SEC Division of Examinations: 2024 Examination Priorities
By Jay Monaghan, CPA, Michael Stellwagen, CPA, Michael Provini, CPA, Rachel DiDio, CPA and Mike Corcione, CMMC-AB, RP
The U.S. Securities and Exchange Commission (SEC) Division of Examinations (the Division) issued its 2024 Examination Priorities on October 16, 2023. The issuance date represents the earliest publication to date in the 10-year history of examination priorities, with the intention to help registrants better prepare for upcoming exams. Driven by the Division’s “four pillars” mission – to promote compliance, prevent fraud, monitor risk and inform policy – the examination priorities are aimed to “better inform investors and registrants of the key risks, trends and examination topics the Division plans to focus on in the upcoming year.”
Due to the dramatic growth and increased complexity of the U.S. capital markets and its participants, the Division continues to explore how examinations are conducted and how it communicates examination observations, results and other valuable information to market participants. Examinations will be performed in-person but will also provide virtual options to both examiners and registrants during various stages of the examinations to broaden access and utilize technological efficiencies.
The Division has also taken steps to publish risk alerts that summarize examination observations and to notify registrants of potential scope areas of examinations that will focus on compliance with new rules and regulations. Joint regulatory training has also been launched with the Financial Industry Regulatory Authority (FINRA) to enhance communication and collaboration between industry regulators on how to protect investors, ensure compliance and preserve market integrity.
Although the Division’s examinations do touch upon emerging issues and risks associated with crypto assets, financial technology (such as artificial intelligence) and cybersecurity, many of the examination priorities remain consistent with the prior year and will focus on recently adopted rules for investment advisers and investment companies, standards of conduct for broker-dealers and investment advisers (fiduciary duties), environmental, social and governance (ESG) investing and information security.
Investment advisers are considered fiduciaries and owe clients a duty of care and loyalty to always serve in the best interest of clients. Investment advisers cannot place their own interests ahead of the interests of their clients. The fiduciary responsibility of investment advisers remains a priority for the Division and examinations will continue to focus on:
- Investment advice provided to clients regarding products, investment strategies and account types, particularly complex products, high cost, illiquid products and unconventional strategies.
- Processes for determining that investment advice provided is in a client’s best interest. Examinations will review how conflicts of interest are addressed and how investment advisers mitigate or eliminate conflicts identified.
- Economic incentives associated with investment advisers that are dually registered as broker-dealers, use affiliated firms to perform client services and have financial professional servicing both customer and advisory clients.
- Adequacy of disclosures made to investors regarding conflicts of interest.
The Division will also remain focused on compliance programs, policies and procedures to assess that conflicts of interest are properly addressed and that investment advisers are properly performing their fiduciary obligations.
Other areas the Division’s examinations will focus on include:
- Marketing practice assessments.
- Compensation arrangements focusing on fiduciary obligations to clients.
- Valuation assessments regarding recommendations to client to invest in illiquid or difficult-to- value investments.
- Safeguarding assessments to protect client’s material non-public information.
- Disclosure assessments to review accuracy of disclosures and completeness of regulatory filings.
Consistent with prior years, the Division continues to prioritize examinations for those investment advisers that have never been examined, recently registered advisers and advisers that have not been examined for several years.
Investment Advisers to Private Funds
Investment advisers to private funds still represent a sizable portion of the SEC-registered investment adviser population and the Division prioritizes certain examination topics, such as:
- Portfolio management risks related to recent market volatility and rising interest rates.
- Adherence to contractual requirements.
- Accurate calculation and allocation of private fund fees and expenses in accordance with fund agreements and valuation policies.
- Due diligence practices with respect to private equity and venture capital fund assessments of prospective portfolio companies.
- Disclosures related to conflicts and controls.
- Compliance with Advisers Act requirements regarding custody, accurate Form ADV reporting, timely completion of private fund audits and distribution of private fund audited financial statements to investors.
- Policies and procedures for reporting on Form PF.
Many of the examination priorities align with areas of recent rulemaking activity which include Private Funds Rules, Marketing Rule, Compliance Rule and Form PF amendments.
Registered investment companies, including mutual funds and exchange traded funds (ETFs), will also be prioritized for examinations due to their importance to retail investors, particularly older investors saving for retirement. Such examinations will assess compliance programs and fund governance practices, disclosures, valuation practices and the accuracy of reporting to the SEC.
The Division’s examinations will also focus on:
- Fund fees and expenses, particularly for funds with weaker performance compared to peers. Regarding fees, a particular focus is placed on:
- Charging different advisory fees to different share classes.
- Fees charged to identical investment strategies offered by the same sponsor.
- High advisory fees compared to industry peers.
- High registered investment company fees and expenses.
- Derivatives risk management assessments and the related written policies and procedures. The Division will assess if policies and procedures are reasonably designed to prevent violations of the fund derivatives rule (Investment Company Act Rule 18f-4).
The Division will also review for compliance with the issues associated with recent market dislocations and volatility, and that investment companies in liquidation are following liquidation procedures.
The SEC’s Regulation Best Interest establishes the standard of conduct from broker-dealers at the time recommendations are made to retail investors about investment securities and investment strategies. Regulation Best Interest enforces a broker-dealer’s fiduciary responsibility to its customers and compliance with:
- Disclosures to investors and information on Form CRS regarding fees and costs, relationships, conflicts of interest and disciplinary history (Disclosure Obligation).
