Navigating the SEC's 2024 Examination Priorities
This year, the U.S. Securities and Exchange Commission's Division of Examinations took an early step by unveiling its 2024 examination priorities in October. In this blog post, we delve into the key highlights and offer insights for financial firms to navigate the evolving regulatory landscape.
1. Outreach and Transparency
The Division of Examinations has commendably enhanced transparency in recent years through risk alerts and compliance outreach events. This increased transparency not only benefits firms under examination but also prompts improvements in compliance for all registrants. As part of this, the 2024 priorities emphasize the importance of compliance professionals reviewing the April 2023 Staff Bulletin for insights into obligations when recommending complex products.
2. Complex Products
Concerns surrounding complex, high-cost, and illiquid products persist in the 2024 priorities. The SEC plans to scrutinize leveraged exchange-traded funds, derivatives, variable annuities, and nontraded real estate investment trusts. Compliance professionals are advised to stay abreast of Regulation Best Interest and the 2019 fiduciary interpretation, with a specific focus on the April 2023 Staff Bulletin for Broker-Dealers and Investment Advisers Care Obligations.
3. Investment Advisers' Duty of Care
A notable shift in priorities is the increased focus on advisers' adherence to the duty of care. This signals a departure from the historical emphasis on the duty of loyalty. The 2024 priorities indicate a review of account types, product lineups, and investment strategies for consistency with retail advisory clients' investment objectives.
4. Private Funds Examination
Private funds remain a perennial examination priority, with a spotlight on limited partnership advisory committees. The 2024 priorities express skepticism about the adequacy of these committees, with a specific focus on adherence to contractual requirements, including notification and consent processes. Fee and expense calculations and disclosures continue to be areas of concern for exam staff.
5. Investment Companies Focus
Investment company exams are set to increase, with a particular emphasis on addressing the backlog of registered investment companies that have never been examined. The priorities also serve as a reminder to investment companies regarding their anti-money laundering (AML) obligations, following a recent enforcement action against an investment adviser for AML-related violations.
6. Broker-Dealers Examination
For broker-dealers, a continued focus on Regulation Best Interest is evident. The priorities outline specific product categories likely to be examined, including complex products, higher-cost products,
illiquid products, proprietary products, and microcap securities. Additionally, there is a subtle shift back to fundamentals, emphasizing the net capital rule, customer protection rule, and various trading practices.
7. ESG, Artificial Intelligence, and Cybersecurity
While Environmental, Social, and Corporate Governance (ESG) is not explicitly mentioned, the blog cautions against overlooking its importance, given Chair Gary Gensler's focus. The SEC is expected to test ESG truth in advertising and compliance with the recently amended names rule. The emergence of artificial intelligence in financial practices prompts a specialized team to evaluate associated risks. Cybersecurity remains a perennial concern, with a focus on operational resiliency and compliance with related regulations.
8. Higher Interest Rates and Commercial Real Estate
The 2024 priorities reflect concerns about strategies addressing rising interest rates and private funds' exposure to market volatility and higher interest rates. While concerns about the commercial real estate market have somewhat diminished, the valuation of illiquid or difficult-to-value assets, such as commercial real estate, remains under scrutiny.
9. Off-Channel Communications and Cybersecurity
Off-channel communications continue to be a critical issue, following significant penalties in recent fiscal years. The exam staff will play a key role in efforts to ensure compliance with communication obligations under the Exchange Act and the Advisers Act. Cybersecurity remains a perennial risk, with a focus on operational resiliency and compliance with identity theft prevention programs.
10. Cryptocurrency and Other New Rules
Given Chair Gensler's emphasis on cryptocurrency regulation, the exam staff will scrutinize registrants' adherence to their standard of care when recommending crypto products. Other new rules, including municipal advisers' compliance with MSRB Rule G-46 and broker-dealers' preparations for the shortening of the trade settlement cycle to T+1, are also on the agenda.
11. Operational Update and Recap of FY 2023
The 2024 priorities highlight the SEC staff's return to office and the continued use of virtual options for examiners and registrants. The blog notes the absence of specific metrics for fiscal year 2023 but anticipates that a majority of exams in fiscal 2024 will remain virtual.
Conclusion: Navigating the Regulatory Landscape
In conclusion, the SEC's Division of Examinations plays a crucial role in overseeing the financial services industry. By closely examining the subtle shifts in the 2024 examination priorities and ensuring adherence to rules and guidance, financial firms can mitigate the risk of serious compliance deficiencies or enforcement actions. Staying informed and proactive is key in navigating the dynamic regulatory landscape set forth by the SEC. For a comprehensive approach to compliance, consult with legal experts well-versed in SEC regulations to ensure your firm is well-prepared for the challenges ahead