2024 SEC Exam Priorities for Registered Investment Advisors
For the first time, the SEC is providing their list of exam priorities closer to the start of the new year to better inform registrants of the key risks, trends, and exam topics they plan to focus on in the upcoming year.
The SEC will continue to examine advisor’s for adherence to their duty of care and duty of loyalty obligations to clients as this remains a priority for the SEC. In reviewing advisors’ adherence to this fiduciary standard, the SEC continues to focus on: investment advice provided to clients related to products, investment strategies and account types; and processes for determining that investment advice is provided in the clients’ best interest.
Additionally, the SEC remains focused on advisors’ compliance programs, including whether their policies and procedures reflect the various aspects of the advisors’ business, compensation structure, services, client base, and operations, and addresses applicable current market risks. The SEC’s review of advisors’ annual review of the effectiveness of their compliance programs is an important part of assessing whether the advisors’ conflicts of interest are addressed in their compliance programs, including those conflicts created by the advisors’ business arrangements or affiliations and related to advisor and registered investment company fees and expenses.
The 2024 Examination Priorities for RIAs include:
Marketing practice assessments for whether advisors, including advisors to private funds, have: (1) adopted and implemented reasonably designed written policies and procedures to prevent violations of the Advisers Act and the rules thereunder including reforms to the Marketing Rule; (2) appropriately disclosed their marketing- related information on Form ADV; and (3) maintained substantiation of their processes and other required books and records. Marketing practice reviews will also assess whether disseminated advertisements include any untrue statements of a material fact, are materially misleading, or are otherwise deceptive and, as applicable, comply with the requirements for performance (including hypothetical and predecessor performance), third-party ratings, and testimonials and endorsements.
Compensation arrangement assessments focusing on: (1) fiduciary obligations of advisors to their clients, including registered investment companies, particularly with respect to the advisors’ receipt of compensation for services or other material payments made by clients and others; (2) alternative ways that advisors try to maximize revenue, such as revenue earned on clients’ bank deposit sweep programs; and (3) fee breakpoint calculation processes, when fee billing systems are not automated.
Valuation assessments regarding advisors’ recommendations to clients to invest in illiquid or difficult to value assets, such as commercial real-estate or private placements.
Safeguarding assessments for advisors’ controls to protect clients’ material non-public information, particularly when multiple advisors share office locations, have significant turnover of investment advisor 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.
The SEC is also focused on advisors’ policies and procedures for: (1) selecting and using third-party and affiliated service providers; (2) overseeing branch offices when advisors operate from numerous or geographically dispersed offices; and (3) obtaining informed consent from clients when advisors implement material changes to their advisory agreements. Such reviews will assess, among other things, whether the advisors’ policies and procedures are reasonably designed and implemented and whether the procedures prevent the advisor from placing their interests ahead of clients’ interests.
As with previous years, the SEC continues to prioritize examinations of advisors that have never been examined, including recently registered advisors, and those that have not been examined for a number of years. I encourage state registered advisors to review this information as well as the states tend to follow the trend of the SEC with examinations.
To read the complete 2024 Examination Priorities release, click here.
SEC Risk Alert for Registered Investment Advisors
On September 6th, the SEC issued a Risk Alert outlining its risk-based approach to examinations, selection process of firms to examine and document requests of registered investment advisor firms. Firms may be selected for an examination based on a tip, complaint, referral or the SEC’s interest in a particular compliance risk area. Among other criteria, the SEC may consider prior examination observations and conduct; supervisory concerns, such as disciplinary history; business activities of the firm or personnel; length of time since the firm was last examined; and material changes in a firm’s leadership or other personnel. The scope of the SEC’s exam and documents they request is based on the firm’s business model, associated risks and the reason for conducting the examination. Typically, exams include reviewing the firm’s operations, disclosures, conflicts of interest and compliance practices with respect to certain core areas, including custody, valuation, portfolio management, fees and expenses, brokerage and best execution. At the conclusion of this Risk Alert is an Attachment which is a typical list of information the examiners may request, which I encourage all to review.
