Compliance October 21, 2024

SEC’s 2025 Exam Priorities Include Fiduciary Conduct, AI Use

The regulator also listed compliance procedures and Regulation Best Interest in its list of priorities published Monday.

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The Securities and Exchange Commission will prioritize fiduciary conduct, compliance and the use of artificial intelligence, among other things, as examination priorities in 2025, the regulator’s division of examinations announced Monday.

The SEC’s division of examinations highlighted in its annual report areas on which it will focus when dealing with investment advisers, investment companies and broker/dealers to try and avert what it deems the most relevant “risks in the U.S. capital markets” for investors. The division, which has some 1,500 staffers, focuses on market players—including SEC-registered investment advisers, investment companies, broker/dealers, clearing agencies and self-regulatory organizations—and their compliance with federal securities laws.

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The 2025 examinations will prioritize such areas as fiduciary duty, standards of conduct, cybersecurity and artificial intelligence, according to the regulator. The list does not include everything the regulator will address during the year, the SEC noted.

Fiduciary Conduct 

The first area the report highlighted is investment adviser adherence to fiduciary standards of conduct, to ensure advisers are acting in the best interest of their clients. The SEC stated that an adviser “must eliminate or make full and fair disclosure of all conflicts of interest which may lead the adviser—consciously or unconsciously—to render advice that is not disinterested such that a client can provide informed consent to the conflict.”

Specifically, the report cited the consideration of high-cost products, unconventional investment instruments, illiquid and difficult-to-value assets, and assets sensitive to higher interest rates or changing market conditions. It also specified dual registrants and advisers with affiliated broker/dealers when assessing investment advice and recommendations and reviewing the appropriateness of account selection practices such as rollovers.

The SEC went on to note areas of focus in terms of an adviser’s compliance program to ensure it is meeting best practices. This could include compliance when dealing with illiquid or difficult to-value-assets or when using artificial intelligence in operations such as portfolio management, trading or marketing.

Off-Channel Communications

One compliance issue on which the SEC has been focused in the past year is off-channel communications among advisers and between advisers and clients, with a series of charges levied against firms for non-compliance.

SEC Chair Gary Gensler on Monday addressed the issue during securities industry trade association SIFMA’s annual conference on Monday.

Kenneth Bentsen, president and CEO of SIFMA, asked Gensler during a question-and-answer session to address the “growing frustration” among firms in trying to deal with the off-channel regulations and asked if the recent charges represented “an area of success, or just a constant liability?”

Gensler responded by saying that “books and records are really important to control the risk at your firms.” The SEC, he said, has found that many firms are communicating off-channel, sometimes for “convenience,” but in other cases with implications of hiding bad practices.

“This is important for risk control for individual firms,” Gensler said. “But it’s not about perfection or something. We have really found that hundreds of people at dozens of firms were just blowing right past the rules that even their firms had in place. So we tried with these settlements to move these market behaviors back to the right zip code.”

Reg BI

The third area of focus spotlighted on Monday was the SEC’s Regulation Best Interest, which regulates broker/dealer practices related to client recommendations, disclosures around conflicts of interest, processes for reviewing reasonable alternatives and consideration of a client’s investment profile and goals.

“In particular, examinations of broker-dealer practices will focus on those recommended products that are complex, illiquid, or present higher risk to investors,” the SEC wrote, pointing to products including cryptocurrency assets, alternative investments, products not registered with the SEC and products that have “complex fee structures or return calculations.”

The SEC also called out recommendations related to opening a self-directed individual retirement account and those made to “certain types of investors, such as older investors and those saving for retirement or college.”

Earlier this year, the Department of Labor’s Retirement Security Rule, otherwise known as the fiduciary rule, was intended to bring certain adviser and broker/dealer recommendations under the Employee Retirement Income Security Act, including IRA rollovers, annuity sales and qualified plan advice to small businesses. That rule was stayed by two federal courts in Texas and is now pending DOL appeal. Many opponents of the rule have pointed, in part, to the SEC’s Reg BI as already policing the standard of care for those retirement-related investment areas.

Trending Areas

Lori Weston, director of product and strategy at STP Investment Services, says the focus areas impact their clients, including private fund advisers and wealth managers. She noted that, while the SEC continues to be focused on the “core tenants of an adviser’s compliance program,” some focus areas came from trending topics such as the integration of AI into operations and procedures.

 “While the SEC did list AI as an emerging technology in its 2024 examination priorities, AI is a lot more prominent in this year’s priorities, accompanied by a list of compliance areas that should be noted by any firm that uses AI or has AI exposure,” she says via email. “[F]irms should pay particular attention to the SEC’s callout regarding the use of AI highlighted in this year’s priorities, including ensuring that they have implemented robust policies and controls, as well as ensuring they have adequate and accurate disclosures.”

