By Anne Sherry, J.D.
The SEC’s Division of Examinations issued a risk alert summarizing its observations from exams in the Registered Investment Company (RIC) Initiatives, a series of exams focusing on mutual funds and ETFs to assess practices and compliance in areas that could affect retail investors. Exams staff found numerous failures in funds’ and advisers’ compliance programs and disclosures to investors, but also some practices that other funds and advisers could model in developing an effective compliance program.
The Office of Compliance Inspections and Examinations announced in November 2018 that it would be conducting the RIC Initiatives, focusing on index funds that track custom indices; smaller ETFs; funds with higher allocations to certain securitized assets; funds with “aberrational” underperformance relative to their peers; advisers relatively new to managing mutual funds; and advisers to both mutual funds and private funds that have similar strategies and/or are managed by the same portfolio managers.
Staff has now conducted examinations of more than 50 fund complexes (covering more than 200 funds and/or series) and nearly 100 advisers. The examinations focused on compliance policies and procedures’ effectiveness at addressing certain risks; disclosures to investors; and fund governance practices. The Exams Division issued deficiency letters to some firms and issued the risk alert so that its observations could help all funds assess compliance risks.
Compliance deficiencies. The staff observed inadequate policies and procedures in the compliance oversight of investments and portfolios; valuation; trading practices; conflicts of interest; fees and expenses; and advertisements. Some funds did not have appropriate policies and procedures for monitoring and reporting accurate information to their boards or have adequate annual review and reporting procedures. In some instances where funds delegated responsibilities to their advisers that were not reflected in the advisers’ compliance programs, the funds lacked appropriate oversight.
Inadequate disclosures. Some of the funds’ filings, advertisements, sales literature, and other shareholder communications contained incomplete or inaccurate disclosures, or omitted to disclose information like investment strategies and risks, conflicts, and a change in the indices used to compare fund performance. Advertising and sales literature specifically had issues with the disclosure of investment strategies and holdings, differences in objectives between predecessor and successor funds, returns, benchmarks, and other information about the strategy and performance of the fund.
Best practices. Finally, the staff observed practices that could help funds and advisers design and implement effective compliance programs. Some funds and advisers adopted and implemented compliance programs that provided for reviews of policies and procedures; periodic disclosure testing; addressing the oversight of key vendors; and adopting and implementing policies and procedures to address compliance with regulations and exemptive orders as well as undisclosed conflicts. Some boards provided oversight of the funds’ compliance programs by assessing whether they provided accurate information to the board and whether the funds were adhering to their processes for board reporting, including an annual review of the compliance program.
Some funds also adopted policies and procedures concerning disclosure. These included review and amendment of disclosures in investor communications, amending disclosures for consistency with board actions; updating website disclosures to conform with new or amended disclosures in other communications; reviewing and testing disclosures of fees and expenses; and reviewing and testing funds’ performance advertising.