April 5, 2024
At the recent SEC Speaks conference, senior SEC staff shared insights on current initiatives and developments. Below are some key takeaways.
Division of Investment Management staff addressed several regulatory issues affecting investment advisers, including T+1, the Marketing Rule, and Form N-PX reporting.
T+1. The staff continue to engage with industry participants on the upcoming transition to the T+1 settlement cycle and have issued FAQs to help firms prepare. These include that an adviser’s obligations under the recordkeeping rule do not vary based on the source or form of allocation, confirmation, or affirmation. The Division is considering providing additional guidance. Staff have received questions related to international securities due to different time zones and trading cycles, as well as on ETFs, which may need to update their policies to address risks in connection with T+1 and ETFs’ operations. The IAA recently held a webinar regarding preparation for T+1 and we have also developed additional FAQs that are available for members on our website.
Marketing Rule. The staff discussed the recent FAQ on the Marketing Rule related to net and gross performance. They cautioned against an overly technical reading of the rule that runs counter to the SEC’s intent. They understand that it is not helpful for the industry to learn about issues through a piecemeal process, and are trying to publish FAQs when they learn of common issues arising in exams. They encourage firms to engage with the Division — even if the staff does not issue a written response, it is helpful for them to understand current issues. The IAA’s Marketing Implementation Group continues to meet on a regular basis to discuss interpretive and implementation challenges, and we continue to engage with the SEC staff regarding the Marketing Rule.
Form N-PX. The staff have received questions related to the new Form N-PX proxy voting reporting requirements that begin in July 2024. However, these questions have apparently been highly technical rather than broad-based, and thus do not warrant FAQs. The IAA has published FAQs for members. They address Form N-PX reporting for Form 13F filers related to say-on-pay executive compensation issues.
Richard Best, Director of the SEC Division of Examinations, discussed the importance of firms maintaining resiliency and adaptability in the face of risks, new technologies and products, and cyber threats. The new national associate director of the Investment Adviser/Investment Company Program, Vanessa Horton, who recently replaced Natasha Greiner in the role, noted that the SEC continues to focus on recent initiatives, such as cybersecurity, marketing, valuation, and derivatives, while also meeting with stakeholders, including the IAA, to help identify risks in the industry and develop exam priorities for 2025. The 2025 exam priorities will closely align with the SEC’s fiscal year, which begins on October 1. Horton also discussed the importance of EXAMS IRisk Alerts and how they provide a roadmap of the SEC’s concerns. She recommended review of the March 2023 Risk Alert on Examinations of Newly-Registered Advisers, the Marketing Rule Risk Alerts in September 2022 and June 2023, and the September 2023 Risk Alert on Assessing Risks, Scoping Examinations, and Requesting Documents.
Use of Artificial Intelligence (AI). The staff discussed the need for advisers to implement supervisory controls around the use of AI, as well as governance and appropriate disclosure. Staff urged firms not to prioritize their interest over clients’ interests in the use of AI. Staff also mentioned the need for appropriate substantiation of asserted facts so that investors are not misled and recommended to “keep a human in the loop.” The SEC warned about deep fake videos and audio and recommended that advisers review the SEC, NASAA, and FINRA’s January 2024 joint Investor Alert on AI and investment fraud. Advisers should focus on oversight of third-party AI tools, the need to comply with Regulation S-P, and the potential loss of client data. The staff noted that the Exam Brochure was updated in 2023 to add information about safeguarding non-public information.
Coordination with Enforcement. The staff noted that the EXAMS Division may coordinate with the Division of Enforcement where their interests align.
Current Initiatives. The Division of Enforcement continues to see non-compliance in the crypto assets space. Other current initiatives include off-channel communications/recordkeeping, the Marketing Rule, delinquent filers, affinity fraud, microcap companies that offer and sell securities in unregistered offerings that fail to comply with Regulation A, and unregistered dealers.
Penalties. The staff insisted that its assessment of penalties is not random, but is rather based on an individualized assessment of each firm, considering factors such as the firm’s size (revenues and number of employees), RAUM, regulatory history, and prompt remediation. The factor that is most likely to result in a lower penalty recommendation is whether the firm self-reported.
Other Remedies. Remedies are tailored with the goals of fostering a culture of compliance and protecting investors. Sanctions are recommended to deter future misconduct and provide a roadmap for the industry to follow. The staff noted that non-financial relief, such as an undertaking to retain an independent compliance consultant, can be effective. They also emphasized that the Division aggressively seeks disgorgement so that a wrongdoer does not keep ill-gotten gains. The amount may be more or less than a victim’s losses.
Cooperation. According to the staff, the Division strives to reward meaningful cooperation. Examples include providing documentation that the staff cannot compel, sharing results of internal investigations, waiving privilege, and sharing financial analyses. By contrast, merely complying with subpoenas, producing requested documents, and giving truthful testimony are expected and do not earn special credit. There are two types of cooperation: informal (available to anyone who cooperates during an investigation) and formal (which must be approved and is evidenced by a signed cooperation agreement, deferred prosecution agreement, or non-prosecution agreement).
Whistleblowers. The staff stressed that confidentiality agreements with employees should carve out communications with regulatory agencies – whether voluntary or compelled – not require employees to forego financial incentives, and avoid contradictory or ambiguous language.
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