2024 SEC Division of Examinations Priorities

Published on Oct 17th, 2023 |

2024 SEC Division of Examinations Priorities | Key Takeaways

SEC Releases

Introduction

On Monday, October 16^th, the SEC Division of Examinations released their examination priorities for 2024.

To no surprise, they will continue to investigate core and perennial risk areas with a new focus on emerging risks to investors and markets.

SEC Chair, Gary Gensler, expressed the goal of protecting investors, facilitating capital formation, and ensuring a functioning market for investors and issuers.

The Division of Examinations will continue following a risk-based approach to improve compliance, prevent fraud, monitor risk, and inform policy.

Key Changes from 2023

The examination priorities for 2024 are similar to those of 2023.

The Division of Examinations will continue to focus on major topics related to conflicts of interest, proper disclosures, compliance with the new Marketing Rule, fiduciary responsibilities, cybersecurity, etc.

As always, Firms should be prepared to demonstrate how their compliance programs have made a good-faith effort to comply with new rules and amendments effective for 2024. Examples include the changes to the securities transaction settlement cycle and the cybersecurity reporting and risk management rules.

It is worth noting that ESG received no mention in the 2024 report, however it is likely that this topic will fall under disclosure and marketing rule requirements.

Key Takeaways

Investment Advisers
- Examination of Investment Advisers
  - Adviser adherence to duty of care and duty of loyalty
    - Advisers must eliminate or make full and fair disclosure of all conscious or unconscious conflicts of interest, and all material facts related, when rendering advice.
    - Any investment advice is included, but with particular focus on complex products, high cost and illiquid products, and unconventional strategies.
    - Advisers must have a process to determine what advice is in the client’s best interest, documenting for:
      - Initial and ongoing suitability.
      - Best execution.
      - The evaluation of costs and risks.
      - Any identified conflicts of interest.
    - Procedures should describe how advisers address conflicts of risk including:
      - Mitigation or elimination.
      - Allocation of investor investments to appropriate accounts.
    - Incentives for advisers and financial professionals to recommend certain products will be scrutinized, particularly in situations involving revenue sharing, markups, or other revenue arrangements, with focus on advisers that:
      - Dual-register as Broker Dealers.
      - Use affiliated Firms to perform client services.
      - Have financial professionals servicing both brokerage customers and advisory clients.
    - Investment advice will also be examined that encourages customers to:
      - Purchase or hold onto certain types of investments.
      - Invest through types of accounts with higher expenses.
      - Utilize proprietary products and affiliated service providers resulting in higher fees.
    - Disclosures should be accurate and descriptive enough that clients are able to give informed consent to any conflicts of interest.
Compliance Programs
- Compliance Programs should properly reflect and pertain to the advisers’ business including:
  - Compensation structure.
  - Services.
  - Client base.
  - Operations.
  - Current Market Risks.
- Annual reviews performed by advisers will themselves to be reviewed for effectiveness.
- Policies and Procedures will also be assessed for effectiveness related to, but not limited to:
  - Portfolio management.
  - Disclosures to investors and regulators.
  - Proprietary trading and personal trading activities of supervised advisory personnel.
  - Safeguarding of client assets from inappropriate use.
  - Accurate creation and maintenance of required records.
  - Privacy protection of client records and information.
  - Trading practices.
  - Marketing Practices.
  - Valuation of client holdings and resulting fees assessed.
  - Business Continuity Plans.
Additional Examination Focuses
- Adherence and effectiveness of policies and procedures towards:
  - The Advisers Act and Marketing Rule reforms.
  - Disclosure requirements for marketing-related information on Form ADV.
  - Substantiation of their processes and other required books and records.
  - Preventing statements that are materially untrue statements of fact, misleading or deceptive, or non-compliant with requirements related to performance, third-party ratings, testimonials, and endorsements.
- The use of compensation arrangements with clients related to:
  - The fiduciary obligation of advisers to clients when receiving compensation.
  - Alternative methods of maximizing adviser revenue.
  - Fee breakpoint calculation processes, especially when not automated.
- How advisers assess value for illiquid or difficult to value assets.
- The accuracy and completeness of regulatory filings (Form CRS) including registration eligibility.
- Adviser policies and procedures related to:
  - Selecting and using third-party services.
  - Overseeing branch offices that are numerous or geographically dispersed.
  - Obtaining informed consent when material changes are made to advisory agreements.
Examination of Investment Advisers to Private Funds
- Advisers should have proper portfolio management of risks to investors in relation to market volatility and higher interest rates, risks of which include:
  - Poor performance.
  - Significant withdrawals.
  - Valuation issues.
  - Increased leverage and less liquidity.
- Adherence to contracts regarding limited partner advisory committees, contractual notification, and consent processes will be examined.
- Calculations and allocation of Private Fund fees/expenses should be accurate including:
  - Valuation of illiquid assets.
  - Calculation of post commitment period management fees.
  - Adequacy of disclosures.
  - Potential offsetting of fees and expenses.
- Advisers should apply due diligence practices for consistent application of policies, procedures, and disclosures in relation to Private Equity and Venture Capital Fund assessments.
- Funds that are managed side-by-side with Registered Investment Companies (“RICs”) and affiliated service providers should include well documented controls and disclosures related to any conflicts of interest.
- Custody requirements under the Advisers Act will be examined including:
  - Accurate Form ADV reporting.
  - Timely completion of Private Fund audits by qualified auditors.
  - The distribution of Private Fund audited financial statements.
