On October 21, 2024, the SEC’s Division of Examinations (the “Division”) announced its examination priorities for fiscal year 2025. Consistent with the Division’s 2023 and 2024 examination priorities, the Division will continue to focus on: (1) investment adviser adherence to duty of care and duty of loyalty obligations, (2) adviser compliance programs, (3) private fund advisers’ practices in times of market volatility and adherence to recently adopted SEC rules, (4) registered investment company fund fees and expenses, (5) information security and operational resiliency, (5) crypto assets and (6) anti-money laundering practices and procedures.

The Division publishes its annual examination priorities to inform investors and the industry about key areas where the Division intends to focus its resources (i.e., those areas the Division believes present the highest risk areas to investors and the markets) and is part of its effort to foster compliance with proactive communication and transparency. Although the Division’s examination priorities identify various market participants, this client alert focuses on investment advisers and investment companies.

As with previous years, the Division will prioritize examinations of advisers and registered investment companies (RICs) that have never been examined and those that have not been recently examined with a continued focus on newly registered advisers and RICs.

Examination of Investment Advisers

A. Fiduciary Duty

Examining for investment advisers’ adherence to their duty of care and duty of loyalty obligations remains the Division’s priority, and the Division will continue to focus on the following areas in particular:

Investment Advice: Investment advice provided to clients regarding products, investment strategies, and account types, and whether that advice satisfies the fiduciary obligations owed to clients. In particular, the Division will focus on recommendations related to: (1) high-cost products; (2) unconventional instruments; (3) illiquid and difficult-to-value assets; and (4) assets sensitive to higher interest rates or changing market conditions, including commercial real estate.

Dual Registrants and Advisers with Affiliated Broker-Dealers: Common areas of focus include: (1) assessing investment advice and recommendations regarding certain products to determine whether they are suitable for clients’ advisory accounts; (2) reviewing disclosures to clients regarding the capacity in which recommendations are made; (3) reviewing the appropriateness of account selection practices (e.g., brokerage versus advisory), including rollovers from an existing brokerage account to an advisory account; and (4) assessing whether and how advisers adequately mitigate and fairly disclose conflicts of interest.

Financial Conflicts. The impact of advisers’ financial conflicts of interest on providing impartial advice and best execution, with consideration given for non-standard fee arrangements.

B. Compliance Programs

The Division will continue to focus on whether the policies and procedures address compliance with the Advisers Act and the rules thereunder and are reasonably designed to prevent the advisers from placing their interests ahead of clients’ interests. Furthermore, the Division’s assessment of the effectiveness of advisers’ compliance programs will continue to be a fundamental part of the examination process.

Compliance with the Advisers Act. Areas on which examinations may focus include: (1) fiduciary obligations of advisers that outsource investment selection and management; (2) alternative sources of revenue or benefits advisers receive, such as selling non-securities based products to clients; and (3) appropriateness and accuracy of fee calculations and the disclosure of fee-related conflicts, such as those associated with select clients negotiating lower fees when similar services are provided to other clients at a higher fee rate.

Compliance Program Effectiveness. Examinations focusing on this topic typically include an evaluation of the core areas of advisers’ compliance programs which include, as applicable and appropriate for each examination, marketing, valuation, trading, portfolio management, disclosure and filings, custody and an analysis of advisers’ annual reviews of the effectiveness of their compliance programs, which are a critical element for addressing and monitoring conflicts of interests (e.g., advisers’ business and compensation arrangements, arbitration clauses, and/or affiliations with certain parties and transactions).

Risk Identification and Implementation of Reasonably Designed Policies. The Division’s review of an adviser’s compliance program may focus on or go into greater depth depending on its practices or products (e.g., if clients invest in illiquid or difficult-to-value assets, examinations may have a heightened focus on valuation). If advisers integrate artificial intelligence (AI) into advisory operations (e.g., portfolio management, trading, marketing and compliance), an examination may look in-depth at compliance policies and procedures as well as related disclosures to investors. If an adviser utilizes a large number of independent contractors working from geographically dispersed locations, examinations may focus on supervision and oversight practices. Examinations may also focus on compliance practices when advisers change their business models or are new to advising particular types of assets, clients, or services.

C. Advisers to Private Funds

The Division will continue to focus on advisers to private funds and prioritize specific topics, such as the following:

Disclosures. Whether disclosures are consistent with actual practices and if an adviser met its fiduciary obligations in times of market volatility and whether a private fund is exposed to interest rate fluctuations. Examples of investment strategies that may be sensitive to market volatility and/or interest rate changes include commercial real estate, illiquid assets, and private credit. The Division may particularly focus on examinations of advisers to private funds that are experiencing poor performance and significant withdrawals and/or hold more leverage or difficult-to-value assets.

Calculations and Allocations of Fees and Expenses. The accuracy of calculations and allocations of private fund fees and expenses (both fund-level and investment-level). Examples of areas that may impact the accuracy of fee calculations include valuation of illiquid assets, calculation of post commitment period management fees, offsetting of such fees and expenses, and the adequacy of disclosures.

