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SEC Examiners to Focus on Complex Products, Annuities, Non-Traded REITS for Reg BI Violations in 2023

The Examinations Division will continue to focus on ESG and look for firm policies that are 'reasonably designed' to comply with the SEC's marketing rule.

In 2023, the Securities and Exchange Commission’s Examinations Division will focus on advisors’ recommendations on complex investment vehicles like derivatives and leveraged ETFs, as well as high cost and illiquid products, including annuities and nontraded REITs, when it comes to investigating Regulation Best Interest violations.

The commission released its annual Exam Priorities this week, detailing its intended areas of focus for the next 12 months. In addition to the aforementioned products, examiners will look at the type of advice and recommendations registrants give clients on proprietary products, microcap securities, as well as “unconventional strategies that purport to address rising interest rates.”

Some of the coming year’s areas of focuses have been mainstays for several years (including Reg BI and ESG), though the type of scrutiny has shifted over time. While in the early days of Reg BI, examiners sought out “good faith” compliance efforts, commission staff are now looking for tangible results (the Enforcement Division also made its first foray into charging registrants for rule violations last year).

According to the division, examiners analyzing Reg BI compliance will look at investment advice and recommendations, disclosures made to clients, the processes firms have in place for making best interest recommendations, as well as the kind of factors that are considered in light of an investor’s profile, including their goals and account characteristics.

“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 report read.

The division is newly focusing on the SEC’s marketing rule, which reached its compliance date last November after first taking effect in May 2021. Examiners will be looking at whether advisors have adopted written rules and procedures that “are reasonably designed” to prevent rule violations.

“The Division will also review whether RIAs have complied with the substantive requirements of the marketing 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 report read.

The division also pledged to focus on firms’ procedures and responses to cyberattacks, including ransomware attacks. They’ll also look at practices meant to safeguard customer information, whether it's stored internally or with a third-party provider, and they’ll look at the ways firms are safeguarding that information, while acknowledging that personnel are going to continue accessing this information remotely in the aftermath of the pandemic.

Additionally, the division said it’ll continue to monitor and potentially conduct examinations on firms offering or recommending crypto or crypto-related assets, particularly in the wake of the “recent financial distress among crypto asset market participants.”

In its introduction, the leadership team, led by Director Richard Best, lauded the division’s work, claiming that the commission examined about 15% of the RIA population, despite that segment of the industry growing above 15,000 advisors managing more than $125 trillion in assets.

“Going forward, as the industry continues to grow and change, we believe increased examinations can only be achieved with significant investments in human capital and technology resources, as noted in our fiscal year 2021 priorities,” the leadership team stressed.

Though exam priorities may seem similar year-to-year, it’s best to look at them in context of what’s happening at the commission, according to Carlo di Florio, global chief services officer at the ACA Group, a risk and compliance consultant. He noted the SEC had a robust rulemaking agenda in both 2022 and 2023, with an enforcement division that issued millions in fines and penalties last year.

“Nothing suggests that’s going to slow down in 2023,” he said.

Di Florio cited examination of advisors to private funds as a key area to keep an eye out, arguing it was a focal point for SEC Chair Gary Gensler as it was such a fast-growing market. In addition to the typical focus on conflicts, fees and expenses, di Florio said the commission highlighted increased scrutiny around “risky” funds that were highly leveraged, that managed alongside business development companies, that invested in crypto, commercial real estate or SPACs.

Like private funds, ESG and cybersecurity have rule proposals on the way toward potentially being finalized, which made them areas in which advisors would have to continue to focus in the years ahead (he also noted both of those areas have dedicated units, which could mean a stronger pull for firms to investigate). 

Finally, di Florio said he wouldn’t be surprised to see enforcement actions related to the marketing rule this year, though he expected those actions to build in significance over time.

“There’s going to be more investigations this year than enforcement actions,” he said.

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