SEC Division of Examinations Risk Alert – June 8, 2023
The Division of Examinations of the SEC issued a Risk Alert on June 8, 2023 expanding its exams to look at how registered investment advisors are using client testimonials and endorsements, third-party ratings and Form ADV disclosures under the Marketing Rule that went into effect November 4, 2022.
Federally registered advisors must comply with the Marketing Rule and some state registered advisors, as well. State registered advisors registered in the following states; Arkansas, Colorado, Delaware, Florida, Georgia, Idaho, Massachusetts, Michigan, Minnesota, Missouri, Nebraska, New Mexico, North Carolina, Vermont and West Virginia are subject to the federal Marketing Rule.
This Risk Alert outlines that SEC staff is “conducting focused examinations, as well as broad reviews into testimonials and endorsements,” including whether there is clear disclosure of whether the person giving the testimonial or endorsement is a client or investor, if the promoter has been paid and if there are material conflicts of interest, the SEC said.
Examiners will also be looking to see that registered investment advisors have written agreements with any promoter they are using, unless they are affiliates of the advisor or the affiliation is disclosed or the promoters receive compensation of $1,000 or less during the preceding twelve months, the SEC said in the alert.
Investment advisors should also expect the SEC to flag instances “where ineligible persons have been compensated for testimonials or endorsements, if the advisor knew or reasonably should have known the person was ineligible, or a ‘bad actor,’” the agency said.
SEC examiners will also be looking to ensure any third-party ratings in advertisements provide clear and prominent disclosure of the date of the rating, the period of time it covers, the identity of the third party that created the rating and any compensation the third party was paid.
Any questionnaires or surveys the investment advisor uses to collect third-party ratings must be structured to make it equally easy for a participant to provide favorable and unfavorable responses. The agency is also expecting investment advisors to use the amended Form ADV to provide additional information regarding their marketing practices.
On a final note, the Risk Alert reiterates that examiners will continue to focus on whether registered investment advisers have disseminated advertisements that violate any of the following general prohibitions:
- including an untrue statement of a material fact, or omitting a material fact necessary to make the statement made, in light of the circumstances under which it was made, not misleading;
- including a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the Commission; • including information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the adviser;
- discussing any potential benefits to clients or investors connected with or resulting from the adviser’s services or methods of operation without providing fair and balanced treatment of any associated material risks or limitations;
- referencing specific investment advice provided by the adviser in a manner that is not fair and balanced; • including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced; or
- including information that is otherwise materially misleading.
SEC Releases 2023 Exam Priorities
The SEC Division of Examinations announced its 2023 examination priorities outlined below:
New Investment Adviser and Investment Company Rules – The Division will focus on the new Marketing Rule (Advisers Act Rule 206(4)-1) and whether registered investment advisers (RIAs) have adopted and implemented written policies and procedures that are reasonably designed to prevent violations of the new rule and whether RIAs have complied with the substantive requirements.
*RIAs to Private Funds *–The Division will review private fund advisers’ portfolio strategies, risk management, and investment recommendations and allocations, focusing on conflicts and disclosures around these areas. In addition, the SEC will focus on RIAs to private funds with specific risk characteristics, including highly leveraged private funds and private funds managed side-by-side with business development companies.
Retail Investors and Working Families – The Division will continue to address standards of conduct issues for RIAs to ensure that retail investors and working families are receiving recommendations and advice in their best interests. Specifically, these examinations will focus on how RIAs are satisfying their obligations under Regulation Best Interest and the Advisers Act fiduciary standard to act in the best interests of retail investors and not to place their own interests ahead of retail investors’. Examinations will include assessments of practices regarding review of investment alternatives, management of conflicts of interest, and consideration of investment goals and account characteristics.
