On October 16, 2023, the U.S. Securities and Exchange Commission (“SEC”) Division of Examinations (the “Division”) published its set of examination priorities for 2024 (the “2024 Priorities”), which represents the earliest publication date in the Division’s 10-year history of releasing these priorities.1 According to the Division, this early release is intended to provide registrants with the opportunity to better prepare themselves for upcoming exams. Additionally, given the short time since the Division published its 2023 priorities eight months ago, the Division acknowledged that several initiatives and focus areas from last year will remain priorities for 2024.
There are, however, two notable differences from prior years, namely that: (i) for the first time in a number of years the Division did not mention ESG as a priority and (ii) venture capital fund advisers were referenced in the 2024 Priorities for the first time, with the Division planning to focus on their due diligence practices and assessments of prospective portfolio companies (see below for more detail). While the Division did not mention ESG as a priority for 2024, we note that the SEC staff is generally very focused on how advisers approach ESG matters. For example, recent SEC routine examination document requests have contained many detailed questions related to ESG, requiring advisers to produce detailed documentation and precise data related to any ESG products or services.2
As in previous years, the Division continues to prioritize examinations of SEC-registered investment advisers (“RIAs”) that have never been examined, including recently registered RIAs and RIAs that have not been examined for several years.3
This alert highlights a high-level summary of what advisers and other market participants should anticipate based on the 2024 Priorities. For additional information, please contact your Croke Fairchild attorney.
Examinations for Investment Advisers Generally:
Examinations for advisers will continue to focus on determining whether an adviser has complied with the Investment Advisers Act of 1940 and the rules thereunder, including reforms to the Marketing Rule 4, especially as it relates to substantiation of marketing materials, performance advertising, testimonials, and compensated endorsements.
The further areas of focus detailed by the Division in the 2024 Priorities center on compliance with advisers’ fiduciary duties and will include assessments of:
- Investment advice provided to clients regarding products, investment strategies, and account types, particularly advice regarding: (1) complex products (e.g., derivatives, leveraged exchange-traded funds); (2) high-cost and illiquid products (e.g., variable annuities and non-traded REITs); and (3) unconventional strategies (e.g., those that purport to address rising interest rates).
- Whether the investment advice being offered is in a client’s best interest, including processes for suitability determinations, seeking best execution, evaluating costs and risks, and identifying and mitigating or eliminating conflicts of interest (as appropriate).
- Compensation arrangements and economic incentives that an adviser and its financial professionals may receive by recommending products, services, or account types.
- Compliance programs, including whether an adviser’s policies and procedures adequately reflect the various aspects of the RIA’s business, compensation structure, services, client base, and operations, particularly as it relates to addressing conflicts of interest, and address applicable current market risks.
- Disclosure relating to conflicts of interest associated with investment advice and whether it includes all material facts sufficient to allow a client to provide informed consent to the conflict.
Examinations for Investment Advisers to Private Funds:
The Division will continue to focus on examinations of advisers to private funds and prioritize specific topics, such as:
- Portfolio management risks that are present when there is exposure to recent market volatility and higher interest rates.
- Adherence to contractual requirements regarding limited partner advisory committees or similar structures, including any contractual notification and consent processes.
- Accurate calculation and allocation of private fund fees and expenses (both fund-level and investment-level).
- Due diligence practices for consistency with policies, procedures, and disclosures, particularly with respect to private equity and venture capital fund assessments of prospective portfolio companies.
- Note that this is the first mention of venture capital advisers by the Division in a priorities release since it began publishing these alerts.
- Custody compliance, including accurate Form ADV reporting, timely completion of private fund audits by a qualified auditor and the distribution of private fund audited financial statements.
- Conflicts, controls, and disclosures regarding private funds managed side-by-side with registered investment companies and use of affiliated service providers.
Examinations for Other Market Participants:
Broker-Dealers. The Division will focus on examinations of broker-dealers (“BDs”), including but not limited to the following areas:
- Compliance with Regulation Best Interest, which establishes the standard of conduct for BDs at the time they recommend a securities transaction or investment strategy to a retail customer. The Division will evaluate whether the BD has established, maintained, and enforced written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest (e.g., conflict disclosures; conflict mitigation; processes for reviewing reasonably available alternatives).
- Disclosure statements contained in Form CRS, with a focus on misleading disclosures and registration eligibility.
- Compliance with financial responsibility rules such as the Net Capital Rule5 and the Customer Protection Rule6 and related internal processes, procedures and controls.
- Trading practices, particularly compliance with alternative trading system regulations.
Municipal Advisers. The Division’s examinations of municipal advisers will include 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.
Security-Based Swap Dealers. The Division’s examinations of security-based swap dealers will include whether security-based swap dealers are complying with applicable capital, margin, and segregation requirements and whether they are meeting obligations under Regulation SBSR.7
Transfer Agents. The Division’s examinations of transfer agents will focus on processing of items and transfers, recordkeeping and record retention, safeguarding of funds and securities, and filings.
Risk Areas Affecting Multiple Market Participants
The following is a list of topics of concern to market participants across various sectors of the industry that the Division highlighted as being a focus of their examination activities.
- Cybersecurity, including the implementation of policies and procedures and internal controls related thereto as well as the oversight of third-party vendors (as appropriate), responses to cyber-related incidents, and training offered to employees.
- Crypto assets and emerging technology (e.g., automated investment tools, artificial intelligence, and trading algorithms).
- Anti-money laundering programs, including customer identification programs (CIP) and customer due diligence programs (CDD) around verifying beneficial ownership of certain legal entities.
For more information, please contact your CFDB lawyer or: