Announcing a significant change to its 2023 examination priorities, the Securities and Exchange Commission’s Division of Examinations advises that the new Marketing Rule will now be a core examination review area for registered investment advisers (RIAs).
Accordingly, the division will, among other things, assess whether RIAs have adopted and implemented written policies and procedures that are “reasonably designed to prevent violations” by advisers and their supervised persons under the Marketing Rule (Advisers Act Rule 206(4)-1), the SEC notes. Full compliance with the rule took effect Nov. 4, 2022.
The division also will review whether RIAs have complied with the substantive requirements of the rule, including the requirement that RIAs have a “reasonable basis for believing they will be able to substantiate material statements of fact and requirements for performance advertising, testimonials, endorsements and third-party ratings.”
The division publishes its examination priorities annually to provide insights into its risk-based approach, including the areas it believes present potential risks to investors and the integrity of the U.S. capital markets.
“Our priorities reflect the changing landscape and associated risks in the securities market and are the product of a risk-based approach to examination selection that balances our resources across a diverse registrant base,” Division of Examinations’ Director Richard R. Best said in a statement. “We will emphasize compliance with new SEC rules applicable to investment advisers and investment companies as well as continue our focus on emerging issues and rules aimed at protecting retail investors.”
Continued Reg BI Focus
To that end, the SEC notes that it will continue to address standards of conduct issues for broker-dealers (BDs) and RIAs to ensure that retail investors and working families are receiving recommendations and advice in their best interests.
Specifically, these examinations will focus on how registrants are satisfying their obligations under Regulation Best Interest (Reg BI) and the Advisers Act fiduciary standard. In this regard, BDs and dually registered RIAs are an area of continued interest, as are affiliated firms with financial professionals that service both brokerage customers and advisory clients, the report notes.
“Examinations may also focus on recommendations or advice to certain types of investors, such as senior investors and those saving for retirement, and specific account recommendations, such as retirement account rollovers and 529 plans,” the SEC advises.
These and other examinations will continue to focus on:
- investment advice and recommendations regarding products, investment strategies, and account types;
- disclosures made to investors and whether such disclosures include all material facts relating to the conflicts of interest associated with the advice and recommendations;
- processes for making best interest evaluations, including those for reviewing reasonably available alternatives, evaluating costs and risks, and identifying and addressing conflicts of interest; and
- factors considered in light of the investor’s investment profile, including investment goals and account characteristics.
The SEC further advises that it plans to focus on advice or recommendations regarding: 1) complex products, such as derivatives and leveraged exchange-traded funds (ETFs); 2) high cost and illiquid products, such as variable annuities and non-traded REITs; 3) proprietary products; (4) unconventional strategies that claim to address rising interest rates; and (5) microcap securities.
Additional areas the SEC has highlighted as part of its exam priorities include the following.
RIAs to Private Funds. Examinations will review issues under the Advisers Act—including an adviser’s fiduciary duty—and will assess risks, including a focus on compliance programs, fees and expenses, custody, the new Marketing Rule, conflicts of interest, and the use of alternative data. The division also will review private fund advisers’ portfolio strategies, risk management, and investment recommendations and allocations, focusing on conflicts and disclosures around these areas.
Environmental, Social and Governance (ESG). The SEC will continue its focus on ESG-related advisory services and fund offerings, including whether funds are operating in the manner set forth in their disclosures. It also will assess whether ESG products are appropriately labeled and whether recommendations of such products for retail investors are made in the investors’ best interests.
Information Security and Operational Resiliency. The division will review the practices of BDs, RIAs and other registrants intended to prevent interruptions to mission-critical services and to protect investor information, records and assets. Reviews will include a focus on the cybersecurity issues associated with the use of third-party vendors, including registrant visibility into the security and integrity of third-party products and services and whether there has been an unauthorized use of third-party providers.
Emerging Technologies and Crypto-Assets. The usage of emerging financial technologies or other new practices, including technological and online solutions to meet the demands of compliance and marketing and to service investor accounts, will be another area of focus. Examinations will center on the offer, sale, recommendation of, or advice regarding trading in crypto-related assets. They will include whether the firm: (1) met and followed their respective standards of care when making recommendations or providing investment advice; and (2) routinely reviewed, updated and enhanced their compliance, disclosure and risk management practices.
The SEC does caution that the published priorities are not all-inclusive of the focus areas in its examinations, risk alerts, and outreach. Moreover, the Commission notes that the scope of any examination includes analysis of an entity’s history, operations, services, products offered and other risk factors.
