On October 16, 2023, the SEC’s Division of Examinations (Division) issued its 2024 Examination Priorities that support its stated mission—promote compliance, prevent fraud, monitor risk, and inform policy. The group will continue its focus on compliance, governance practices, and cybersecurity. Here’s what investment advisers, investment companies, and broker-dealers need to know about the 2024 focus areas.
Background
In 2022, the Division examined roughly 15% of the registered investment adviser (RIA) population. This population has grown to 15,000 investment advisers overseeing $125 trillion in assets under management. For broker-dealers, the Division completed 360 exams and—together with FINRA—roughly half of the 3,500 registered broker-dealers were examined in 2022. Results for 2023 are expected to be released in early December.
Investment Advisers
Particular examination focus will include:
- Marketing practice assessments for whether advisers have:
- Adopted and implemented reasonably designed written policies and procedures to prevent violations of the Advisers Act, including reforms to the Marketing Rule
- Appropriately disclosed their marketing-related information on Form ADV
- Maintained substantiation of their processes and other required books and records
- Reviews will assess whether advertisements include any untrue statements of a material fact, are materially misleading, or are otherwise deceptive and comply with the requirements for performance (including hypothetical and predecessor performance), third-party ratings, testimonials, and endorsements.
- Compensation arrangement assessments focusing on:
- Fiduciary obligations of advisers to their clients
- Alternative ways that advisers try to maximize revenue, such as revenue earned on clients’ bank deposit sweep programs
- Fee breakpoint calculation processes, particularly when fee billing systems are not automated
- Valuation assessments regarding advisers’ recommendations to clients to invest in illiquid or difficult-to-value assets, such as commercial real estate or private placements.
- Safeguarding assessments for advisers’ controls to protect clients’ material nonpublic information, particularly when multiple advisers share office locations, have significant turnover of investment adviser representatives, or use expert networks.
- Disclosure assessments to review the accuracy and completeness of regulatory filings, including Form CRS, with a particular focus on inadequate or misleading disclosures and registration eligibility.
Resources:
- New Fund Shareholder Report and Advertising Rules
- Have You Complied with the New Fair Valuation Rules?
Investment Advisers to Private Funds
The 2024 examinations will focus on:
- Exposure to recent market volatility and higher interest rates. This may include private funds experiencing poor performance, significant withdrawals, valuation issues, and funds with more leverage and illiquid assets.
- Adherence to contractual requirements on limited partnership advisory committees/boards, including adhering to any contractual notification and consent processes.
- 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.
- Due diligence practices for consistency with policies, procedures, and disclosures, particularly for private equity and venture capital fund assessments of prospective portfolio companies.
- Conflicts, controls, and disclosures regarding private funds managed side by side with registered investment companies (RICs) and use of affiliated service providers.
- Compliance with Advisers Act requirements on 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.
- Policies and procedures for Form PF reporting, including upon the occurrence of certain reporting events.
Resource: SEC Finalizes Extensive Private Fund Reforms
Investment Companies
Examination focus areas may include:
- Fees and expenses and reviewing whether RICs have adopted effective written compliance policies and procedures on oversight of advisory fees and implemented any associated fee waivers and reimbursements. A particular focus will be 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 RIC fees and expenses, particularly those of RICs with weaker performance relative to their peers
- Examinations also will review the boards’ approval of the advisory contract and RIC fees.
- Derivatives risk management assessments to review whether RICs and business development companies (BDCs) have adopted and implemented written policies and procedures reasonably designed to prevent violations of the new derivatives rule. Review of compliance with the derivatives rule may include review of the adoption and implementation of a derivatives risk management program, board oversight, and whether disclosures concerning the RICs’ or BDCs’ use of derivatives are incomplete, inaccurate, or potentially misleading. Examinations also may cover the associated RICs’ or BDCs’ procedures for—and oversight of—derivative valuations.