Focus Areas for Examinations of RIAs – The Division remains focused on whether the various aspects of RIAs’ operations and compliance practices have appropriately adopted and considered current market factors, such as those that might impact valuation and the accuracy of RIA regulatory filings.
During a typical examination, the Division reviews the compliance programs and related disclosures of RIAs in one or more core areas, such as custody and safekeeping of client assets, valuation, portfolio management, and brokerage and execution.
Often examinations also include a review for conflicts, compliance issues and the oversight and approval process related to RIA fees and expenses, including: (1) the calculation of fees; (2) alternative ways that RIAs may try to maximize revenue, including revenue earned on clients’ bank deposit sweep programs; and (3) excessive fees.
In addition to reviewing these core focus areas, examinations will review RIA policies and procedures for retaining and monitoring electronic communications and selecting and using third-party service providers.
As in previous years, the Division prioritizes RIAs that have never been examined, including recently registered firms, and those that have not been examined for a number of years. Typically, these examinations focus on firms’ compliance programs.
Form CRS – Compliance with Form CRS will continue to be prioritized and incorporated into the Division’s core examinations of RIAs. SEC rules require that firms deliver their relationship summaries to new and prospective retail investors, as well as to existing retail investors, file their relationship summary with the Commission and post the current relationship summary on the firm’s public website, if the firm has one.
Environmental, Social, and Governance (ESG) – The Division will continue its focus on ESG-related advisory services and fund offerings, including whether funds are operating in the manner set forth in their disclosures. In addition, the SEC will assess whether ESG products are appropriately labeled and whether recommendations of such products for retail investors are made in the investors’ best interests.
Information Security and Operational Resiliency – The Division will review broker-dealers’, RIAs’, and other registrants’ practices to prevent interruptions to mission-critical services and to protect investor information, records, and assets. Reviews of RIAs will include a focus 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.
Emerging Technologies and Crypto-Assets – The Division will conduct examinations of broker-dealers and RIAs that are using emerging financial technologies or employing new practices, including technological and on-line solutions to meet the demands of compliance and marketing and to service investor accounts. Examinations of registrants will focus on the offer, sale, recommendation of, or advice regarding trading in crypto or crypto-related assets and include whether the firm (1) met and followed their respective standards of care when making recommendations, referrals, or providing investment advice; and (2) routinely reviewed, updated, and enhanced their compliance, disclosure, and risk management practices.
SEC Exam Priorities for 2022 – Registered Investment Advisors
*The SEC Division of Examinations announced its 2022 examination priorities for Registered Investment Advisors as outlined below: *
Private Funds
The Division will focus on registered investment advisers (RIAs) who manage private funds.
Examinations will review issues under the Advisers Act, including an adviser’s fiduciary duty, and will assess risks, including a focus on compliance programs, fees and expenses, custody, fund audits, valuation, conflicts of interest, disclosures of investment risks, and controls around material nonpublic information.
The Division will also review private fund advisers’ portfolio strategies, risk management, and investment recommendations and allocations, focusing on conflicts and disclosures around these areas.
Environmental, Social, and Governance Investing (ESG)
The Division will continue its focus on ESG‑related advisory services and investment products, including mutual funds, exchange traded funds, and private fund offerings.
Examinations will focus on whether RIAs and registered funds are accurately disclosing their ESG investing approaches and have adopted and implemented policies, procedures, and practices designed to prevent violations of the federal securities laws in connection with their ESG‑related disclosures, including review of their portfolio management processes and practices.
Examinations will review the voting of client securities in accordance with proxy voting policies and procedures, including whether the votes align with their ESG‑related disclosures and mandates, and whether there are misrepresentations of the ESG factors considered or incorporated into portfolio selection.
Standards of Conduct: Regulation Best Interest, Fiduciary Duty, and Form CRS
The Division will continue to address standards of conduct issues for broker‑dealers and RIAs, with reviews focused on how they are satisfying their obligations under Regulation Best Interest and the Advisers Act fiduciary standard to act in the best interests of retail investors and not to place their own interests ahead of retail investors’ interests.
