division of Exams intends to continue to focus on the following exam priorities in 2024 that impact the entire population of registrants:

• Information security and operational resiliency.
  • A registrant’s preventative measures with respect to interruptions to critical services and the steps taken to safeguard investor information, records, and assets.
  • Policies and procedures of the registrant, internal controls, oversight of third-party vendors, governance practices, and cyber-related incident response.
  • Cyber risks arising from a registrant’s use of multiple other branch offices.
  • Registrant preparations and readiness concerning the rule changes (effective May 28, 2024) reducing the settlement cycle From T+2 to T+1 for most broker-dealer transactions.
• Crypto assets and emerging financial technology.
  • Crypto assets. Exams will focus on the offer, sale, recommendation of, advice regarding, trading in, and other activities in crypto assets.
  • Emerging financial technology. Examiners will target new products and services, especially technological and online solutions (including compliance and marketing solutions) that service online accounts. Certain services will remain squarely in the SEC’s spotlight, including automated investment tools, artificial intelligence, trading algorithms or platforms, and alternative data sources.
• Regulation Systems Compliance and Integrity (SCI), adopted by the SEC in 2014.
  • Regulation SCI entities include national securities exchanges, registered and certain exempt clearing agencies, FINRA, MSRB, plan processors, and alternative trading systems that meet certain volume thresholds. The Division will review whether SCI entities have established, maintained, and enforced written policies and procedures reasonably designed to ensure that their systems’ capacity, integrity, resiliency, availability, and security are adequate to maintain their operational capability and promote the maintenance of fair and orderly markets.
• Anti-Money Laundering
  • The Bank Secrecy Act (BSA) requires certain financial institutions, including broker-dealers and certain RICs, to establish anti-money laundering (AML) programs customized to address entity-level risks. The Division will continue to focus on AML programs of registrants.

Conclusion

The SEC is making a concerted effort to increase the transparency of its examination programs. The publication of exam priorities equips registrants with information that can be used to achieve compliance with securities laws. Furthermore, disseminating the exam priorities increases the reach of the SEC’s exam program by enabling registrants not selected for examination access to the SEC’s priorities, focus areas, and concerns and to incorporate these insights into their compliance programs.

Source

1. All information cited in this article is sourced from 2024 Examination Priorities published by the Securities and Exchange Commission’s Division of Examinations.