- Policies and procedures should ensure accurate reporting on Form PF and the accurate recognition of reporting events.
Investment Companies
- Examination Focus Areas
  - Compliance programs and governance practices.
  - Board processes for assessing and approving fees.
  - Fair Valuation practices
    - Board oversight duties.
    - Recordkeeping and reporting requirements.
    - Overseeing valuation designees.
  - Fees and Expenses focuses:
    - Different advisory fees charged to different share classes of the same Fund.
    - Identical strategies offered by the same sponsor that charge differing fee structures.
    - High advisory fees relative to similar peers.
    - Increased fees and expenses with weaker performance.
  - Derivative Risk Management Assessments
    - Policies and procedures should be designed to prevent violations of the Fund Derivatives Rule.
    - Disclosures of the use of derivatives should be complete, accurate, and without any potentially misleading statements.
  - Liquidation procedures
Broker-Dealers
- Regulation BI (“Reg BI”)
  - Making recommendations
    - Disclosure Obligation: certain disclosures must be made before, or at the time of, recommendation.
    - Care Obligation: reasonable diligence, care, and skill when making recommendations.
    - Conflict of Interesting Obligation: creating and enforcing policies and procedures to address conflicts of interest.
    - Compliance Obligation: creating and enforcing policies and procedures to comply with Reg BI.
  - Examinations will focus on recommended products that are:
    - Complex.
    - High cost.
    - Illiquid.
    - Proprietary.
    - Microcap Securities.
- Form CRS – Broker Dealer relationship summary of:
  - Services and relationships offered to retail customers.
  - Fees and costs.
  - Conflicts of interests.
  - Disclosures of disciplinary history.
- Broker Dealer Financial Responsibility – Examination Focuses:
  - Compliance with the Net Capital and Customer Protection Rule
    - Fully paid lending programs.
    - Accounting for different types of liabilities.
    - Risk Management.
    - Liquidity and Stress management.
- Broker Dealer Trading Practices – compliance with:
  - Regulation SHO.
  - Regulation ATS.
  - Market Making Regulations
    - Quote generation.
    - Order routing and execution.
    - Market data ingestion, regulatory controls
    - Risk management.
Risk Areas Impacting Various Market Participants
- Information Security and Operational Resiliency
  - Broker Dealers and Registered Investment Advisers (“RIAs”) practices should prevent interruptions to mission-critical services and the protection of investor records, information, and assets.
  - Cybersecurity has become a perennial focus area, including registrants’ processes related to:
    - Internal controls.
    - Oversight of vendors – how registrants assess risks to their business operations from the use of third parties.
    - Governance practices.
    - Responses to cyber-related incidents – how registrants work to prevent account intrusions, especially with offices under supervision.
    - Compliance with rule changes to standard settlement cycle effective May 28^th, 2024.
    - Adequate training of staff regarding identity theft prevention and other criminal acts related to cybersecurity.
- Regulation SCI (Common Questions)
  - Have SCI entities established, maintained, and enforced written policies and procedures as required?
  - Are policies and procedures reasonably designed to ensure security of SCI systems?
- Anti-Money Laundering (“AML”) programs should:
  - Be tailored to their business model and AML risks.
  - Conduct independent testing.
  - Establish an adequate customer identification program.
  - Meet SAR filing obligations.
  - Provide oversight for financial intermediaries.
  - Monitor for, and ensure compliance with, OFAC sanctions.
Self-Regulatory Organizations
- National Securities Exchanges
  - Exchanges should meet their obligation to enforce compliance with SRO rules and securities laws.
- FINRA
  - The SEC performs risk-based oversight examinations of areas that it determines are most important and at greatest risk to affect market integrity and investor protection.
- MSRB
  - The SEC performs oversight assessments similar to FINRA oversight assessments.
  - The SEC also examines registered firms for compliance with MSRB rules.
Clearing Agencies
- Examinations of agencies designated as systemically important include:
  - Core risks.
  - Processes.
  - Controls.
  - Operations and assessment of risks.
- Risk Assessments of non-systemically important agencies will also be performed.
- 2024 General areas of focus
  - Risk management of liquidity.
  - Models and model validation.
  - Margin systems.
  - Third-party service providers.
  - Operations and internal audit functions.
Other Market Participants
- Municipal Advisors Examination Topics
  - Fiduciary duty to clients.
  - Documentation of municipal advisory relationships.
  - Disclosure of conflicts of interest.
  - Compliance with MSRB Rule G-46, effective March 1^st 2024.
- Security-Based Swap Dealers Examinations Topics
  - Obligations under Regulation SBSR.
  - Compliance with applicable capital, margin, and segregation requirements.
  - Compliance with general security-based swap rules.
- Transfer Agents Examination Topics
  - Processing of items and transfers.
  - Recordkeeping and record retention.
  - Safeguarding of funds and securities.
  - Filings with the commission.
  - Issuers of microcap and crypto asset securities.ec
  - Use of emerging technologies.

Vigilant's Conclusion

Vigilant’s Conclusion

It is vital that Firms carefully evaluate the focused topics we have discussed in detail and consider whether their compliance programs will meet regulatory requirements.

Successful compliance relies on a proactive approach that anticipates potential investigative actions and adjusts accordingly. There is simply no sign that the aggressive regulatory agenda pursued so far will be relaxed any time soon.

In such a dynamic regulatory environment, compliance professionals can provide invaluable support to limit the business risks from compliance failures.

Leveraging deep industry insights and decades of combined compliance experience, Vigilant can help your firm properly prepare for 2024.

Through our initial gap analysis for on-going engagements, Mock SEC Examinations, and other compliance tools, our professionals can identify areas of weakness and assess the strengths and weaknesses of your compliance programs.

Please reach out to us for any questions or concerns related to this announcement.