SEC Exam Priorities Require Advisers to Account for Client-Specific Needs in Recommendations

The Securities and Exchange Commission published its 2024 exam priorities for investment advisers and broker/dealers Monday. The document highlights next year’s areas of focus for the SEC.

The exam priorities repeatedly noted certain areas. Advice rendered relating to complex, expensive or illiquid products will come under scrutiny, as will an adviser’s policies and practices related to tailoring advice to the specific needs and characteristics of the client, especially for retail investors, elderly investors and retirement assets.

Products

Certain products were identified by the regulator as being of special interest. “Derivatives and leveraged exchange-traded funds” were listed explicitly as examples of complex investments, and “variable annuities and non-traded real estate investment trusts” as examples of high cost and/or illiquid investments, both areas of focus. Recommendations concerning these products must be accompanied by proper disclosure and informed consent and must be made in the client’s best interest.

Jennifer Klass, a partner in K&L Gates LLP, explains that with these products, advisers must focus on a “combination of disclosure and appropriate training and knowledge, as well as ensuring they are offering those products to the right clients.”

The SEC noted that recommendations of “unconventional strategies, including those that purport to address rising interest rates” would be examined. It also highlighted “proprietary” products—those owned by the adviser—and “microcap securities” as additional product recommendations it will scrutinize.

Cryptocurrencies and digital assets had their own section in the notice, and the industry in general has been a target of SEC enforcement and has been described by Chairman Gary Gensler as “rife with fraud and scams and hucksters.”

Klass says that cryptocurrency is a focus of the SEC, and “it has been for some time, especially since the current chair, Gary Gensler, took over.” The SEC is particularly focused on the proper custody of crypto and “ensuring clients understand the product and risks.”

The notice explained the importance of an adviser being sure the investor understands the digital asset in which he is investing and that the adviser should take particular care to inform a client “when the investors are retail-based (including older investors) and investments involve retirement assets.”

Client Profiles

The regulator emphasized that advisers must account for the profile of each client and not render irrelevant or general advice.

The SEC called out the specific needs of the elderly, especially as they relate to complex or expensive products. According to the notice, advisers need to tailor their advice to those needs, and SEC exams “may also focus on recommendations to certain types of investors, such as older investors and those saving for retirement or college,” whose time horizons can vary considerably.

Klass notes that advisers should have a “framework around senior investors and make sure products are appropriate for them.” This includes their investment needs, but also “whether they are competent to understand the investments or if other people need to be involved in the process.”

The distinctions between investors are a key component of Regulation Best Interest, and advisers must have policies to consider the “initial and ongoing suitability” of a recommendation, seek best execution, evaluate costs and risks, and identify and mitigate conflicts of interest, the notice stated.

Compliance Policies

The new marketing rule will also be a focus for SEC examiners. Specifically, the SEC will be looking to see that advisers can substantiate fact-based claims in marketing materials and whether marketing activities are reported properly on Form ADV.

Many other items were briefly discussed or listed in the notice as an area of SEC focus. These included proper disclosures; policies for proprietary trading; training procedures; record integrity; the valuation of private holdings; and business continuity policies.