On Monday, October 16, the Securities and Exchange Commission’s (“SEC”) Division of Examinations (“Division”) “released its 2024 examination priorities to inform investors and registrants of the key risks, examination topics, and priorities that the Division plans to focus on in the upcoming year.”[1] In a break from previous years, the Division released its examination priorities at the start of the SEC’s fiscal year and only eight months after the Division published its priorities for fiscal year 2023. As the Director of the Division explained, “[w]e hope that aligning the publication of our examination priorities with the beginning of the SEC’s fiscal year will provide earlier insight to registrants, investors, and the marketplace of adjustments in our areas of focus year to year.”[2] The Division indicates that examinations this year “will prioritize areas that pose emerging risks to investors or the markets, as well as examinations of core and perennial risk areas”—with several focus areas carrying through from the previous year’s priorities.[3] As with this blog’s coverage of the 2023 priorities, below is a sampling of some of the more notable priorities described in the report:

Investment Advisers

As the Division explains, investment advisers act as fiduciaries to their clients and owe them duties of care and loyalty. To ensure that advisers adhere to this fiduciary standard, the Division indicates that it will focus on the following in its examinations:

• The investment advice provided to clients, particularly for “(1) complex products, such as derivatives and leveraged [EFTs]; (2) high costs and illiquid products, such as variable annuities and non-traded [REITs]; and (3) unconventional strategies, including those that purport to address rising interest rates.” The Division may further scrutinize advice given to “certain types of clients, such as older investors and those saving for retirement.”
• The processes for determining the investment advice—including “processes for (1) making initial and ongoing suitability determinations, (2) seeking best execution, (3) evaluating costs and risks, and (4) identifying and addressing conflicts of interest.”
• The economic incentives for advisers “to recommend products, services, or account types, such as the source and structure of compensation, revenue, or other benefits.”
• The “disclosures made to investors and whether they include all material facts relating to conflicts of interest . . . sufficient to allow a client to provide informed consent to the conflict.”[4]

In addition, the Division will continue to focus on the compliance programs for advisers, with the following as particular areas of examination focus in 2024:

• Marketing practice assessments to determine whether marketing advisors have—among other things— “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.” Compliance with the new Marketing Rule was a notable area of focus in the 2023 examination priorities.
• “Compensation arrangement assessments focusing on: (1) fiduciary obligations of advisers to their clients, . . . (2) alternative ways that advisers try to maximize revenue, . . . (3) fee breakpoint calculation processes, particularly when fee billing systems are not automated.”
• Valuation assessments related to investment recommendations “in illiquid or difficult to value assets, such as commercial real-estate or private placements.”
• Safeguarding assessments for the protection of clients’ material non-public information.
• Disclosure assessments on the accuracy and completeness of regulatory filings, “with a particular focus on inadequate or misleading disclosures and registration eligibility.” [5]

As with the previous year’s examination priorities, the Division also indicates that it will continue to focus on examinations of investment advisers to private funds—a significant portion of the registered investment adviser population—with priority on the following: (1) “[t]he portfolio management risks present when there is exposure to recent market volatility and higher interest rates”; (2) “[a]dherence to contractual requirements regarding limited partnership advisory committees or similar structures”; (3) “[a]ccurate calculation and allocation of private fund fees and expenses”; (4) “[d]ue diligence practices for consistency with policies, procedures, and disclosures”; (5) “Conflicts, controls, and disclosures regarding private funds managed side-by-side with registered investment companies and use of affiliated service providers”; (6) “[c]ompliance with Advisers Act requirements regarding custody”; and (7) “[p]olicies and procedures for reporting on Form PF . . . .”[6]

Notably, while environmental, social, and governance (“EGS”) investing was an area of focus in the Division’s 2023 examination priorities—with the Division observing that there was “RIAs and registered funds are competing for the rising investor demand for ESG-related investments and strategies that incorporate certain ESG criteria”—EGS investing is not mentioned as an examination priority for 2024.[7]

Registered Investment Companies

Registered investment companies—which include mutual funds and ETFs—remain an area of focus for the Division in 2024 “due to their importance to retail investors, particularly those saving for retirement.”[8] To that end, the Division notes that examinations may focus on areas like the following:

• Fees and expenses as well as written policies and procedures with respect to fees, associated waivers, and reimbursements. In particular, there will be a focus on situations where (1) different fees are charged for different shares classes in the same fund, (2) identical strategies are offered through different distribution channels with different fee structures, “(3) high advisory fees relative to peers”, and “(4) high registered investment company fees and expenses, particularly those of registered investment companies with weaker performance relative to their peers.”
• Whether companies “have adopted and implemented written policies and procedures reasonably designed to prevent violations of the Commission’s fund derivatives rule . . .” This review may include examining the company’s “derivatives risk management program, board oversight,” and disclosures on the use of derivatives. Compliance with the Derivatives Rule was also a notable area of focus in the 2023 examination priorities.
• Whether companies have complied “with the terms of exemptive order conditions and the issues associated with recent market dislocations and volatility . . .”[9]

For both investment companies and investment advisers, the Division will continue its prior practice of prioritizing entities that have never been examined or have not been examined in several years.