Resource: New Derivatives Rules for Investment Funds
Broker-Dealers
- Regulation best interest. Examinations will focus on those recommended products that are:
- Complex, such as derivatives and leveraged exchange-traded funds
- High cost, such as variable annuities
- Illiquid, such as nontraded real estate investment trusts and private placements
- Proprietary
- Microcap securities
- Examinations also may focus on recommendations to certain types of investors, such as older investors and those saving for retirement or college.
- Form CRS. Examinations will review the content of a broker-dealer’s relationship summary, such as how the broker-dealer describes:
- The relationships and services that it offers to retail customers
- Its fees and costs
- Conflicts of interest, and whether the broker-dealer discloses any disciplinary history
- Financial responsibility rules. Areas of review will include fully paid lending programs and broker-dealer accounting for certain types of liabilities, such as reward programs, point programs, gift cards and nonbrokerage services, and also will assess broker-dealer credit, interest rate, market, and liquidity risk management controls to assess whether broker-dealers have sufficient liquidity to manage stress events.
- Trading practices. Examinations will review compliance with Regulation SHO, including the rules regarding aggregation units and locate requirements; Regulation ATS, and whether the operations of alternative trading systems are consistent with the disclosures provided in Forms ATS and ATS-N; and Exchange Act Rule 15c2-11.
Areas of Ongoing Focus
Noticeably absent from this year’s list is environmental, social, and governance (ESG) investing as an ongoing area of concern.
Information Security & Operational Resiliency
The Division will continue to review broker-dealers’ and advisers’ practices to prevent interruptions to mission-critical services and protect investor information, records, and assets. Operational disruption risks remain elevated due to the proliferation of cybersecurity attacks, firms’ dispersed operations, intense weather-related events, and geopolitical concerns. The Division will focus on registrants’ policies and procedures, internal controls, oversight of third-party vendors (where applicable), governance practices, and responses to cyber incidents, including those related to ransomware attacks. Part of this review will consider whether registrants adequately train staff regarding their identity theft prevention program and their policies and procedures designed to protect customer records and information. With respect to third-party products and services in particular, the Division will continue to assess how registrants identify and address risks to essential business operations. In connection with its mission to inform policy, the Division also will look at the concentration risk associated with the use of third-party providers, including how registrants are managing this risk and the potential impact to the U.S. securities markets.
In February, the SEC shortened the standard settlement cycle for most broker-dealer transactions from two business days after the trade date to one business day, effective May 28, 2024. The Division will assess preparations for this change.
Resources:
Crypto Assets & Emerging Financial Technology
Examinations will focus on the offer, sale, recommendation of, or advice regarding trading in cryptocurrency or crypto-related assets and include whether the firm met and followed its respective standards of care when making recommendations, referrals, or providing investment advice; and routinely reviewed, updated, and enhanced its compliance, disclosure, and risk management practices.
The Division will focus on broker-dealers and advisers offering new products and services or employing new practices, particularly technological and online solutions that service online accounts aimed at meeting the demands of compliance and marketing. The Division remains focused on certain services, including automated investment tools, artificial intelligence, and trading algorithms or platforms, and the risks associated with the use of emerging technologies and alternative sources of data.
Anti-Money Laundering (AML)
Examiners will review whether broker-dealers and certain RICs are:
- Appropriately tailoring their AML program to their business model and associated AML risks
- Conducting independent testing
- Establishing an adequate customer identification program, including for beneficial owners of legal entity customers
- Meeting their suspicious activity report filing obligations
Conclusion
The asset management team at FORVIS has more than 50 years of experience providing accounting, tax, and consulting services to various types of investment holdings, including conventional debt and equity investments, loans, businesses, alternative investments, and other unique assets. As of August 2022, Convergence Optimal Performance ranked FORVIS as a top 25 accounting and audit firm to RIAs. FORVIS also was ranked in the top 20 by assets under management. We have experience providing services to fund complexes with net assets ranging from a couple million to several billion dollars. Our experience allows us to provide tailored services to help meet your unique needs. For more information, reach out to a professional at FORVIS.