The SEC’s Division of Examinations got a head start this fiscal year, announcing its 2024 Examination Priorities (2024 Priorities) at the beginning of the fiscal year for the first time. This novel approach likely signifies the Division’s intent to be very active over the next 12 months and a desire to give registrants and other market participants more time to shore up areas of concern.
Not surprisingly, the 2024 Priorities emphasize that conflicts of interest will remain a priority for the Division’s examiners. For investment advisers, that means examiners will scrutinize not only how advisers identify and disclose conflicts to clients, but also their processes for mitigating or eliminating those conflicts where appropriate. Key areas of focus will include:
- The adviser’s processes and practices for allocating investments to accounts where clients have multiple accounts (e.g., allocating between accounts that are adviser fee-based, brokerage commission-based, and wrap fee, and between taxable and non-taxable accounts)
- Investment advice regarding complex products (derivatives and leveraged ETFs), high-cost and illiquid products (such as variable annuities and non-traded REITs), and unconventional strategies (including ones purporting to address rising interest rates)
- The economic incentives an adviser and its professionals may have to recommend certain products, services, or accounts over others; and
- The adviser’s disclosures of all material facts relating to conflicts of interest.
The Division also intends to focus on advisers’ compliance with the SEC’s new Marketing Rule, which became effective on May 4, 2021, with a compliance deadline of November 4, 2022. This was expected, given the SEC’s recent spate of enforcement activity this past fiscal year charging advisers with failing both to comply with the amended rule and to adopt or implement appropriate processes and procedures reasonably designed to ensure compliance with the rule.
For broker-dealers, their compliance with Regulation Best Interest, including its conflict-of-interest provisions, will once again receive special attention from examiners. 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. That means a broker-dealer must 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. The 2024 Priorities highlight several areas of “particular interest” for examiners, including (1) recommendations with regard to products, investment strategies, and account types; (2) disclosures made to investors regarding 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, including investment goals and account characteristics.
The 2024 Priorities also highlight specific areas of exam focus for self-regulatory organizations, clearing agencies, and other market participants, such as municipal advisors and transfer agents. And while it is no surprise that the Division promises that “cybersecurity remains a perennial focus area for all registrants,” it is notable that this year’s Priorities contain no mention of environmental, social, and governance standards (ESG). Although we do not believe examiners will completely disregard ESG standards during their reviews, their complete absence from the 2024 Priorities suggests they will play a less prominent role in examinations going forward.
This year marks the first time the Division of Examinations has published its yearly examination priorities at the beginning of the SEC fiscal year. All market participants and their compliance professionals should carefully review the Division’s 2024 Priorities, as they provide helpful insight into the Division’s examination agenda. And given the unprecedented timing of the publication of those priorities, we believe the Division is signaling to registrants and other market participants that it intends to increase its examination activity—both in person and virtually—this year.