RIA examinations will focus on whether advisers are acting consistently with their fiduciary duty to clients, looking at both duties of care and loyalty, including best execution obligations, financial conflicts of interest and related impartiality of advice, and any attendant client disclosures.
Focus areas include: (1) revenue sharing arrangements; (2) recommending or holding more expensive classes of investment products when lower cost classes are available (e.g., RIAs that recommend no transaction fee mutual fund share classes that have 12b‑1 fees in wrap fee accounts where the RIA may be responsible for paying transaction fees); (3) recommending wrap fee accounts without assessing whether such accounts are in the best interests of clients, including the impact of the move to zero commissions on certain types of securities transactions by a number of broker‑dealers; and (4) recommending proprietary products resulting in additional or higher fees.
Such reviews also will include an assessment of the adequacy of RIAs’:
(1) compliance policies and procedures designed to address conflicts and ensure advice in the best interest of clients, including the cost of investing; and (2) disclosures to enable investors to provide informed consent.
Retail Investors and Working Families
The Division will continue to address standards of conduct issues for broker‑dealers and RIAs to ensure that retail investors and working families are receiving recommendations and advice in their best interests. Specifically, these examinations will focus on how registrants are satisfying their obligations under Regulation Best Interest and the Advisers Act fiduciary standard to act in the best interests of retail investors and not to place their own interests ahead of retail investors’.
Examinations will include assessments of practices regarding consideration of investment alternatives, management of conflicts of interest, trading, disclosures, account selection, and account conversions and rollovers.
Information Security and Operational Resiliency
The Division will review broker‑dealers’, RIAs’, and other registrants’ practices to prevent interruptions to mission‑critical services and to protect investor information, records, and assets.
Examinations will continue to review whether firms have taken appropriate measures to safeguard customer accounts and prevent account intrusions; oversee vendors and service providers; address malicious email activities, such as phishing or account intrusions; respond to incidents, including those related to ransomware attacks; identify and detect red flags related to identity theft; and manage operational risk as a result of a dispersed workforce.
The Division will also be reviewing registrants’ business continuity and disaster recovery plans, with particular focus on the impact of climate risk and substantial disruptions to normal business operations.
Emerging Technologies and Crypto‑Assets – The Division will conduct examinations of broker‑dealers and RIAs that are using emerging financial technologies (automated digital investment advice/mobile apps/robo‑advisers) to review whether the unique risks these activities present were considered by the firm when designing their regulatory compliance programs.
RIA and broker‑dealer examinations will focus on firms that are, or claim to be, offering new products and services or employing new practices to assess whether operations and controls in place are consistent with disclosures made and the standard of conduct owed to investors and other regulatory obligations; advice and recommendations, including by algorithms, are consistent with investors’ investment strategies and the standard of conduct owed to such investors; and controls take into account the unique risks associated with such practices.
Examinations of market participants engaged with crypto‑assets will continue to review the custody arrangements for such assets and will assess the offer, sale, recommendation, advice, and trading of crypto‑assets.
*The entire SEC Division of Examination 2022 Exam Priorities can be found here. *
Exam Priorities for 2021-Investment Advisors
As of December 17, 2020, the Office of Compliance Inspections and Examinations (OCIE) has been renamed as the Division of Examinations of the US Securities and Exchange Commission (“The Examinations Division” or “EXAMS”).
EXAMS has announced their examination priorities for 2021 that contains priorities emphasized in previous years, however this year they outline emerging risks, including those related to environmental, social and governance matters (“ESG”) and climate change.