Conflicts of Interests. Disclosure of conflicts of interests and risks, and adequacy of policies and procedures. Examples of products or practices for the focus of such conflicts, controls, and risks reviews include: (1) use of debt, fund-level lines of credit, investment allocations, adviser-led secondary transactions, transactions between fund(s) and/ or others; (2) investments held by multiple funds; and (3) use of affiliated service providers.

Compliance with Recent SEC Rules. Compliance with recently adopted SEC rules, including amendments to Form PF, and the updated rules that govern investment adviser marketing, to assess whether advisers have established adequate policies and procedures and whether their actual practices conform to them.

Examination of Investment Companies

The Division continues to prioritize examinations of RICs, including mutual funds and exchange-traded funds, due to their importance to retail investors, particularly those saving for retirement. Examinations of RICs will generally review their compliance programs, disclosures, and governance practices. Particular examination focus areas may include review of specific topics or characteristics involving: (1) fund fees and expenses, and any associated waivers and reimbursements; (2) oversight of service providers (both affiliated and third-party); (3) portfolio management practices and disclosures, for consistency with claims about investment strategies or approaches and with fund filings and marketing materials; and (4) issues associated with market volatility. The Division will also continue to monitor certain developing areas of interest, such as RICs with exposure to commercial real estate and compliance with new and amended rules.

Risk Areas Impacting Various Market Participants

A. Information Security and Operational Resiliency

Cybersecurity. The Division will continue to review registrant practices to prevent interruptions to mission-critical services and to protect investor information, records, and assets. Particular attention will be on firms’ policies and procedures, governance practices, data loss prevention, access controls, account management, and responses to cyber-related incidents, including those related to ransomware attacks, as well as cybersecurity risks and resiliency goals associated with third-party products and similar services.

Regulation S-ID and Regulation S-P. Examinations will focus on firms’ policies and procedures, internal controls, oversight of third-party vendors, and governance practices. Examinations will also assess a firm’s efforts to address operational risk, including technology risks, as operational failures may impact a firm’s ability to safeguard customer records and information.

Shorter Settlement. The Division will evaluate advisers’ compliance with amended books and records requirements associated with T+1. The Division will also consider advisers’ operational changes, or impacts related to adviser facilitation of institutional transactions that are involved in the allocation, confirmation, or affirmation processes subject to Rule 15c6-2(a)¹.

B. Emerging Financial Technologies

The Division remains focused on registrants’ use of certain services, such as automated investment tools, AI, and trading algorithms or platforms, and the risks associated with the use of emerging technologies and alternative sources of data. As such, the Division will, in particular, examine firms that employ certain digital engagement practices, such as digital investment advisory services, recommendations, and related tools and methods. When conducting these reviews, assessments generally will include whether: (1) representations are fair and accurate; (2) operations and controls in place are consistent with disclosures made to investors; (3) algorithms produce advice or recommendations consistent with investors’ investment profiles or stated strategies; and (4) controls to confirm that advice or recommendations resulting from digital engagement practices are consistent with regulatory obligations to investors, including older investors.

With respect to AI, the Division will review registrant representations regarding their AI capabilities or AI use for accuracy. In addition, the Division will assess whether firms have implemented adequate policies and procedures to monitor and/or supervise their use of AI, including for tasks related to fraud prevention and detection, back-office operations, anti-money laundering (AML), and trading functions, as applicable. Reviews will also consider firm integration of regulatory technology to automate internal processes and optimize efficiencies. In addition, the Division will examine how registrants protect against loss or misuse of client records and information that may occur from the use of third-party AI models and tools.

C. Crypto Assets

Examinations of registrants will focus on the offer, sale, recommendation, advice, trading, and other activities involving crypto assets that are offered and sold as securities or related products, such as spot bitcoin or ether exchange-traded products. In particular, these examinations will review whether the registrants: (1) meet and follow their respective standards of conduct when recommending or advising customers and clients regarding crypto assets with a focus on an initial and ongoing understanding of the products that have a particular focus on scenarios where investors are retail-based (including older investors) and investments involving retirement assets; and (2) routinely review, update, and enhance their compliance practices (including crypto asset wallet reviews, custody practices, Bank Secrecy Act (BSA) compliance reviews, and valuation procedures), risk disclosures, and operational resiliency practices (i.e., data integrity and business continuity plans), if required. The Division will assess registrant practices to address the technological risks associated with the use of blockchain and distributed ledger technology, including risks pertaining to the security of crypto assets.

D. Anti-Money Laundering

The Division will continue to focus on AML programs and review whether certain RICs are: (1) appropriately tailoring their AML program to their business model and associated AML risks; (2) conducting independent testing; (3) establishing an adequate customer identification program, including for beneficial owners of legal entity customers; and (4) meeting their SAR filing obligations. Examinations of certain RICs will also review policies and procedures for oversight of applicable financial intermediaries. Lastly, the Division will review whether advisers are monitoring the Department of Treasury’s Office of Foreign Assets Control sanctions and ensuring compliance with such sanctions.²