RIAs: Keep the SEC’s 2024 examination priorities top of mind

This blog was originally published on February 9, 2024. It was updated on August 5, 2024.

For registered investment advisers (RIAs) who like to get a head start on compliance, this is your year. The SEC’s Division of Examinations (DOE) released its 2024 Examination Priorities back in October 2023, quite a bit earlier than its usual release in February/March for the upcoming year. Throughout the 2024 fiscal year, it’s a good idea to revisit these priorities to refamiliarize yourself with what the SEC intends to focus on this year, even if these priorities haven’t substantially changed since 2023.

This year’s priorities include fiduciary responsibility, the annual review of the compliance program and the Marketing Rule, in addition to several areas specific to private fund advisers. So without further ado, here are a few of the key topic areas that RIAs should pay attention to in 2024 and beyond.

Fiduciary responsibility

One of the primary focuses for the DOE continues to be assessing whether investment advisers are fulfilling their fiduciary responsibilities. The fiduciary standard has two major components: 1) the adviser’s duty of care (its duty to provide advice that is in the client’s best interest and 2) the adviser’s duty of loyalty (its duty to not subordinate its clients’ interests to its own).

Duty of Care

As it pertains to an adviser’s duty of care, the obligations are straightforward. Collect and document enough information about your clients to enable your firm to provide recommendations in the clients’ best interests and in products suitable for that specific client type. There is no prescription for the information that must be collected, but the SEC has strongly implied the bare minimum they expect RIAs to document.

Duty of Loyalty

An adviser’s duty of loyalty is not quite as straightforward, as it requires firms to fully examine their affiliations, vendors and personnel to consider all potential conflicts of interest that may exist. To meet its duty of loyalty, an adviser must either eliminate these conflicts or fully and fairly disclose them to clients. In many cases, it is impossible or impractical to eliminate many of these conflicts of interest, and so the best way to fulfill this obligation boils down to adequate disclosure and monitoring/supervision.

If your advisory firm is not dually registered as, or affiliated with, a broker-dealer (and/or your advisory representatives are not registered representatives with an unaffiliated broker-dealer) there may be considerably fewer conflicts of interest to address. However, it does not mean you are completely out of the woods. For example, if you offer a wrap fee program, there is likely a conflict of interest to transact less in a client’s account to avoid the additional burden of trading costs absorbed by the adviser. In this example, full and fair disclosure of this conflict (in the brochure, Form CRS, etc.), in conjunction with monitoring of wrap accounts for reverse churning concerns, could be an appropriate disclosure/mitigation approach.

If your firm is dually registered, or has an affiliated broker-dealer, there will likely be additional conflicts of interest to consider. At a minimum, you should consider the conflict to recommend a fee-based account or brokerage account in a manner that benefits the firm (e.g., amongst other considerations, recommending a fee-based account to a client whose account subsequently trades very infrequently). There are numerous other considerations when brainstorming potential conflicts of interest, including but not limited to:

• Recommending the purchase of certain products that generates revenue for the firm, such as 12b-1 fees, no-transaction-fee mutual funds that pay revenue sharing, and bank deposit sweep programs
• Compensation arrangements when your affiliated/dually registered broker-dealer is the introducing broker to advisory client account custodians, such as mark-ups to fees assessed by those custodians (e.g., mark-ups to wire, ACAT fees, etc.) and/or revenue sharing arrangements (e.g., sharing in margin interest revenue)

When conducting this analysis, consider all business practices and relationships where there is potential for the firm to increase revenue or decrease its costs; ask yourself if this conflict pertains to advisory clients; and confirm appropriate measures are taken to either eliminate these conflicts, or fully and fairly disclose them to advisory clients. It may be helpful to inventory these conflicts in order to map them to disclosures and mitigating controls.

Annual review of compliance program

The DOE remains focused on advisers’ compliance programs and whether they have adopted and implemented policies and procedures reasonably designed to prevent violations of the Advisers Act. The DOE will expect your policies and procedures to be tailored and comprehensive to cover all material aspects of your business. Advisers can address this concern in their at-least-annual compliance program reviews, which are required under the Advisers Act. This review, if conducted thoroughly and thoughtfully, is one of the primary ways advisers can identify and correct gaps in their compliance programs.

If the annual compliance review is something your firm has not been dedicating much time to, or you are unsure what a comprehensive annual review entails, you may want to consider engaging an external compliance consultant to assist with this process.

SEC Marketing Rule

The SEC, to no surprise, indicated it will continue to examine advisers’ compliance with the Marketing Rule. If your firm engages in marketing practices, there are many aspects of the Rule that require careful consideration and review. Even if your firm does not engage in actively marketing its services, keep in mind that the adviser’s website(s), social media pages and communications to current clients may all potentially be considered marketing materials that require compliance with the Rule.

It’s also worth noting the SEC expects tailored policies and procedures to address the regulatory risks pertaining to the firm’s marketing practices and materials. While the marketing of performance gets a lot of the industry’s attention, you should also pay attention to qualitative statements utilized on your website or in marketing materials that may not be statements of fact, or are difficult to substantiate in general (e.g. “industry leader,” reference to being “the best,” implications of positive expected performance, superlatives, etc.). The SEC has been citing firms in numerous examinations for these unsubstantiated claims.

If you haven’t already done so, it’s a good idea to conduct a full assessment of your advertising and marketing materials, processes and procedures, compliance manuals and training programs, and client referral arrangements. An independent compliance consultant can assist with this process.

Private fund adviser-specific areas to watch

As it pertains to its examinations of advisers to private funds, the SEC essentially reminded the industry that it will continue to focus on the high-risk areas it has in the past, most notably:

• Compliance with the Custody Rule and timeliness of delivery of audited financial statements to underlying investors
• Fees and expenses
• Conflicts of interest

Custody Rule

Many in the industry seem to struggle with the timely delivery of audited financial statements to private fund investors, and we have seen the SEC’s Division of Enforcement charge firms for this type of violation.

If this is an area you continue to struggle with, be sure to find the root cause. For example, many firms have had issues with transmitting accurate data to their auditors in a timely fashion. This is often due to a lack of resources, expertise or organized accounting practices. Outsourcing fund accounting to a qualified fund administrator can be an efficient, effective way to manage this practice and provide auditors with timely, easy-to-use financial data. Confirm that your fund administrator has the expertise and resources to manage the accounting for complex funds, as well as the ability to maintain records in a manner the fund’s auditor can effectively utilize.

Additional conflicts of interest

While some of the conflicts of interest noted previously in this article may apply to private fund advisers, if you manage private funds you will also want to consider additional conflicts of interest, such as: using affiliated service providers (common for real estate/PE funds), side-by-side management of fund clients, and co-investment opportunities and cross transactions between fund clients. These are just a few of the many potential conflicts of interest your firm should think about if you manage private funds.

Preparing your RIA for 2024 SEC examinations

Should your firm be examined by the SEC’s Division of Examinations, these priorities represent just a portion of the areas that may be of interest to an examination team. Compliance with applicable rules and regulations an RIA is subject to can be a difficult and tedious task.

Kaufman Rossin can support your compliance efforts in various ways, including annual compliance program reviews, mock examinations, performing outsourced reviews/testing, creating or enhancing policies and procedures for your firm, as well as fund administration services through our affiliate Kaufman Rossin Alternative Investment Services. Contact me or another Risk Advisory Services practice member for assistance with these and other SEC and FINRA regulatory compliance matters. Additionally, reach out to the Kaufman Rossin Alternative Investment Services team for assistance with fund administration.