On October 26, 2021, the U.S. Securities and Exchange Commission’s Division of Examinations (Exams) issued a Risk Alert regarding mutual funds and exchange-traded funds intended to "highlight risk areas and assist funds and their advisers in developing and enhancing their compliance programs and practices" as they pertain to retail investors. This Risk Alert is the result of the registered investment companies (RIC) initiatives that were announced in a Risk Alert in November of 2018, and observations made by the staff of Exams in regard to the RIC Initiatives.
In all, Exams looked at more than 50 fund complexes - covering more than 200 funds and/or series of funds - and nearly 100 advisers. This Risk Alert highlights the most frequent deficiencies and weaknesses found by the staff of Exams.
The deficiencies noted by the Exams concerning fund’s and advisers’ compliance programs for portfolio management and other business practices, and board oversight of funds’ compliance programs included the following:
- Inadequate compliance programs concerning business practices. These inadequacies include oversights regarding investments and portfolios, valuations, trading practices, conflicts of interests, fees and expenses and fund advertisements.
- Issues with boards’ oversight of the funds compliance programs. An observation was made that many funds lacked policies and procedures for monitoring issues and reporting them to the fund’s board. Annual reviews did not address the adequacy of current programs and the effectiveness of their implementation. In other circumstances, the board lacked the appropriate means to provide oversight.
- Inaccurate, incomplete, and/or omitted disclosures. Some of the issues noted included (a) omissions related to investing risk, conflicts, performance, (b) inaccuracies related to funds’ net asset and expense ratios, and (c) failing to disclose some required information in the funds’ SAIs.
- Deficient disclosures in advertising material. Among other things, the Exam’s staff noted inaccurate, incomplete and/or omitted disclosures in a variety of advertising and sales-related material. Examples provided ranged from issues with inception dates to performance and expense information.
After noting the deficiencies, the Exams went on to provide a sample list of practices that may help funds and advisors in understanding and implementing their compliance programs. Suggestions included the following:
- Conduct reviews of compliance programs – for consistency with current practices and for specific risks.
- Periodically test and review for compliance with disclosures – auditing to review the effectiveness of existing compliance policies and procedures.
- Ensure compliance programs adequately provide oversight of key vendors.
- Adopting and implementing policies and procedures to address the areas of (1) applicable regulation, (2) required disclosures and (3) undisclosed conflicts of interests.
- Assuring the accuracy of the information provided to the board and that the processes for providing the information were followed.
- Reviewing and, if necessary, amending required disclosures for accuracy, completeness and appropriateness.
Practical Tip/Action Item
- The Risk Alert is a helpful summary of what funds and their advisers can expect Exams staff to focus on during an examination of funds’ compliance programs and practices. Funds and their advisers should use the Risk Alert as an opportunity to review their compliance policies, their trading practices, and their client disclosure.
- Incorporate reviews of compliance policies and controls periodically as part of an on-going effort to identify problem areas and make appropriate improvements in compliance programs and disclosure practices, as appropriate.
- Avoid inaccuracies and omissions in disclosures requirements, particularly in advertising and sales-related material.
Contact your Faegre Drinker Investment Management attorney with questions or assistance developing and implementing a comprehensive compliance program.