Broker-Dealers

As the Division explains, “Regulation Best Interest establishes the standard of conduct for broker-dealers at the time they recommend to a retail customer a securities transaction or investment strategy.”[10] In determining whether the broker-dealer’s recommendations are in the customer’s best interest, the Division highlighted the following areas of interest: (1) the recommendations themselves; (2) disclosures of conflicts of interest; “(3) conflict mitigation practices; (4) processes for reviewing reasonably available alternatives; and (5) factors considered in light of the investor’s investment profile . . . .”[11]

As to the recommended products, the Division indicates that the focus would be on products that are “(1) complex, such as derivatives and leveraged ETFs; (2) high cost, such as variable annuities; (3) illiquid, such as nontraded REITs and private placements; (4) proprietary; and (5) microcap securities.”[12]

In terms of the types of broker-dealers subject to examination, the Division notes that it will continue its prior practice of focusing on dual registrants—with examinations covering conflicts of interest as well as account allocation and selection practices.

Information Security and Operational Resiliency

As with the 2023 examination priorities, the Division continues to stress that “the proliferation of cybersecurity attacks, firms’ dispersed operations, intense weather-related events, and geopolitical concerns” pose a risk to operations.[13]

Similar to the examination priorities for 2023, the Division indicates that it will focus on “policies and procedures, internal controls, oversight of third-party vendors (where applicable), governance practices, and responses to cyber-related incidents, including those related to ransomware attacks.”[14] In particular, this review will cover policies and procedures to protect customer data and training to prevent identity theft. As to third parties, the Division notes that it will continue to assess how registrants identify and address the risks associated with third party services and products to their essential business operations.

In addition, the Division notes that it will assess how broker-dealers are preparing for the new rule shortening the settlement cycle between execution and settlement.[15] By shortening the transaction cycle, this new rule, with a compliance date of May 28, 2024, aims to reduce risk, protect investors, and increase efficiency.[16]

Finally, while the 2024 examination priorities do mention the risk of operational disruptions from weather-related events, they do not flag assessments of climate risk planning for systematically significant registrants—like the 2023 priorities did.[17]

Crypto Assets and Emerging Financial Technology

With continued volatility in the crypto markets, the Division notes that it will continue to monitor and examine registrants to ensure that registrants (1) meet and follow “standards of conduct when recommending or advising customers and clients regarding crypto assets, with a focus on an initial and ongoing understanding of the products . . . , particularly when the investors are retail-based (including older investors) and investments involve retirement assets” and that registrants “(2) routinely review, update, and enhance their compliance practices . . . risk disclosures, and operational resiliency practices . . . , if required.”[18]

The 2024 examination priorities also include a brief mention of artificial intelligence as an area of emerging technologies that the Division is focused on—along with automated investment tools and trading algorithms or platforms. With the SEC proposing a new rule in July on conflicts of interest associated with the usage of artificial intelligence, it is possible that the Division will have more to say in this area in its 2025 examination priorities.[19]

Conclusion

While the Division cautions that “[t]he published priorities are not exhaustive of the focus areas of the Division in its examinations, risk alerts, and outreach,” the 2024 examination priorities do provide a look at the topics that the Division believes are important as it conducts its examination in the upcoming fiscal year.[20]

[1] Press Release, U.S. Securities and Exchange Commission, SEC Division of Examinations Announces 2024 Priorities, (Oct. 16, 2023), https://www.sec.gov/news/press-release/2023-222.

[2] Id.

[3] U.S. Securities and Exchange Commission, 2024 Examination Priorities, Division of Examinations 7, https://www.sec.gov/files/2024-exam-priorities.pdf.

[4] Id. at 7-8.

[5] Id. at 9-10.

[6] Id. at 10-11.

[7] U.S. Securities and Exchange Commission, 2023 Examination Priorities Release, Division of Examinations 13, https://www.sec.gov/files/2023-exam-priorities.pdf.

[8] 2024 Examination Priorities at 11.

[9] Id. at 12.

[10] Id. at 13.

[11] Id.

[12] Id.

[13] Id. at 18.

[14] Id.

[15] Id. at 19.

[16] U.S. Securities and Exchange Commission, Fact Sheet: Reducing Risk in Clearance and Settlement 1-2, https://sec.gov/files/34-96930-fact-sheet_0.pdf, at 1.

[17] Compare 2023 Examination Priorities at 14 with 2024 Examination Priorities at 18-19.

[18] 2024 Examination Priorities at 20.

[19] See Press Release, U.S. Securities and Exchange Commission, SEC Proposes New Requirements to Address Risks to Investors From Conflicts of Interest Associated With the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers (July 26, 2023), https://sec.gov/news/press-release/2023-140.

[20] Press Release, U.S. Securities and Exchange Commission, SEC Division of Examinations Announces 2024 Priorities, (Oct. 16, 2023), https://www.sec.gov/news/press-release/2023-222.