- Due diligence, care and skill in making investment recommendations (Care Obligation).
- Establishing policies and procedures to address conflicts of interest (Conflict of Interest Obligation).
- Establishing and maintaining written policies and procedures designed to promote compliance with Regulation Best Interest (Compliance Obligation).
The examination will focus on recommended products that are complex, high cost, illiquid, propriety and microcap securities.
The Division will also continue to focus on dual registrants, and examinations will touch upon firms’ conflicts of interest, account allocation practices, account selection processes and will also assess broker-dealers’ supervision of branch office locations.
Consistent with prior years, the Division’s examinations will also place an emphasis on broker-dealer compliance with the SEC’s Net Capital Rule and the Customer Protection Rule and internal processes, procedures and controls. Specific areas of focus include fully paid lending programs, accounting for reward programs, gift cards and non-brokerage services and assessing liquidity risk management controls. Examinations will also review compliance with the Exchange Act Rule 15c2-11, Regulation SHO, Regulation ATS and whether operations of alternative trading systems are consistent with disclosures provided in Forms ATS and ATS-N.
As required by Title VIII of the Dodd-Frank Act and the Customer Protection Act, the Division will conduct at least one annual risk-based examination of each clearing agency designated as systemically important and for which the SEC serves as a supervisory agency. These examinations will focus on clearing agencies’ core risks, processes and controls and will cover the nature of clearing agencies’ operations and assessment of financial and operational risk.
In addition, the Division will conduct risk-based examinations of other clearing agencies which will focus on compliance with the SEC’s Standards for Covering Clearing Agencies which requires maintaining sufficient financial resources, protecting against credit risks, managing member defaults and managing operational and other risks. For 2024, areas of focus may include, among other things, risk management liquidity, models and model valuation, margin systems, third party services providers, operations and the internal audit function.
In addition to risk-based examinations, the Division will continue to perform Corrective Action Reviews which includes assessing the adequacy and timeliness of remediation of prior deficiencies.
Other Market Participants
Examinations will continue to review whether municipal advisors have met their fiduciary obligation to municipal clients. Compliance with new MSRB Rule G-46, which becomes effective March 1, 2024, will also be a focus of the examinations to review disclosures of conflicts of interest and documentation of client relationships.
Security-Based Swap Dealers
Examinations will focus on security-based swap dealers and if policies and procedures related to compliance with security-based swap rules are in place and that obligations under Regulation SBSR to accurately report security-based swap transactions to data repositories are fulfilled. Compliance with capital, margin and segregation requirements will also be subject to review.
The Division will continue to examine transfer agents’ core functions, which include the timely turnaround of transfers, recordkeeping and retention, the safeguarding of funds and securities and filings with the SEC.
Risk Areas Impacting Market Participants
Information Security and Operational Resiliency
Cybersecurity remains a perennial priority focus for the Division in efforts to protect investor information, records and assets maintained at broker-dealers and investment advisers. The Division will focus on policies and procedures, internal controls, oversight of third-party vendors, governance practices and responses to cyber-related attacks, including ransomware and the compromise of personally identifiable information (PII). In addition, the Division will consider if adequate training is offered by registrants regarding identity theft prevention programs and policies and procedures to protect customer records.
Third-party products and services will be assessed for their risk to essential business operations. Risks include operational impact, concentrated use of third parties and how registrants are managing the risk and identifying the potential impact to the U.S. securities markets.
Finally, the Division will assess registrant’s preparations associated with rule changes to shorten the standard settlement cycle for most broker-dealer transactions from two business days after trade date to one business day after trade date. The compliance date for this rule takes effect May 28, 2024.
Crypto Assets and Emerging Financial Technology
Certain types of investments (including crypto assets) and emerging financial technology (such as mobile applications, artificial intelligence and automated investment tools) will continue to be observed and reviewed by the Division. Examinations will focus on whether registrants:
- Meet and follow their respective standards of conduct when recommending or advertising crypto assets to customers.
- Routinely review, update and enhance their compliance practices and assess and update operational resiliency.
The Division will also consider if advisers are in compliance with custody requirements of the Advisers Act [Rule 206(4)02] and will assess technology risks associated with blockchain and distributed ledger technology.
Regulated Systems Compliance and Integrity
The SEC adopted Regulation Systems Compliance and Integrity (SCI) in 2014 to strengthen the technology infrastructure of the U.S. securities markets. The Division will continue to review and assess that SCI entities have established, maintained and enforced their written policies and procedures as required and that these are reasonably designed to ensure the security of the SCI systems, including the physical security of the systems housed in data centers.
Financial institutions, certain registered investment companies and broker-dealers are required to establish anti-money laundering programs which should include policies, procedures and internal controls reasonably designed to achieve compliance with the Bank Secrecy Act, which includes customer due diligence, monitoring suspicious activity and filing suspicious activity reports (SARs) when appropriate.
We are here to help advise you on questions you may have regarding your business’ best practices and compliance with the SEC’s priorities. You can view the complete 2024 Examination Priorities here. For assistance, reach out to the partner in charge of your account or any of the following: