Monday, November 12, 2018

OCIE announces risk-based exam initiatives focused on funds and advisers

By Amy Leisinger, J.D.

The SEC’s Office of Compliance Inspections and Examinations has issued a risk alert announcing its intention to conduct a series of examination initiatives focused on issues affecting certain registered investment companies and investment advisers. According to the alert, examiners will focus on mutual funds and ETFs, adviser activities, and oversight by fund boards of directors and target compliance potential problems that could directly affect retail investors.

In particular, examinations will focus on index funds tracking custom-built indexes and assess the unique challenges associated with the selection and weighting of the custom-built or bespoke index components. Examiners will also review how portfolios are managed in comparison with disclosures describing strategy and the adequacy of disclosures made to the fund boards regarding index providers, as well as efforts to address conflicts of interest between index providers and advisers.

In addition, OCIE will focus on small ETFs and ETFs with minimal secondary-market trading volume and assess whether board oversight incorporates a given fund’s ability to continue as an ongoing concern and whether tracking errors are effectively monitored. The staff will also evaluate whether ETFs adequately disclose investment risks, including liquidation risks, to investors and, as necessary, whether portfolios are appropriately liquidated for distribution to shareholders upon liquidation.

With regard to underperforming funds, the staff will review the effectiveness of the funds’ compliance programs and board oversight activities and assess whether the funds are investing in a manner consistent with disclosed objectives and strategies and using marketing materials containing complete and accurate statements. OCIE staff also will evaluate whether funds with higher allocations to certain securitized assets adhere to applicable requirements when borrowing or investing in instruments that may leverage the funds and examine risk identification, monitoring, and mitigation activities to evaluate how advisers are managing the portfolio holdings and liquidity. Examiners will also consider valuation and pricing policies and procedures, particularly with respect to illiquid or difficult-to-value securities.

OCIE has also determined that side-by-side management of mutual funds and private funds may present certain risks to retail investors and, as such, will evaluate advisers’ policies and procedures for addressing conflicts of interest and other risks associated with the practice and controls designed to ensure appropriate brokerage, best execution, and trade allocation practices. Advisers new to the industry will be evaluated to ensure that their fund boards are provided with sufficient information to perform their duties and to assess the effectiveness of compliance programs of both the advisers and their funds under management.

OCIE urges registrants to reflect upon their own practices to consider improvements as appropriate., as the adequacy of supervisory, compliance and risk management systems can be determined only with reference to the circumstances of a specific firm.