United States: Investment Management Legal And Regulatory Update - January 2024

LATEST DEVELOPMENTS

SEC Announces 2024 Examination Priorities

The SEC's Division of Examinations (Division) announced its 2024 examination priorities in October 2023. The report reflects the Division's experience engaging with registrants and investors through its over 1,100 staff members in 11 regional offices and in Washington, D.C.

The 2024 report was published to align with the start of the SEC's fiscal year. The Division hopes that early publication will better inform advisers, funds and broker-dealers of the key risks, trends and topics to be the focus in the upcoming year's examinations. The early release means that only eight months have passed since the publication of the 2023 examination priorities and, as a result, several focus areas from last year are included as 2024 priorities. Although the 2024 list is silent on environmental, social and governance (ESG) investing, the SEC remains active in this area and a proposed rule regarding enhanced ESG disclosures by advisers and funds is expected to be finalized in 2024.

Advisers

Fiduciary Duty of Advisers. The Division will continue to focus on:

• Investment advice to certain types of clients, such as older investors, and regarding complex, high cost or illiquid products and unconventional strategies.
• Processes for determining that investment advice is in clients' best interest, such as suitability, best execution and identifying and addressing conflicts of interest.
• Economic incentives for an adviser to recommend products, services or account types, such as revenue sharing, affiliated service providers and proprietary products.
• Disclosures to investors and whether they include all material facts relating to conflicts of interest.

Compliance Programs. The Division remains focused on compliance programs and can be expected to carefully review advisers' annual written reviews of the effectiveness of their compliance programs. Particular attention will be paid to:

• Marketing practices, including whether advisers adopted and implemented policies and procedures to comply with the Marketing Rule (Rule 206(4)-1 under the Advisers Act), answered the marketingrelated questions accurately in Part 1 of Form ADV, and maintained supporting documentation. Marketing practice reviews will assess whether advertisements comply with the requirements for performance (including hypothetical and predecessor performance), third-party ratings, and testimonials and endorsements.
• Compensation arrangements, including advisers' receipt of compensation for services to clients, including registered investment companies, and fee breakpoint calculation processes.
• Valuation assessments regarding recommendations for clients to invest in illiquid or difficult to value assets, such as private placements.
• Safeguarding assessments of controls to protect clients' material non-public information, including through the use of expert networks.
• Disclosure assessments regarding the accuracy and completeness of regulatory filings, including Form CRS.
• Policies and procedures for:
  • Selecting and using third-party and affiliated service providers;
  • Overseeing branch offices; and
  • Obtaining informed consent from clients when advisers make material changes to their advisory agreements.

Advisers to Private Funds

The Division will continue to prioritize topics relevant to private funds, including:

• Portfolio management risks related to market volatility and higher interest rates, including funds that experience poor performance, significant withdrawals, increased leverage or valuation issues;
• The accurate calculation and allocation of private fund fees and expenses;
• Conflicts, controls and disclosures regarding private funds managed side-by-side with registered investment companies;
• Compliance with the custody rule under the Advisers Act, including accurate Form ADV reporting and timely completion of audits and distribution of financial statements; and
• Procedures for Form PF reporting.

Registered Investment Companies

The Division continues to prioritize examinations of mutual funds and ETFs due to their importance to retail investors, particularly those saving for retirement. The Division will prioritize examination of funds that have never been examined and those that have not been examined in recent years. Examinations may focus on:

• Board processes for assessing and approving advisory contracts, advisory fees and other fund fees and expenses.
• Fee and expense procedures, including:
  • Oversight of fee waivers and reimbursements;
  • Whether different advisory fees are charged to different share classes of the same fund;
  • Identical strategies that charge different fee structures depending on their distribution channel; and
  • High advisory fees and expenses, particularly for funds with weaker performance than peers.
• Fair valuation practices, including board oversight of valuation designees.
• Derivatives risk management and liquidity risk management programs, including board oversight.

Broker-Dealers

The Division will examine broker-dealers' compliance with Regulation Best Interest, conflicts of interest for dual registrants, the content of Form CRS, compliance with the net capital rule and other financial responsibility rules, and trading practices.

Information Security and Operational Resiliency

The Division notes that operational disruption risks remain elevated due to the "proliferation of cybersecurity attacks, firms' dispersed operations, intense weather-related events, and geopolitical concerns" and that "cybersecurity remains a perennial focus area for all registrants." The Division will focus on firms' policies and procedures, oversight of third-party vendors and responses to ransomware attacks and other cyber events. The Division will also assess employee training regarding identity theft prevention programs and firms' policies and procedures to safeguard client information.

Crypto Assets and Emerging Financial Technology

The Division continues to monitor the crypto asset markets and will examine advisers and broker-dealers to determine whether they meet the appropriate standard of conduct when advising clients, trading or recommending crypto assets. The Division will also assess whether advisers are complying with the custody requirements under the Advisers Act.

With respect to emerging technology, the Division is focused on automated investment tools, artificial intelligence and trading algorithms or platforms and the associated risks.

Anti-Money Laundering (AML)

The Division will continue to focus on AML programs to review whether funds and broker-dealers are tailoring their programs to their business model and risks, conducting independent testing, maintaining an appropriate customer identification program, and filing required Suspicious Activity Reports.

In addition, the Division will evaluate whether advisers and broker-dealers monitor and adhere to Office of Foreign Assets Control (OFAC) sanctions.

Conclusion

Advisers, funds and broker-dealers should review their compliance policies and practices to confirm they are ready for a potential SEC examination. We anticipate 2024 will remain a challenging regulatory and enforcement environment. The SEC has seven proposed rules that it intends to finalize during the second quarter of 2024.

To view the full article, click here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.