Overview

On Feb. 7, 2023, the Division announced its 2023 examination priorities. These priorities, updated and published annually, provide insights into the Division’s prioritization of certain practices, products and services in its upcoming examinations. They also focus on those areas that the Division typically believes present potentially heightened risks to investors or the integrity of the U.S. capital markets. In a statement accompanying the release, SEC Chair Gary Gensler noted that these “priorities reflect the changing landscape and associated risks in the securities market and are the product of a risk-based approach to examination selection that balances our resources across a diverse registrant base.”

The 2023 examination priorities are of particular importance for investment advisers, broker-dealers and private funds subject to examinations by the Division. While the Division lists a number of topics as part of its priorities, it is expected to particularly focus on compliance with recently adopted rules; standards of conduct for broker-dealers and RIAs; environmental, social and governance (ESG) products, disclosures and advisory services; emerging technologies and cryptocurrency; and information security and operational resiliency.

2023 Examination Priorities

• Compliance with Recently Adopted Rules Under the Investment Advisers Act of 1940 and Investment Company Act of 1940: The Division will prioritize compliance with new rules that went into effect in 2022. Specifically, the SEC will prioritize compliance with (1) the Fair Valuation Rule, which pertains to the valuation of complex assets; (2) the Derivatives Rule, which governs the way in which mutual funds and other firms can use derivatives; and (3) the Marketing Rule, which specifies the way in which RIAs can market themselves. In particular, the Division highlighted the Marketing Rule requirement that RIAs “have a reasonable basis for believing they will be able to substantiate material statements of fact and requirements for performance advertising, testimonials, endorsements and third-party ratings.” For all three rules, however, the Division will look for firms to have robust policies and procedures designed to prevent violations, manage risk and comply with substantive requirements.
• Reg BI – Focus on Broker-Dealers and Investment Advisers as Fiduciaries: The Division will continue to focus on broker-dealers’ and investment advisers’ fiduciary obligations and applicable standard of conduct in connection with Reg BI. Examinations will focus on “(1) investment advice and recommendations with regard to products, investment strategies, and account types; (2) disclosures made to investors and whether such disclosures include all material facts relating to the conflicts of interest associated with the advice and recommendations; (3) processes for making best interest evaluations, including those for reviewing reasonably available alternatives, evaluating costs and risks, and identifying and addressing conflicts of interest; and (4) factors considered in light of the investor’s investment profile, including investment goals and account characteristics.” The Division will also focus on whether RIAs’ conflict of interest disclosures are sufficient to provide informed consent to the conflict, whether express or implied.[1]
• Broker-Dealer Compliance Programs: As part of its continued emphasis on the importance of robust broker-dealer compliance programs, the Division plans to focus examinations on “broker-dealer compliance and supervisory programs generally, including those for electronic communications related to firm business, as well as the recordkeeping for those electronic communications.” For broker-dealers that hold customer cash and securities, this implicates the Customer Protection Rules and the Net Capital Rules. The Division further intends to continue to “prioritize the examination of broker-dealers for compliance with these rules, including the adequacy of internal processes, procedures, and controls.” The Division will also continue to examine broker-dealer trading practices related to both equities and fixed-income securities.
• ESG Investing: The Division recognized ongoing competition among funds in response to rising investor demand for ESG-related investments and strategies that incorporate certain ESG criteria. In response to funds offering and evaluating investments that employ those strategies and investments, the Division intends to focus on whether ESG-related advisory services and fund offerings are operating in the manner set forth in their disclosures. This focus will further include assessing whether these ESG products are appropriately labeled and “whether recommendations of such products for retail investors are made in investors’ best interest.”
• Emerging Technologies and Cryptocurrency: The Division’s focus in this area is twofold. The first is on emerging financial technology such as broker-dealer mobile applications and digital investment advice provided by RIAs. The Division plans on examining new technological practices and online solutions to ensure they are meeting compliance standards. This is expected to impact online brokerage services, internet advisers and automated “robo-adviser” RIAs, among others. The second focus is on cryptocurrency assets. Given the recent volatility in these markets, the Division will focus on monitoring and, if appropriate, examinations of registrants who offer, sell or give advice regarding trading in crypto or crypto-related assets. The Division specifically stated it will focus on whether registrants “met and followed their respective standards of care when making recommendations, referrals, or providing investment advice” and whether registrants “routinely reviewed, updated, and enhanced their compliance, disclosure, and risk management practices.”

Finally, examinations will also focus on digital engagement practices, including tools with behavioral prompts, gamification and other design elements designed to engage with retail investors (e.g., websites and applications). These examinations will assess whether (1) recommendations are made or advice is provided; (2) representations are fair and accurate; (3) operations and controls are in place and consistent with investor disclosures; (4) advice or recommendations are in the best interest of the investor, including taking into account the investor’s financial situation and investment objectives; and (5) there are risks associated with such practices, including the impact they may have on certain affinity group investors, such as seniors.

• Information Security and Operational Resiliency: The Division identified cybersecurity as an elevated area of risk going into 2023 “given the larger market events, geopolitical concerns, and the proliferation of cybersecurity attacks, particularly ransomware attacks.” The Division will continue to review practices of broker-dealers and RIAs to prevent cyber intrusions and safeguard investor data. Additionally, the Division will now look to security issues stemming from the use of third-party products and services, particularly with respect to the risk for unauthorized access to customer records. The Division identified the unauthorized use of third-party vendors by RIAs when attempting to migrate client data to a new firm as a particular area of interest.

Conclusion

Companies and individuals should be aware of the Division’s priorities when preparing for an examination. Additionally, the Division of Enforcement receives referrals from the Division of Examinations for significant non-compliance with SEC rules and regulations that can result in an inquiry or investigation. Companies should therefore ensure that their policies and procedures are updated to reflect the Division’s concerns. Additionally, companies should strive to stay informed of risk alerts released by the Division that may provide more insight into specific priorities.

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