Investment advisers, broker-dealers, fund managers and other financial professionals could be impacted in 2024 by the U.S. Securities and Exchange Commission’s (SEC) continued focus on upcoming examinations. The SEC unveiled a blueprint of sorts last fall with its annual publication, 2024 Priorities. While it specifically identifies certain practices, products and services that the SEC believes present heightened risk to investors, it is not an exhaustive list for the year. Instead, the 2024 Priorities represent certain areas or topics that the SEC anticipates will continue to be of significant importance.

Four topics applying to a wide range of companies and financial market participants are highlighted: (a) information security and operational resiliency, (b) crypto assets and emerging financial technology, (c) compliance related to regulation systems and integrity, and (d) anti-money laundering protections. Interestingly, after including Environmental, Social and Governance (ESG) as an examination focus in 2021, 2022 and 2023, the SEC omitted ESG in the 2024 Priorities.

Also, the SEC will continue to prioritize examinations of advisers and investment companies that have never been examined (including new registrants) as well as those who have not been examined for a few years. The SEC will also continue to focus on advice that is provided by advisers to “older investors and those saving for retirement”, which may overlap with a review of advice related to ERISA with respect to retirement funds or investments.  Overall, if your firm is registered with the SEC and has not been examined in a few years, now is the time to review your compliance programs, policies and procedures manual, and internal operations to ensure that all are up to date.  

Investment Advisors

Investment Advisers’ fiduciary duties continue to remain at the forefront for the SEC. In the 2024 Priorities, the SEC identified that it will be considering compliance with, and adherence to, both the duty of care and the duty of loyalty. Specifically, the SEC will look at:

• Investment advice relating to complex products (derivatives and ETFs), high-cost and illiquid products (variable annuities and REITs) and unconventional strategies (high interest rates) especially when an adviser’s client is closer to retirement;
• The process used to determine whether investment advice is in the client’s best interest, including suitability determinations, best execution, costs and risk evaluation, conflicts of interest, the client’s investment profile, goals and account being considered;
• Any economic incentives that investment advisers may recommend to clients, such as certain products, services or account types;
• Disclosures made to clients (and investors), and whether such disclosures include all material facts relating to conflicts of interest to allow informed consent;
• Compliance programs and the investment advisers’ annual review of the effectiveness of such, and whether the investment adviser’s policies and procedures are reasonably designed, implemented and tailored to the adviser’s business; and more specifically:
  • Portfolio management processes;
  • Disclosures made to investors and regulators;
  • Proprietary trading by the investment adviser and the personal trading activities of supervised personnel.
  • Safeguarding client assets;
  • Accurate creation, maintenance and protection of required records;
  • Safeguards for the protection and maintaining privacy of client records and information;
  • Trading practices;
  • Marketing and advisory services;
  • Processes utilized to value client holdings and how the investment adviser assess fees based on those valuation; and
  • Business continuity plans.
• Marketing practices for investment advisers including private fund advisers to ensure:
  • Compliance with the Advisers Act of 1940 and the SEC’s new “Marketing Rule”;
  • Proper Form ADV disclosure including disclosures provided in the investment adviser’s Form CRS;
  • Books and records substantiations;
  • Advertisements do not include untrue statements of a material fact or are materially misleading or deceptive; and
  • Compliance with rules governing reporting, third-party ratings, testimonials and endorsements.
• Compensation Arrangements;
• Valuations relating to recommendations for investments into illiquid or difficult-to-value assets;
• Safeguarding client’s material non-public information; and
• Branch-office oversight.

Private Fund Advisors

Investment Advisers to private funds make up a significant portion of the investment adviser population, and as such, have been, and continue to be, an area of focus for the SEC. These investment advisers should review the following sections in the 2024 Priorities in order to prepare for a future examination:

• Portfolio management risks particularly with exposure to recent volatility and higher interest rates- particularly private funds with poor performance, valuation issues or higher rate of leverage or illiquid assets;
• Adherence to limited partnership agreements, advisory committees, and other contractual obligations;
• Accurate calculation and allocation of private fund fees and expenses;
• Due diligence practices for consistency with policies, procedures, and disclosures, especially relating to private equity and venture capital fund assessments of prospective portfolio companies; and
• Conflicts, controls and disclosures, regarding private funds managed side-by-side with registered investment companies and the use of affiliated service providers.

Broker-Dealers

In 2024 Priorities, the SEC has indicated that it will focus on a broker-dealer’s (and dual-registrants’) compliance with standing regulatory priorities, including  Regulation Best Interest, the Net Capital Rule and Customer Protection Rule, Regulation SHO, Regulation ATS, and Exchange Act Rule 15c2-11.

Regulation Best Interest

Regulation Best Interest establishes the standard of conduct for broker-dealers at the time a recommendation is made to a retail customer in connection with a securities transaction or investment strategy. In future examinations, the SEC will focus on compliance with Regulation Best Interest, including:

• Broker-dealer recommendations with regard to products, investment strategies and account types;
• Conflicts-of-interest disclosures;
• Conflict mitigation practices;
• Processes for reviewing reasonably available alternatives; and
• Factors considered in light of the investor’s goals, age, sophistication, etc.

In particular, the SEC will look closely at recommendations concerning complex, high-cost, illiquid, proprietary and microcap securities investments and products; especially those made to investors saving for specific goals –  such as college or retirement.

Of course, the SEC will evaluate the broker-dealers supervisory system to ensure compliance, including written supervisory procedure, allocation practices for dual registrants, and supervision of branch offices.

Form CRS

The content of the customer relationship summary (“Form CRS”) will be an examination priority, and specifically, to confirm whether both broker-dealers (or investment advisers, as applicable) have met their filing and delivery requirements for the Form CRS. Also, the SEC intends on reviewing Form CRS disclosures relating to:

• The relationships and services that are disclosed and provided to retail customers;
• Fees and costs;
• Conflicts-of-interest; and
• Whether the Form CRS includes disclosures regarding disciplinary history.

Net Capital Requirement

Given the banking system turmoil earlier in 2023, its not too surprising that the SEC will prioritize an examination of a broker-dealer’s compliance with the Net Capital Rule and Consumer Protection Rule, along with the related internal processes, procedures and controls. The SEC has also indicated that it will also assess broker-dealer credit, interest rate, market and liquidity risk management controls to assess sufficient liquidity.

Trading Practices

The 2024 Priorities also suggests that broker-dealer’s trading practices will be a key subject of examinations in 2024, including:

• Regulation SHO, including the rules regarding aggregation units and locate requirements;
• Regulation ATS, including whether ATS operations are consistent with disclosures provided in forms ATS and ATS-N;
• Exchange Act 15c2-11, regarding publishing quotations other than on exchanges.

Key Takeaways

Although the 2024 Priorities provide a roadmap for the SEC’s examination priorities and agenda, it is not an exhaustive list of the issues that the SEC may consider. It is vital that all investment adviser firms, private fund advisers, broker-dealers, and all other firms subject to SEC oversight carefully evaluate the focused topics that may apply to them, and consider whether their compliance programs and policies and procedures meet current standards. Firms are urged to consult with legal counsel to review their policies and procedures in connection with emerging risks, enforcement activities, and agency risk alerts to best mitigate risks in 2024 and thereafter.