SEC Announces 2024 Examination Priorities11/20/2023
On October 16, 2023, the Securities and Exchange Commission’s Division of Examinations (“DOE”) announced its examination priorities for fiscal year 2024 (“2024 Examination Priorities”) (available here). Examination priorities, which are released annually, inform investors and registrants of the key risks, examination topics and priorities that DOE plans to focus on in the upcoming year.
DOE continues to use a risk-based examination process to accomplish its work. This year, for the first time, DOE is aligning publication of its priorities with the start of the fiscal year. Given the shorter interval between publication of 2023 priorities (February 2023) and this year's fiscal 2024 priorities, several initiatives and focus areas from last year remain as fiscal 2024 priorities.
DOE continues to coordinate and share experiences and information with other federal and state regulators, as well as with self-regulatory organizations. It also launched a series of joint regulatory trainings with FINRA staff to enhance communication and collaboration with FINRA. Regional offices also organized several compliance events with other regulators and industry and professional associations within their prospective regions. The “four pillars” of DOE’s remain the foundation of its work, to (1) promote compliance, (2) prevent fraud, (3) monitor risk and (4) inform policy.
Fiscal Year 2024 Examination Priorities
- Investment Advisers
- Examinations of Investment Advisers
- Examinations of Investment Advisers to Private Funds
- Investment Companies
- Regulation Best Interest
- Form CRS
- Broker-Dealer Financial Responsibility Rules
- Broker-Dealer Trading Practices
- Self-Regulatory Organizations
- National Securities Exchanges
- Financial Industry Regulatory Authority
- Municipal Securities Rulemaking Board
- Clearing Agencies
- Other Market Participants
- Municipal Advisors
- Security-Based Swap Dealers
- Transfer Agents
- Risk Areas Impacting Various Market Participants
- Information Security and Operational Resiliency
- Crypto Assets and Emerging Financial Technology
- Regulation Systems Compliance and Integrity
- Anti-Money Laundering
Using the context of the priorities stated above, DOE “prioritizes examinations of certain practices, products, and services that it believes present potentially heightened risks to investors or the integrity of the U.S. capital markets. This year’s examinations will prioritize areas that pose emerging risks to investors or the markets, as well as examinations of core and perennial risk areas.”
A. Examination of Investment Advisers
As a fiduciary, an investment adviser owes a duty of care and a duty of loyalty to its clients. At all times, an adviser must serve the best interest of its clients and not subordinate its clients’ interests to its own. In addition, an adviser is required to eliminate or make full and fair disclosure of all conflicts of interest. Examining advisers’ adherence to their duty of care and duty of loyalty obligations remains a priority for DOE. DOE will focus on:
- Investment advice provided to clients with regard to “products, investment strategies and account types,” particularly those involving complex products, high cost and illiquid products, and unconventional strategies. Examinations also may focus on advice provided to older clients and those saving for retirement.
- Processes for determining that investment advice is provided in clients’ “best interest,” including processes for making initial and ongoing suitability determinations, seeking best execution, evaluating costs and risks, and identifying and addressing conflicts of interest. Such assessments also will review the factors advisers consider in light of the clients’ investment profiles. Examinations will review how advisers address conflicts of interest.
- Economic incentives that an adviser and its financial professionals may have to recommend products, services, or account types. Examinations will focus on the “economic incentives and conflicts of interest associated with advisers that are dually registered as broker-dealers, use affiliated firms to perform client services, and have financial professionals servicing both brokerage customers and advisory clients.”
- Disclosures made to investors, including all material facts relating to conflicts of interest associated with the investment advice sufficient to allow a client to provide “informed consent to the conflict.”
DOE remains focused on advisers’ compliance programs, including whether their policies and procedures reflect the various aspects of the “advisers’ business, compensation structure, services, client base, and operations, and address applicable market risks.” DOE even reviews advisers’ own internal annual reviews of their own compliance programs.
In particular, DOE examinations will assess:
- Marketing practices, as to whether advisers (including advisers to private funds) have: (a) adopted and implemented reasonably designed written policies and procedures to prevent violations of the Investment Advisers Act of 1940, as amended (the “Advisers Act”); (b) appropriately disclosed their marketing-related information on Form ADV; and (c) maintained substantiation of their processes and other required books and records. Marketing practice reviews also will assess whether disseminated advertisements include any untrue statements of material facts, are materially misleading, or otherwise are deceptive and, as applicable, comply with the requirements for performance, third-party ratings, and testimonials and endorsements.
