(Article from Registered Funds Regulatory Update, January 2024)
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The SEC’s Division of Examinations released its 2024 Examination Priorities, aligning the release of the priorities with the start of the SEC’s fiscal year to provide earlier insight to its focus areas for the upcoming year. The following sets forth an overview of the Division’s 2024 examination priorities:
Investment Companies. The Division will continue to prioritize examining registered investment companies given their importance to retail investors, particularly those saving for retirement. Examination focus areas will include:
- Fees and expenses and reviewing whether the fund has adopted effective written compliance policies and procedures regarding oversight of advisory fees and implemented any associated fee waivers and reimbursements. Specifically, the SEC intends to focus on (i) funds that charge different advisory fees to different share classes; (ii) identical strategies that are offered by the same sponsor through different distribution channels but with different fee structures; (iii) funds with high advisory fees relative to peers; and (iv) funds with high fees and expenses, particularly those with poor performance relative to their peers. Notably, examinations will review the board’s approval of the advisory contract and fees.
- Derivatives risk management assessments to review whether (i) funds have adopted and implemented policies and procedures reasonably designed to manage the fund’s derivatives risks and prevent violations of the Investment Company Act Rule 18f-4 (Derivatives Rule); and (ii) review for compliance with Rule 18f-4, including the adoption and implementation of a derivatives risk management program, board oversight, and whether disclosures concerning the fund’s use of derivatives are incomplete, inaccurate, or potentially misleading.
- Compliance with the terms of exemptive order conditions and issues involving recent market dislocations and volatility, such as whether funds in liquidation are following liquidation procedures.
Investment Advisers. The Division will continue to review a registered investment adviser’s adherence to duty of care and duty of loyalty to its clients by focusing on (i) investment advice provided to certain types of clients, such as older investors and those saving for retirement; (ii) processes for determining that investment advice is provided in clients’ best interests; (iii) 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; (iv) disclosures made to investors and whether such disclosure includes 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.
The Division also remains focused on adviser compliance programs and compliance program reviews and will assess whether the policies and procedures are sufficient to support compliance with the adviser’s fiduciary obligations. The Division’s particular examination focus will include:
- marketing practice assessments, such as (i) compliance with the Advisers Act and the rules thereunder, including reforms to the Marketing Rule; (ii) appropriate disclosure or marketing-related information on Form ADV; and (iii) substantiation of processes and other required books and records;
- compensation arrangement assessments focusing on (i) fiduciary obligations of advisers to their clients; and (ii) alternative ways that advisers try to maximize revenue;
- valuation assessments regarding adviser recommendations to clients to invest in illiquid or hard to value assets, such as commercial real-estate or private placements;
- safeguarding assessments for controls protecting material non-public information; and
- disclosure assessments to review the accuracy and completeness of regulatory filings, including Form CRS.
Information Security and Operational Resiliency. The Division will continue to review broker-dealer and adviser practices to prevent interruptions to mission critical services and to protect investor information, records, and assets. The Division’s exams will focus on safeguarding customer records and information (including those stored via third-party service providers), governance practices, and responses to cyber-related incidents. In addition, the Division will assess registrant preparations associated with compliance with adopted rule changes to shorten the standard settlement cycle for most broker-dealer transactions from T+2 to T+1, which has a compliance date of May 28, 2024.
Crypto-Assets and Emerging Financial Technology. Given the continued volatility of, and activity around, the crypto asset markets, the Division will continue to monitor and, when appropriate, conduct examinations of registrants focusing on the offer, sale, recommendation of, or advice regarding trading and other activities in crypto assets or related products and include whether the firm (i) met and followed its respective standards of conduct when making recommendations or providing advice to customers or clients regarding crypto assets; and (ii) routinely reviewed, updated, and enhanced its compliance practices, risk disclosures, and operational resiliency practices. The Division also will conduct examinations of broker-dealers and advisers using emerging financial technologies (e.g., broker-dealer mobile apps, automated “robo-adviser” investment tools, and trading platforms) to meet compliance and marketing demands and service investor accounts. The Division will also assess whether any technological risks associated with the use of blockchain and distributed ledger technology have been addressed.
Investment Advisers to Private Funds. The Division notes a focus on ensuring adherence to contractual requirements regarding advisory boards. Sponsors should carefully review fund governing documents for notice and consent obligations and monitor, document, and test compliance with these requirements. Also included in the Examination Priorities for advisers to private funds are (i) for both private equity and venture capital firms, adequate due diligence practices for investments in portfolio companies, including a focus on consistency with policies and disclosures on this topic; (ii) a focus on conflicts, controls, and disclosures related to affiliated service providers; and (iii) for the second consecutive year, a priority on private funds managed side-by-side with registered investment companies. Finally, the Examination Priorities include other topics, such as policies and procedures for reporting on Form PF (which was recently amended), compliance with the amended Marketing Rule—underscoring the SEC’s overall focus on ensuring compliance with (and enforcing) newly adopted rules—as well as cybersecurity, AI, and anti-money laundering, among other areas.
Broker Dealers. The Division will continue to focus on standards of conduct for broker-dealers, specifically related to compliance with Regulation Best Interest. The Division’s examinations will assess practices regarding review of investment alternatives, management of conflicts of interest, and consideration of investment goals and account characteristics. The Division notes the following areas of assessment for its examinations:
- recommendations with regard to products, investment strategies, and account types;
- disclosure made to investors regarding conflicts of interest;
- conflict mitigation practices;
- processes for reviewing reasonably available alternatives; and
- factors considered in light of the investor’s investment profile, including investment goals and account characteristics.
Additionally, the Division’s examinations will review the content of a broker-dealer’s relationship summary, such as how the broker-dealer describes (i) the relationships and services that it offers to retail customers; (ii) its fees and costs; and (iii) its conflicts of interests, and whether the broker-dealer discloses any disciplinary history. The examinations will also evaluate whether broker-dealers met their obligations to file their relationship summary with the SEC and delivered it to retail customers.
2024 Examination Priorities, Division of Examinations, SEC (Oct. 16, 2023),
available at: https://www.sec.gov/files/2024-exam-priorities.pdf.