The new focus on ESG and climate change-related risks is consistent with recently announced initiatives from the SEC’s staff that further integrate climate change and ESG considerations into the SEC’s regulatory framework. For example, on March 4, 2021, the SEC’s Division of Enforcement announced the creation of a Climate and ESG Task Force, which will develop initiatives to proactively identify ESG-related misconduct and whose initial focus will be to identify material gaps or misstatements in issuers’ disclosure of climate risks under existing rules as well as analyze disclosure and compliance issues relating to investment advisors’ and registered funds’ ESG strategies.
The themes for 2021 are included here and below is the detail:
- Retail Investors, Including Seniors and Those Saving for Retirement
- Information Security and Operational Resiliency
- Financial Technology (Fintech) and Innovation, Including Digital Assets
- Anti-Money Laundering Programs
- Focus Areas Relating to Investment Advisors and Investment Companies
- Compliance Programs
- Registered Funds, including Mutual Funds and ETFs
- RIAs to Private Funds
Retail Investors, Including Seniors and Those Saving for Retirement: EXAMS will focus on compliance with Form CRS and whether investment advisors have fulfilled their fiduciary duties of care and loyalty. Specifically, EXAMS will examine whether registered advisors are appropriately mitigating conflicts of interest and, where necessary, providing disclosure of conflicts that is sufficient to enable informed consent by retail investors. With respect to those investments heavily used by retail investors or those that may present elevated risks, EXAMS will continue to prioritize these products, including mutual funds, exchange-traded funds (ETFs), municipal securities and other fixed income securities, variable annuities, private placements, and microcap securities. EXAMS also noted that examinations will review firms’ disclosures related to fees and expenses as well as registered advisors that operate and utilize turnkey asset management platforms (and whether fees and revenue sharing arrangements in such platforms are adequately disclosed).
Information Security: EXAMS will review whether investment advisors have taken appropriate measures to: safeguard customer accounts and prevent account intrusions, including verifying an investor’s identity to prevent unauthorized account access; oversee vendors and service providers; address malicious email activities, such as phishing or account intrusions; respond to incidents, including those related to ransomware attacks; and manage operational risk as a result of dispersed employees in a work from home environment. These types of risks have increasing become important as registered advisors have adopted remote working environments in light of the COVID-19 pandemic. EXAMS will focus on controls surrounding online and mobile application access to investor account information, the controls surrounding the electronic storage of books and records and personally identifiable information maintained with third-party cloud service providers, and firms’ policies and procedures to protect investor records and information.
Operational Resiliency/Business Continuity: EXAMS will continue to review business continuity and disaster recovery plans of registered advisors, but for 2021 will shift its focus to whether such plans, are accounting for the growing physical and other relevant risks associated with climate change. As climate-related events become more frequent and more intense, EXAMS has stated that it will review whether investment advisors are considering effective practices to help improve responses to large-scale events.
Financial Technology (FinTech) and Innovation, including Digital Assets and Electronic Investment Advice: EXAMS stated that examinations of market participants engaged with digital assets (including robo-advisory firms or traditional firms that rely on mobile or electronic platforms) will continue to assess the following: whether investments are in the best interests of investors; portfolio management and trading practices; safety of client funds and assets; pricing and valuation; effectiveness of compliance programs and controls; and supervision of representatives’ outside business activities.
Anti-Money Laundering Programs: EXAMS will continue to review for compliance with applicable anti-money laundering requirements, including evaluating whether registered funds have adequate policies and procedures in place that are reasonably designed to identify suspicious activity and illegal money-laundering activities.
Focus Areas Relating Specifically to Registered Advisors and Registered Funds:
Registered Advisor Compliance Programs: EXAMS will continue to review the compliance programs of registered advisors, including whether those programs and their policies and procedures are reasonably designed, implemented, and maintained in accordance with applicable federal securities laws. In evaluating the effectiveness of a compliance program, EXAMS stated that it frequently reviews whether registered advisors appear to have sufficient resources to perform core compliance responsibilities. This year EXAMS noted that it is focusing on registered advisors that employ investment strategies related to ESG factors, particularly products in these areas that are widely available to investors, including open-end registered funds and ETFs, as well as those offered to accredited investors such as qualified opportunity funds. To that end, EXAMS stated that it will review the consistency and adequacy of the disclosures registered advisors and fund complexes provide to clients regarding their ESG strategies, determine whether the firms’ processes and practices match their disclosures, review fund advertising for false or misleading statements, and review proxy voting policies and procedures and votes to assess whether they align with the strategies.