- Compensation arrangements focusing on: (a) fiduciary obligations of advisers with respect to their receipt of compensation for services or other material payments made by clients and others; (b) alternative ways that advisers try to maximize revenue, such as revenue earned on clients’ bank deposit sweep programs; and (c) fee breakpoint calculation processes.
- Valuations regarding advisers’ recommendations to clients to invest in illiquid or difficult to value assets.
- Safeguarding regarding advisers’ controls to protect clients’ material non-public information.
- Disclosures regarding the accuracy and completeness of regulatory filings.
DOE also is focused on advisers’ policies and procedures for: (a) selecting and using third-party and affiliated service providers; (b) overseeing branch offices; and (c) obtaining informed consent from clients when advisers implement material changes to their advisory agreements.
DOE continues to prioritize examinations of advisers that have never been examined, including recently registered advisers, and those that have not been examined for a number of years.
B. Examinations of Investment Advisers to Private Funds
DOE continues to focus on advisers to private funds, and will prioritize the following topics:
- Portfolio management risks present when there is exposure to recent market volatility and higher interest rates.
- Adherence to contractual requirements regarding limited partnership advisory committees or similar structures.
- Accurate calculation and allocation of private fund fees and expenses.
- 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.
- Conflicts, controls, and disclosures regarding private funds managed side-by-side with registered investment companies and use of affiliated service providers.
- 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.
- Policies and procedures for reporting on Form PF.
DOE continues to prioritize examinations of registered investment companies (“RICs”) including mutual funds and ETFs, due to their importance to retail investors, particularly those saving for retirement.
DOE will examine RIC compliance programs and fund governance practices, disclosures to investors, and accuracy of reporting to the SEC. In assessing RIC compliance programs and governance practices, DOE will “review boards’ processes for assessing and approving advisory and other fund fees, particularly for funds with weaker performance relative to their peers.” DOE also will review RIC valuation practices, particularly for those addressing “fair valuation practices” and, as applicable, will assess the effectiveness of their derivatives risk management and liquidity risk management programs.
The focus areas of the examinations will include:
- Reviewing whether RICs have adopted effective written compliance policies and procedures concerning the oversight of advisory fees and implemented any associated fee waivers and reimbursements. Particular focus will be on: (a) charging different advisory fees to different share classes of the same fund; (b) identical strategies offered by the same sponsor through different distribution channels but that charge differing fee structures; (c) high advisory fees relative to peers; and (d) high RIC fees and expenses, particularly those of RICs with weaker performance relative to their peers. Examinations also will review board approval of advisory contracts and fees.
- Reviewing whether RICs and business development companies (“BDCs”) have adopted and implemented written policies and procedures reasonably designed to prevent violations of the SEC’s “fund derivatives rule.” The review 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, and procedures for and oversight of derivative valuations.
A. Regulation Best Interest (“BI”)
When recommending to a retail customer a securities transaction or investment strategy, Regulation BI requires a broker-dealer “to act in the retail customer’s best interest and cannot place the financial or other interest of the broker-dealer ahead of the customer’s interest.”
In reviewing whether a broker-dealer’s recommendations are in a customer’s best interest, the following are of particular interest: (a) recommendations with regard to products, investment strategies, and account types; (b) disclosures made to investors regarding conflicts of interest; (c) conflict mitigation practices; (d) processes for reviewing reasonably available alternatives; and (e) factors considered in light of the investor’s investment profile, including investment goals and account characteristics.
Examinations will focus on recommended products that are complex, high cost, illiquid, proprietary, and microcap securities. Examinations also may focus on recommendations to older investors and those saving for retirement or college.
DOE will evaluate whether the broker-dealer has established, maintained, and enforced written policies and procedures reasonably designed to achieve compliance with the areas described above as well as with Regulation BI.
DOE will continue to focus on dual registrants and will examine firms’ conflicts of interest, account allocation practices and account selection practices. Examinations also will assess broker-dealers’ supervision of branch office locations.
