The Securities and Exchange Commission’s (SEC) Division of Examinations (DoE) recently released its 2024 examination priorities – its annual list of focus points as it identifies and addresses risks in the capital markets.
2024’s examination priorities will educate the DoE’s forthcoming examinations and inspections of registered investment advisers, investment companies, broker-dealers, transfer agents, municipal advisors, securities-based swap dealers, clearing agencies and other self-regulatory organizations.
Below, we provide a summary of Division’s focus areas for the coming year:
Investment Advisers
The DoE lists two sets of focus areas as it pertains to investment advisers:
Examinations of Investment Advisers
The Division will continue to focus on compliance programs to ensure their policies and procedures reflect all parts of the advisers’ business, compensation structure, services, client base and operations, and that they address applicable current market risks.
The DoE says it will continue to prioritize advisers’ adherence to their duty of care and duty of loyalty obligations, which includes investment advice provided to clients with regard to products, investment strategies and account types; processes for determining that investment advice is provided in clients’ best interest; economic incentives of advisers and their financial professionals; and disclosures made to investors.
The DoE says that in 2024, it will particularly focus on:
- Marketing practice assessments to determine whether advisers have adopted and implemented reasonably designed written policies and procedures to prevent violations of the Advisers Act, appropriately disclosed marketing-related information on Form ADV, and maintained substantiation of their processes and other required books and records.
- Compensation arrangement assessments focusing on fiduciary obligations of advisers to their clients, alternative ways advisers try to maximize revenue and fee breakpoint calculation processes.
- Valuation assessments regarding advisers’ recommendations to clients to invest in illiquid or difficult-to-value assets.
- Safeguarding assessments for advisers’ controls to protect clients’ material non-public information.
- Disclosure assessments to review the accuracy and completeness of regulatory filings, including Form CRS.
Examinations of Investment Advisers to Private Funds
The Division will also continue to prioritize specific topics pertaining to advisers to private funds, including (but not limited to):
- Portfolio management risks present when there’s exposure to recent market volatility and higher interest rates.
- Accurate calculation and allocation of private fund fees and expenses.
- Conflicts, controls and disclosures regarding private funds managed side-by-side with registered investment companies.
- Compliance with Advisers Act requirements regarding custody.
- Policies and procedures for reporting on Form PF.
Investment Companies
The Division will focus on the following pertaining to registered investment companies, including mutual funds and ETFs:
- Fees and expenses, including a particular focus on:
- Charging different advisory fees to different 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 registered investment company fees and expenses, particularly those of registered investment companies with weaker performance relative to their peers.
- Derivatives risk management assessments to review whether registered investment companies and business development companies (BDCs) have adopted and implemented written policies and procedures reasonably designed to prevent violations of the Commission’s fund derivatives rule.
Broker-Dealers
The Division highlights four areas within the broader scope of broker-dealers:
Regulation Best Interest
The DoE’s focus areas for Regulation Best Interest (Reg BI) will include:
- Recommendations about products, investment strategies and account types.
- Disclosures made to investors regarding conflicts of interest.
- Conflict mitigation practices.
- Processes for reviewing reasonably available alternatives.
- Factors considered in light of the investor’s investment profile, including investment goals and account characteristics.
Examinations will focus on products that are complex, high cost, illiquid, proprietary and/or microcap securities.
Form CRS
DoE examinations will review the content of a broker-dealer’s relationship summary, including how it describes the relationships and services it offers to retail customers, fees and costs, and conflicts of interest.
Broker-Dealer Financial Responsibility Rules
The Division’s examinations will focus on broker-dealer compliance with the Net Capital Rule and the Customer Protection Rule, with areas of review including fully paid lending programs and broker-dealer accounting for certain types of liabilities.
Broker-Dealer Trading Practices
The DoE will also examine broker-dealer equity and fixed income trading practices, including compliance with Regulation SHO, Regulation ATS and Exchange Act Rule 15c2-11.
Self-Regulatory Organizations
The Division breaks its focus areas under the self-regulatory organizations umbrella into three parts:
National Securities Exchanges
The DoE’s examinations will focus on national securities exchanges’ order handling and exchange surveillance, investigation and enforcement programs to detect and discipline member firm violations.
Financial Industry Regulatory Authority
The Division, in its risk-based oversight examinations of FINRA, will examine various aspects of FINRA’s operations, including FINRA’s implementation of investor protection initiatives such as Regulation Best Interest and Form CRS.
Municipal Securities Rulemaking Board
The DoE, along with FINRA and federal banking regulators, will conduct examinations of registered firms to assess compliance with MSRB rules, and applicable federal securities laws. It also will continue to apply a risk assessment process to identify areas to examine at the MSRB.
Clearing Agencies
In 2024, the Division will examine the registered clearing agencies for compliance with the Commission’s Standards for Covered Clearing Agencies.
Areas of examination focus may include risk management of liquidity, models and model validation, margin systems, third-party service providers and operations, and the internal audit function.
Other Market Participants
The DoE highlights three other groups of market participants and their focus areas:
Municipal Advisors
The Division will continue to review whether municipal advisors have met their fiduciary duty obligation to clients, particularly when providing advice regarding the pricing, method of sale, and structure of municipal securities. In particular focus during the second half of fiscal year 2024 will be compliance with the new MSRB Rule G-46.
Security-Based Swap Dealers
The DoE will continue to focus on whether security-based swap dealers have implemented policies and procedures related to compliance with security-based swap rules generally and are meeting their obligations under Regulation SBSR to accurately report security-based swap transactions to security-based swap data repositories.
Transfer Agents
The Division’s 2024 examinations will focus on transfer agent processing of items and transfers, recordkeeping and record retention, safeguarding of funds and securities, and filings with the Commission, among other issues.
Risk Areas Impacting Various Market Participants
The Division has identified several risk areas that will be key in its 2024 examinations:
Information Security and Operational Resiliency
Cybersecurity will remain a major focus area for the Division in 2024.
The Division will look at registrants’ policies and procedures, internal controls, third-party vendor oversight – especially as it pertains to risks to essential business operations – governance, and responses to cyber-related incidents.
DoE examinations of broker-dealers and advisers will also look at firms’ practices to prevent account intrusions and safeguard customer records and information, especially as it pertains to multiple offices.
Lastly, the Division will assess registrant preparations associated with the shortening of the standard settlement cycle, which has a compliance date of May 28, 2024.
Crypto Assets and Emerging Financial Technology
The DoE will continue to observe crypto assets, including determining whether registrants involved with crypto assets meet and follow their respective standards of conduct when recommending or advising customers and clients regarding crypto assets, and whether they routinely review, update and enhance their compliance practices, risk disclosures and operational resiliency practices.
The Division also will keep monitoring emerging financial technologies such as broker-dealer mobile apps and automated investment advice.
Regulation Systems Compliance and Integrity
The DoE will continue to evaluate whether Regulation Systems Compliance and Integrity (SCI) entities have established, maintained and enforced written policies and procedures. The Division says one area of focus will be whether the policies and procedures of SCI entities are reasonably designed to ensure the security of the SCI systems.
Anti-Money Laundering
The Division will continue to focus on anti-money laundering (AML) programs to review whether broker-dealers and certain registered investment companies are:
- Appropriately tailoring their AML program to their business model and associated AML risks
- Conducting independent testing
- Establishing an adequate customer identification program
- Meeting their SAR filing obligations
We suggest advisers view the full text of the 2024 exam priorities, which can be found here.
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