The SEC’s 2024 Examination Priorities: Key Takeaways for Investment Advisers

On October 16, 2023, the SEC released its 2024 Examination Priorities manual. When identifying its annual priorities, the Division of Examinations focuses on the practices and policies that it believes pose the greatest risk to capital markets generally and individual investors specifically. This year’s risk/focus areas are summarized below.

Fiduciary Duty

A foundational principle of investment adviser regulation is that advisers owe a duty of care and loyalty to their clients, must put their clients’ interests ahead of their own, and must disclose all conflicts of interest. As to fiduciary duty, the SEC plans to focus on the following areas: 

• Investment advice regarding: complex products, including derivatives and leveraged ETFs; high cost and illiquid investments, including variable annuities and non-traded REITs; and unconventional strategies, including those that “purport to address rising interest rates.” The SEC is particularly interested in whether and how such advice is given to vulnerable clients, such as older investors and those saving for retirement. 

• The processes used to determine if investment advice is in a client’s best interest, including processes for determining suitability, seeking best execution, evaluating costs and risks, and identifying and addressing conflicts of interest. 

• The processes used to mitigate or eliminate conflicts of interest and allocate investments among accounts when investors have more than one account with the adviser. How does the adviser allocate between “accounts that are adviser fee-based, brokerage commission-based, and wrap fee, as well as between taxable and non-taxable accounts?” 

• Economic incentives to recommend particular products or services, including the source/structure of adviser compensation and benefits (with a particular focus on revenue sharing, markups, and other incentive revenue arrangements). 

• Whether disclosures include all material facts relating to conflicts of interest, such that investors can provide informed consent. 

• Economic incentives to advise investors to use certain investments, accounts, products, or service providers when lower cost options are available. This item is particularly relevant to advisers who are also registered as broker-dealers, service clients using affiliated firms, or have financial professionals servicing brokerage customers and advisory clients. 

Compliance Programs

The Division of Examinations wants to ensure that compliance programs include customized policies and procedures that reflect the unique features of each adviser’s business. Compliance programs should take into account the adviser’s compensation structure, client base, operations, and unique conflicts of interest. The SEC plans to focus on the following areas:

• Compliance with the new Investment Adviser Marketing Rule, including whether policies and procedures prevent violations of the new rule, proper disclosure of marketing on Form ADV, and proper books and records related to marketing. The SEC also plans to check for compliance with the Marketing Rule’s requirements regarding hypothetical and predecessor performance, third-party ratings, and testimonials and endorsements. 

  
  

  As I noted in a recent LinkedIn post, the SEC recently filed charges against nine investment advisers for violating the marketing rule's prohibition on using hypothetical performance in public-facing ads.

  
  

• Fiduciary obligations with respect to compensation and other payments from clients, “alternative ways that advisers try to maximize revenue” (such as client bank deposit sweeps), and fee breakpoint calculations (especially when done manually). 

• Valuation assessments when advisers recommend that clients invest in illiquid assets or hard-to-value assets, such as commercial real estate.

• The controls used to protect clients’ material non-public information, “particularly when multiple advisers share office locations, have significant turnover of investment adviser representatives, or use expert networks.” 

• The accuracy and completeness of regulatory filings, with a focus on inadequate or misleading disclosures. 

• Policies for selecting third-party service providers. 

• Procedures to oversee branch offices (for advisers with multiple locations). 

• Policies for obtaining informed consent from clients when advisers implement material changes to their advisory agreements. 

Private Funds 

Specifically with regard to advisers to private funds, the SEC plans to focus on the following areas: 

• Portfolio management risks stemming from recent market volatility and high interest rates (with particular attention paid to private funds with poor performance, significant withdrawals, valuation issues, high leverage, and illiquid assets).

• Meeting contractual requirements regarding advisory boards and complying with notification/consent processes. 

• The accuracy of fee and expense calculations, “including valuation of illiquid assets, calculation of post commitment period management fees, adequacy of disclosures, and potential offsetting of such fees and expenses.”

• Due diligence to ensure consistency with policies, procedures, and disclosures, “particularly with respect to private equity and venture capital fund assessments of prospective portfolio companies.” 

• Conflicts of interest, controls, and disclosures regarding private funds managed alongside registered investment companies (mutual funds, ETFs, etc.) and the use of affiliated service providers. 

• Compliance with custody obligations, accurate Form ADV reporting, timely audits, and proper distribution of audited financial statements. 

• Policies and procedures for reporting on Form PF.

Which Advisers are Most Likely to be Examined?

The Division of Examinations notes that it “continues to prioritize examinations of advisers that have never been examined, including recently registered advisers, and those that have not been examined for a number of years.”  

The SEC press release about its 2024 Examination Priorities is available here.