B. Form CRS
DOE will examine the content of a broker-dealer’s “relationship summary,” namely, a broker-dealer’s description of services, fees and costs, conflicts of interest and whether it discloses its disciplinary history. DOE will evaluate whether broker-dealers have filed their relationship summary with the SEC and delivered their relationship summary to retail customers.
C. Broker-Dealer Financial Responsibility Rules
Examinations will focus on broker-dealer compliance with the Net Capital Rule and the Customer Protection Rule and related internal processes, procedures and controls. DOE will review fully paid lending programs and broker-dealer accounting for certain types of liabilities. DOE also will assess broker-dealer “credit, interest rate, market, and liquidity risk management controls” to determine whether they have sufficient liquidity to manage “stress events.”
D. Broker-Dealer Trading Practices
Examinations will cover broker-dealer equity and fixed income trading practices, and will review compliance with Regulation SHO, Regulation ATS, and Rule 15c2-11 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Examinations of wholesale market makers may include “quote generation, order routing and execution practices, market data ingestion, regulatory controls, and risk management.”
A. National Securities Exchanges
DOE will examine whether national securities exchanges are meeting their obligations to enforce compliance with self-regulatory organization rules and the federal securities laws, including “exchange order handling and exchange surveillance, investigation, and enforcement programs to detect and discipline member firm violations.” Examinations also will focus on exchange oversight of regulatory service agreements.
B. Financial Industry Regulatory Authority (“FINRA”)
DOE conducts risk-based oversight examinations of FINRA that are designed to identify “those aspects of FINRA’s operations important to the protection of investors and market integrity, including FINRA’s implementation of investor protection initiatives.” Based on the outcome of these oversight examinations, DOE will conduct inspections of FINRA’s major regulatory programs. DOE also conducts oversight examinations of FINRA’s examinations of certain broker-dealers and municipal advisors. From its observations, DOE makes detailed recommendations to improve FINRA’s programs, its risk assessment processes, and its future examinations.
C. Municipal Securities Rulemaking Board (“MSRB”)
MSRB regulates the activities of broker-dealers that buy, sell, and underwrite municipal securities, and municipal advisors. DOE (along with FINRA and the federal banking regulators) conducts examinations of registered firms to assess compliance with MSRB rules and applicable federal securities laws. DOE applies a risk assessment process, similar to the one it uses to oversee FINRA.
As required by Title VIII of the Dodd-Frank Act, DOE examines, at least once annually, each clearing agency designated as “systemically important” and for which the SEC serves as the supervisory agency. These examinations will focus on clearing agencies’ “core risks, processes, and controls and will cover the specific areas required by statute.” DOE also will conduct risk-based examinations of other registered clearing agencies that have not been designated as systemically important. DOE will examine the registered clearing agencies to make certain they have policies and procedures that address “maintaining sufficient financial resources, protecting against credit risks, managing member defaults, and managing operational and other risks.”
Examinations of registered clearing agencies assess: (a) whether the clearing agencies’ respective risk management frameworks comply with the Exchange Act, and serve the needs of their members and the markets they serve; (b) the adequacy and timeliness of their remediation of prior deficiencies, and (c) other risk areas identified in collaboration with other SEC divisions and other regulators. DOE also will examine security-based swap data repositories and entities operating pursuant to an SEC order exempting them from clearing agency registration requirements.
Areas of focus include “risk management of liquidity, models and model validation, margin systems, third-party service providers, and operations, and the internal audit function.”
A. Municipal Advisors
DOE will continue to review whether municipal advisors have met their fiduciary duty obligation to clients. DOE will review whether municipal advisors are “complying with their obligations to document municipal advisory relationships and disclose conflicts of interest and requirements related to registration, professional qualification, continuing education, recordkeeping, and supervision.”
DOE will examine solicitor municipal advisors during the second half of fiscal year 2024, focusing on their compliance with new MSRB Rule G-46, which becomes effective on March 1, 2024, and is designed to “establish core standards of conduct for solicitor municipal advisors, which include disclosure of conflicts of interest and documentation of client relationships.”
B. Security-Based Swap Dealers (“SBSDs”)
DOE examinations of SBSDs will continue to focus on whether SBSDs have implemented policies and procedures related to compliance with security-based swap rules generally and are meeting their obligations to “accurately report security-based swap transactions to security-based swap data repositories.” Examinations will focus on whether SBSDs are complying with applicable “capital, margin, and segregation requirements.”
