SEC emphasizes probing ESG, marketing rule, Reg BI compliance

The agency's other examination priorities for this year include RIAs who manage private funds, ESG investing and crypto

The SEC will place an emphasis on its new marketing rule, Regulation Best Interest, private funds and environmental, social and governance investing in its regulatory examinations this year.

It didn’t take long for the Securities and Exchange Commission to launch probes of how registered investment advisors advertise their practices. It’s one of several regulations highlighted in the SEC’s 2023 Examinations Priorities released late Tuesday afternoon by the agency’s Examinations Division.

The marketing regulation, which went into force in November, overhauled rules that had been in place for more than 60 years governing how advisors promote themselves.

The measure gives advisors latitude to use client testimonials but also puts in place dozens of requirements for staying in compliance on that and other kinds of advertising. The SEC said it will do more than evaluate advisors’ written policies and procedures to comply with the marketing rule.

“The Division will also review whether RIAs have complied with the substantive requirements of the marketing rule, including the requirement that RIAs have a reasonable basis for believing they will be able to substantiate material statements of fact and requirements for performance advertising, testimonials, endorsements and third-party ratings,” the examinations priority document states.

The SEC also will focus on Reg BI, as the broker-dealer standard of conduct is known, and on investment advisors’ compliance with the fiduciary standard that governs them. The agency will be looking especially at financial professionals who are dually registered as advisors and brokers.

Examinations of the standards of conduct will focus on brokers’ and advisors’ recommendations about products, investment strategies and account types; disclosures about conflicts of interest; their processes for evaluating reasonably available alternatives to and the costs and risks of recommendations; and how they assess an investor’s objectives and characteristics when making recommendations.  

SEC examiners will zero in on advice or recommendations concerning complex products, such as derivatives and leveraged exchange-traded funds; high cost and illiquid products, such as variable annuities and nontraded REITs; proprietary products; unconventional strategies that purport to address rising interest rates; and microcap securities, according to the priorities document. The agency is especially interested in recommendations pertaining to retirement account rollovers and 529 education savings plans.

The SEC also said it will probe financial incentives, such as revenue sharing, that can cause brokers or advisors to act in their own interests instead of those of their customers or clients.

“Examinations will review how firms are managing conflicts of interest, including mitigating or eliminating [them], when appropriate,” the priorities document states.  

The examinations preview follows a Reg BI risk alert the SEC released last week. Both show the agency is stepping up its probes into whether advisors are complying with Reg BI.

“The two go hand-in-hand,” said Tim Nagy, a partner at Mayer Brown. “They’re definitely doing a deeper dive now. The big point is managing conflicts of interest and mitigating or eliminating them.”

Two increasingly popular investing areas also are drawing the attention of SEC examiners. The agency said it is has a special interest in probing advisors to private funds because those advisors “represent a significant portion of the RIA population,” the priorities document states.

Rising investor demand for ESG investments and strategies has piqued SEC examiners’ interest as well.

“[T]he Division will assess whether ESG products are appropriately labeled and whether recommendations of such products for retail investors are made in investors’ best interest,” according to the priorities document.

Other areas drawing special SEC examination attention include crypto assets and emerging financial technology, such as message apps and digital financial advice.

This article first appeared in InvestmentNews.