U.S. SEC Examination Priorities 2024
On 16th October 2023, the Securities and Exchange Commission (“SEC”) in the United States of America (“U.S.”) issued its 2024 Examination Priorities Report (“Report”).
PDF version: U.S. SEC Examination Priorities 2024
Introduction
Examination Priorities for Investment Advisers
Within this Report, the SEC’s Division of Examinations (“the Division”) not only sheds light on their regulatory focus for the upcoming fiscal year, but also provides valuable insights for firms seeking to enhance their compliance programs, risk management strategies and operational practices. The priorities outlined reflect the Division’s assessment of certain risks, issues and policy matters arising from market and regulatory developments, insights from previous examinations, and other sources, including tips, complaints and referrals.
While the Report outlines areas that pose as emerging risks to investors or other capital markets within the U.S., this publication focuses on the Examination Priorities for Investment Advisers.
Section 202(a)(11) of the U.S. Investment Advisers Act of 1940 defines Investment Advisers refer to any person or firm that is engaged in the business of providing investment advice to clients and/or issuing reports or analyses regarding securities for compensation.
The Division’s examination will scrutinize the following 4 key areas pertaining to their business operations:
1. Fiduciary Duties
The Division will examine whether investment advisers have adhered to fiduciary standards pertaining to products, investment strategies, and account types. The inspection is likely to revolve around advice related to:
- Complex Products: Derivatives and leveraged exchange-traded funds (“ETFs”);
- High-Cost and Illiquid Products: Variable annuities and non-traded Real-Estate Investment Trusts (“REITs”); and
- Unconventional strategies that purport to address rising interest rates.
The Division has also highlighted a particular emphasis on investment advice provided to senior investors and those in retirement planning stages.
2. Suitability
The Division will assess processes determining whether investment advice is in the clients’ best interest, including suitability determinations, best execution, evaluating costs and risks, and identifying and addressing conflicts of interest.
3. Conflicts of Interest
The Division will scrutinize how Investment Advisers navigate potential conflicts of interest, as these can arise in a multitude of scenarios. Several prevalent examples of conflicts of interest that Investment Advisers may encounter include:
- Multiple Client Accounts: Conflicts can emerge when clients maintain several accounts. Therefore, the Division would expect to see a balanced and impartial allocation of investments and advising services across these accounts.
- Disclosure of Material Facts: The Division would expect that Investment Advisers ensure that all pertinent facts are adequately disclosed to enable clients to provide informed consent to any conflicts of interest. This includes full transparency about investment risks, costs, and adviser compensation.
- Economic Incentives: The Division will pay particular attention to the economic incentives offered to advisers and financial professionals when recommending certain products, services, or account types. This is of particular interest in the event that advisers are dually registered as broker-dealers, use affiliated firms for client services, or have financial professionals who service both brokerage customers and advisory clients.
4. Compliance Programs
The Division will also assess compliance programs to ensure that they accurately reflect the business, compensation structures, services, client demographics, operations, as well as address current market risks. The Division’s inspection of compliance policies will cover several areas, including, but not limited to:
- Portfolio management process
- Disclosures to investors and regulators
- Proprietary and personal trading activities
- Safeguarding of client assets and non-public information
- Maintenance of required records
- Trading practices
- Marketing of advisory services
- Valuation processes and fee assessment
- Business continuity plans
- Selection and use of third-party and affiliated service providers
- Overseeing branch office
In addition, the Division will also seek to assess whether the policies and procedures are sufficient to support compliance with the advisers’ fiduciary obligations.
Investment Advisers to Private Funds
Given that Investment Advisers to private funds constitute a substantial segment of the SEC-registered investment adviser population, the Division shall place a particular focus on this category of advisers. The following topics intend to be prioritised, among others previously mentioned:
1. Portfolio Management
In light of recent market volatility and higher interest rates, private funds may be subject to greater portfolio management risks. Therefore, the Division expects that measures are taken to deal with situations whereby private funds experience poor performance, significant withdrawals and valuation issues and private funds with more leverage and illiquid assets.
2. Contractual Requirements
It is expected that contractual requirements regarding limited partnership advisory committees or similar structures (e.g., advisory boards) are adhered to, including adhering to any contractual notification and consent processes.
3. Allocation of Fees, Accuracy of Calculations and Disclosures
It is expected that the advisers ensure the accurate calculation and allocation of private fund fees and expenses (both fund-level and investment-level), including valuation of illiquid assets, calculation of post commitment period management fees, adequacy of disclosures, and potential offsetting of such fees and expenses.
4. Due Diligence
Due diligence practices should be in place for consistency with policies, procedures, and disclosures, particularly with respect to private equity and venture capital fund assessments of prospective portfolio companies.
5. Conflicts of Interest
Conflicts, controls, and disclosures regarding private funds managed side-by-side with registered investment companies and use of affiliated service providers should be accounted for.
6. Compliance with the Advisers Act
The SEC expects that advisers are in full compliance with Advisers Act requirements regarding custody, including accurate Form ADV reporting, timely completion of private fund audits by a qualified auditor and the distribution of private fund audited financial statements.
7. Appropriate Policies and Procedures
Appropriate policies and procedures should be in place, particularly for reporting on Form PF, including upon the occurrence of certain reporting events.
Additional Key Risk Areas
Besides the prioritized emerging market participants focus, the SEC shall continue to focus on potential risks from fields that affect all financial market entities in the U.S., including Information Security, Crypto Assets and Anti-Money Laundering (“AML”).
Risk Area #1: Information Security & Operational Resiliency
- Policies and procedures.
- Internal controls and governance practices (e.g., prevention of account intrusions, safeguarding customer records and information, etc.).
- Oversight of third-party vendors.
- Responses to cyber-related incidents (including those related to ransomware attacks).
- Adequate staff training.
Risk Area #2: Crypto Assets & Emerging Financial Technology
- Risks associated with the use of emerging technologies (automated investment tools, artificial intelligence, and trading algorithms or platforms) and alternative sources of data to provide investment advice to clients.
- Ensure that standards of conduct and suitability requirements are complied with when recommending or advising customers on crypto assets.
- Policies and procedures (e.g., custody requirements, crypto asset wallet reviews, valuation procedures, etc.).
- Risk disclosures.
Operational resiliency practices (e.g., data integrity, business continuity plan, etc.).
Risk Area #3: Anti-Money Laundering
- Establish and tailor their AML programs to its business model and associated AML risks.
- Conduction of independent testing.
- Establish customer identification
- Fulfil Suspicious Activity Report (“SAR”) filing duties.
- Oversight of applicable financial intermediaries.
- Continuously monitor Office of Foreign Assets Control sanctions and ensure compliance with such sanctions.
The Division’s Report encapsulates the SEC’s commitment to upholding market integrity and safeguarding investors in the current dynamic financial landscape. While the outlined priorities do not encompass an exhaustive list of the areas that the Division will focus on, Investment Advisers are encouraged to use this as a starting point to adopt a comprehensive, risk-based approach with respect to their compliance programs.
