How SEC will approach exams in 2023

The Securities and Exchange Commission’s exam priorities for 2023 include compliance with Regulation Best Interest, its pursuit of off-channel recordkeeping failures, municipal advisor registrations and its continued oversight of self-regulatory organizations like the Municipal Securities Rulemaking Board.

While many of these issues may not be specific to munis, the SEC’s expanded view of Reg BI and off-channel communications represent new priorities for how the Division of Examinations views the market.

“Our priorities reflect the changing landscape and associated risks in the securities market and are the product of a risk-based approach to examination selection that balances our resources across a diverse registrant base,” said Richard Best, director of the Division of Examinations. “We will emphasize compliance with new SEC rules applicable to investment advisers and investment companies as well as continue our focus on emerging issues and rules aimed at protecting retail investors.”

“Our examination program continues moving forward and remains committed to furthering investor protection through high-quality examinations and staying abreast of the latest industry trends and emerging risks to investors and the markets.”

The Commission also cited the Examination Department’s constant communication with its enforcement division, which resulted in two of its first ever charges last year and that will follow into 2023.

“In fiscal year 2022, firms returned more than $50 million to investors in response to EXAMS’ proactive work on examinations. EXAMS also made numerous referrals to Enforcement and we anticipate there may be additional referrals from our 2022 examinations,” the SEC said.

In September 2022 the Commission charged 15 broker-dealers and one investment advisor with failing to maintain electronic communications. Ernesto Lanza, of counsel and former acting director of the SEC’s Office of Municipal Securities believes they’re looking at that hard.

“I think we’re at the early end of that trend,” Lanza said. “What they’re looking at is what kind of procedures do the firms have around whether people can use other means of communications beyond the formal means, whether those processes are enforced and whether they have a way to keep a record of communications and to review them as part of the supervisory procedures.”

Some of those banks fined by the Commission have been recouping funds from the individual employees charged and Lanza feels this is a big ticket item for 2023.

Examination efforts on Reg BI will also be one of the SEC’s highest priorities, where it said it will focus on investment advice and recommendations, disclosures, processes for making best interest evaluations and investment goals and account characteristics. But other factors may be considered as well.

“My guess is they’re going to be looking very carefully at whether firms are properly treating their high net worth individuals as retail customers for purposes of Reg BI,” said Lanza. ” I think some places have in the past treated them as institutional customers and basically Reg BI kind of pulls in those high net worth individuals under the rule.”

In regards to policies and procedures around Reg BI, the Commission will be looking for firms to spell out specifically how they’re implementing Reg BI such as how firms look at alternatives to what they’re recommending, what specific processes come in line with Reg BI and how do firms balance costs and risks and how do they go about identifying conflicts of interest.

“I think the SEC is looking for more meat on the bone in terms of how firms implement that Reg BI process,” Lanza said. 

The SEC has also singled out firms that wear multiple hats, including those registered as broker dealers, investment advisors and municipal advisors and discerning whether firms are acting under the appropriate hat for each of their roles.

The year’s examinations may also focus on retirement account rollovers and 529 plans, which were highlighted in the Financial Industry Regulatory Authorities’ recent action on 529 plan waivers and continue its oversight of municipal advisors through MSRB Rule G-42 on core standards of conduct.

“Focusing exam efforts on the main MA Rule G-42, conflicts, professional qualifications and other documentation and supervisory items is what we have been hearing from the SEC and what MAs should be expecting going forward,” said Susan Gaffney, executive director of the National Association of Municipal Advisors. “The MA exam program continues to mature and focus more on firm and practitioner practices than ‘paperwork’ items.” 

The SEC singled out conflicts of interest, relationship documentation, registration, professional qualification and supervision requirements as particular focuses for MAs.

“One item we continue to discuss with the SEC is that you can’t examine MAs that aren’t registered; and hope the SEC will continue efforts to crack down on unregistered MAs in the marketplace,” Gaffney added.

The Division of Enforcement maintains its continued oversight of the MSRB and FINRA through a “risk assessment process” and will continue to use it to identify those areas to examine this year.