C. Transfer Agents
DOE will examine transfer agents’ processing of items and transfers, recordkeeping and record retention, safeguarding of funds and securities, and filings with the SEC. Examinations also will focus on transfer agents that service microcap and crypto asset issuers, and transfer agents that use emerging technologies to perform their transfer agent functions.
A. Information Security and Operational Resiliency
DOE will continue to review broker-dealers’ and advisers’ practices to prevent interruptions to “mission-critical” services and to protect investor information, records, and assets. Operational disruption risks remain elevated due to “proliferation of cybersecurity attacks, firms’ dispersed operations, intense weather-related events, and geopolitical concerns.” Cybersecurity remains a “perennial focus area.”
DOE will focus on registrants’ policies and procedures, internal controls, oversight of third-party vendors (where applicable), governance practices, training of staff, and responses to cyber-related incidents. DOE will assess the risk associated with the use of third-party providers, including how registrants are managing this risk and the potential impact on the U.S. securities markets.
Examinations of broker-dealers and advisers will continue to review firms’ practices to prevent account intrusions and safeguard customer records and information, especially as it pertains to broker-dealers and advisers having multiple offices.
DOE will assess registrant preparations associated with the new rule that shortens the standard settlement cycle for most broker-dealer transactions from two business days after the trade date to one business day after the trade date.
Examinations of broker-dealers and advisers will continue to look at firms’ practices to promote “cyber resiliency.” Reviews will include firm practices, policies, and procedures to prevent account intrusions and safeguard customer records and information. Additional focus will be on the “cybersecurity issues associated with the use of third-party vendors, including registrant visibility into the security and integrity of third-party products and services,” and whether there has been an unauthorized use of third-party providers.
B. Crypto Assets and Emerging Financial Technology
DOE 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. DOE remains focused on “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.”
Examinations will focus on the offer, sale, and other activities in crypto assets or related products. DOE will review whether registrants involved with crypto assets: (a) meet and follow their respective standards of conduct when recommending or advising customers and clients regarding crypto assets; and (b) routinely review, update, and enhance their compliance practices, risk disclosures, and operational resiliency practices. DOE will assess whether advisers are complying with the custody requirements under the Advisers Act. DOE also will assess whether any technological risks associated with the use of blockchain and distributed ledger technology have been addressed.
C. Regulation Systems Compliance and Integrity (“SCI”)
Regulation SCI was adopted to strengthen the technology infrastructure of the U.S. securities markets. DOE will continue to evaluate whether SCI entities have established, maintained and enforced written policies and procedures that are reasonably designed to ensure that their systems’ capacity, integrity, resiliency, availability, and security is adequate to maintain their operational capability and promote the maintenance of fair and orderly markets.
D. Anti-Money Laundering (“AML”)
The Bank Secrecy Act (“BSA”) requires certain financial institutions, including broker-dealers and RICs to establish AML programs. These programs, among other things, must include policies, procedures, and internal controls reasonably designed to achieve (a) “compliance with the BSA and its implementing rules;” (b) “independent testing;” and (c) “risk based procedures to perform customer due diligence,” which includes identifying and verifying the identity of customers and conducting ongoing monitoring to identify and report suspicious transactions. Where appropriate, certain financial institutions must file Suspicious Activity Reports (SARs) with the Financial Crimes Enforcement Network. SARs are used to detect and combat terrorist financing, fraud, and a variety of other “illicit” activities violative of securities and other laws and regulations.
DOE will focus on AML programs to review whether broker-dealers and RICs are: (a) tailoring their AML program to their business model and associated AML risks; (b) conducting independent testing; (c) establishing an adequate customer identification program, including for beneficial owners of legal entity customers; and (d) meeting SAR filing obligations.
DOE’s fiscal 2024 Examination Priorities are not exhaustive. These priorities reflect DOE’s current assessment of certain risks, issues, and policy matters arising from market and regulatory developments, information gathered from examinations, and other sources, including tips, complaints, and referrals, and coordination with other divisions and offices of the SEC and other regulators.
If you receive a notice of a notice of a DOE examination or would like assistance preparing for one, or if you would like guidance establishing or updating your compliance program, please contact Meryl Wiener (email@example.com or 212-984-7731), any of the undersigned, or your regular Warshaw Burstein attorney.
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