Weston also pointed to the importance of advisers reviewing third-party vendors’ use of AI, noting that “these must be understood by the adviser, and the adviser must ensure they are adequately disclosed.”

Another area on which the SEC announced it will focus is cybersecurity and how firms are protecting client information and data, with attention 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.” It will also be focused on Regulation S-ID and Regulation S-P, both related to identity theft and fraud monitoring, protection and timely notification.

“The Commission has indicated it plans to engage firms regarding their preparedness for adoption of the amendments to Reg S-P, released earlier this year,” STP’s Weston says of this focus area. “These amendments broaden the scope of the information covered by Reg S-P and may also impact the firms’ incident response programs.”

Other areas of focus include how firms are complying with a new rule that has implemented a shorter settlement time for most securities to be the “day after trade date,” or T+1, along with investments in cryptocurrency assets, both for clients and among asset managers. Cryptocurrency has been an area of focus for Gensler, who has called for tighter regulation and caution by the market in dealing in digital assets.
Compliance October 21, 2024

DOL Publishes 1st List of Firms Using Qualified Plan Exemptions

The list includes nearly 900 companies as part of the DOL’s finalized amendment to PTE 84-14.

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The U.S. Department of Labor last week published a list of nearly 900 companies that have used or planned to use the qualified professional asset manager exemption, as of September 30.

The initial public list comes after the DOL published in April a new amendment to the rule governing the QPAM exemption, which regulates transactions between an investment manager and a qualified plan. The prohibited transaction exemption, or PTE 84-14, provides relief for those employee benefit plan and individual retirement account transactions that would otherwise not be allowed by the Employee Retirement Income Security Act.

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Under the amended PTE 84-14, any firm that relies on the exemption must notify the DOL. The regulator’s list, published Wednesday, lists firms that have used the exemption and includes many of the biggest names in asset management, insurance and recordkeeping. According to the DOL, the list will be updated periodically.

The publication and maintenance of the list is required by the amendment that both broadened the types of misconduct that would require an investment manager exemption and made it easier for a retirement plan sponsor to exit a QPAM relationship. The amendment was first proposed in July 2022 and received industry pushback and comment over the subsequent years before it was finalized.

Ruth Delaney, a partner in the asset management and investment funds practice group of K&L Gates, says the DOL had indicated it would maintain a public list of firms relying on the QPAM exemption on its website and that the lengthy list makes sense, given the circumstances.

“Given that the QPAM exemption is one of the broadest and most commonly relied on exemptions in the financial services industry, the long list of entities, including many major players in the industry, does not come as a surprise,” she says.

The DOL noted in Wednesday’s release that it had not directly verified whether any of the listed entities met the exemption’s requirements and that inclusion on the list should “not be taken as the Department’s endorsement of the use of the entity as a service provider or fiduciary.” Plan fiduciaries, it noted, should consult with legal counsel regarding working with a QPAM.

David Kaleda, a principal in Groom Law Group, Chartered, says it is important that plan fiduciaries do not see this list of disclosures as a “blessing” by the DOL.

“The DOL makes clear on the webpage that disclosure on the page does not … mean that the entity is in fact a ‘qualified professional asset manager’ or that an entity that is otherwise a QPAM in fact complies with the conditions of the QPAM Exemption,” he says. “That is, the DOL does not independently verify QPAM status or exemption compliance, and it is the responsibility of plan fiduciaries to make that determination.” 

Kaleda also notes that many organizations have multiple affiliates listed, showing that “each discretionary manager” within a firm that wants to use the exemption must independently meet its requirements.

The DOL stated in April that the amendment to PTE 84-14 was designed to modernize the rule from its initial 1984 creation. It included changes such as:

  • Clarifying that foreign convictions are included in the scope of the exemption’s ineligibility provision;
  • Adding a one-year transition period intended to mitigate potential costs and disruptions to plans and individual retirement account owners when a QPAM becomes ineligible;
  • Updating asset management and equity thresholds in the QPAM definition;
  • Clarifying the requisite independence and control a QPAM must have with respect to investment decisions and transactions; and
  • Adding a standard recordkeeping requirement.

Kaleda believes the public disclosure requirement and web page will serve as an enforcement tool for the DOL. For example, if the regulator sees that a financial services firm is being convicted of certain crimes or has entered into a settlement related to certain crimes, “it may look to see if such entity or its affiliates are listed on the website. Then, it could use its investigation and enforcement authority to assure that the entity and its affiliates no longer rely on the QPAM exemption or get an individual exemption.”

In addition, he notes, the web page is the “only centralized, comprehensive list of which I am aware available to the DOL of asset managers who likely manage ERISA-covered assets. These are managers over which DOL has enforcement authority, regardless of whether they rely on the QPAM exemption.”

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