Registered Funds, Including Mutual Funds and ETFs: EXAMS stated that its examinations of registered funds will focus on disclosures to investors, valuation, personal trading activities, contracts and agreements, and will include a review of fund governance practices and compliance programs.
Similar to prior years, EXAMS noted that it will prioritize examinations of mutual funds or ETFs that have not previously been examined or have not been examined in a number of years, and will generally focus such examinations on fund compliance programs and financial condition, particularly where funds have instituted advisory fee waivers. In addition, EXAMS stated that it will focus on compliance with exemptive relief, including for the newly created non-transparent, actively managed ETFs, and will also review funds’ and advisors’ disclosures and practices related to securities lending.
Registered Advisors to Private Funds: EXAMS will continue to focus on advisors to private funds, and will assess compliance risks, including a focus on liquidity and disclosures of investment risks and conflicts of interest. For 2021, EXAMS stated that it will also focus on advisors to private funds that have a higher concentration of structured products, such as collateralized loan obligations and mortgage backed securities, to assess whether the private funds are at a higher risk for holding non-performing loans and having loans with higher default risk than that disclosed to investors.
For all of the important details around these categories and more, click here for a complete copy of the Exam Priorities for 2021-Investment Advisors.
SEC Registered Investment Advisers
Mayer Brown a global law firm recently published their very thorough Legal Update on the SEC’s OCIE Risk Alert published on November 19, 2020, discussing its observations from a series of examinations that focused on SEC Registered Investment Advisers related to compliance rule 206(4)-7 under the Investment Advisers Act of 1940.
The Risk Alert includes a comprehensive set of compliance program deficiencies that OCIE has identified in a sample of deficiency letters from recent SEC Registered Investment Advisers examinations. Also included in this Legal Update is a link to OCIE’s National Investment Adviser/Investment Company Compliance outreach 2020 seminar focusing on the role of the SEC Registered Investment Adviser’s Chief Compliance Officer.
From a high level, the Compliance Rule Deficiencies and Weaknesses identified by OCIE in the Risk Alert cover the following topics:
- Inadequate Compliance Resources
- Insufficient Authority of CCOs
- Annual Review Deficiencies
- Implementing Actions Required by Written Policies and Procedures
- Maintaining Accurate and Complete Information in Policies and Procedures
- Maintaining or Establishing Reasonably Designed Written Policies and Procedures
I encourage you to review Mayer Brown’s Legal Update. If you need assistance with your RIA ongoing compliance requirements, contact us today for your free consultation!
Happy Thanksgiving
To all of our clients, we hope you have a safe and wonderful holiday!
RIA Compliance
RIA Compliance. Recently, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a risk alert outlining certain compliance risk and considerations for SEC-registered broker dealers and registered investment advisors during the COVID-19 pandemic. The pandemic has created uncertainty among firms regarding how they should comply with their regulatory requirements while members of their firm may be working from home.
To help firms address some of this uncertainty, OCIE made a number of observations and suggestions that broadly address the following areas:
(1) protection of investors’ assets;
(2) supervision of personnel;
(3) practices relating to fees, expenses, and financial transactions;
(4) investment fraud;
(5) business continuity;
(6) the protection of investor and other sensitive information.
The Risk Alert is provided with this link. I encourage all registered investment advisors to read the Alert and remain vigilant with your firm’s practices during these uncertain times. If you need assistance with your RIA Compliance contact us today for a free consultation!
