$400k 18f-4 Fine for ETF Compliance Failures
SEC Releases
Introduction
The SEC charged a $14 Billion RIA with multiple ETFs $400,000 for multiple violations of the Investment Company Act of 1940, including breaching Rule 18f-4.
According to the SEC, the violations involved prohibited affiliated transactions, Rule 18f-4 derivatives risk management and reporting requirements, required shareholder notices, and compliance program deficiencies.
Vigilant’s Chief Operating Officer, Chuck Martin, MBA, was quoted in Ignites providing his thoughts on the recent SEC enforcement. He noted that “while portfolio compliance breaches can occur from time to time, the key expectation is that the compliance function understand the applicable requirements and responds appropriately when a breach occurs, including ensuring that any required notifications and escalation procedures are followed.”
Key Takeaways
1. Affiliate Transactions Must Comply with the Investment Company Act
- The SEC found that the Adviser caused an affiliated Trust to engage in prohibited in-kind transactions with one of its ETFs without obtaining the required exemptive relief.
2. Rule 18f-4 Requires Timely Reporting
- The SEC found that one ETF exceeded its Value-at-Risk (VaR) limit under Rule 18f-4 and that required Board notifications and Form N-RN filings were not made on time.
3. Required Shareholder Notices Must Be Provided
- The SEC found that several ETFs failed to provide required return of capital notices to shareholders when distributions included a return of capital, even though the information was later included in financial statements.
4. Compliance Policies Must Address Regulatory Obligations
- The SEC concluded that certain ETFs failed to adopt and implement reasonably designed compliance policies and procedures to address their regulatory obligations.
Vigilant’s Conclusion
The SEC’s Order reinforces the importance of timely escalation, regulatory reporting, and maintaining compliance policies that address a Fund’s regulatory obligations.
As Chuck observed, “the most significant concern” is when “a compliance function either doesn’t understand or doesn’t follow the notification process once Rule 18f-4’s leverage risk limits are breached.”
This enforcement action serves as a reminder that understanding regulatory requirements is only one part of an effective compliance program. Following required notification and escalation procedures is equally important when compliance issues arise.
The Order also underscores the importance of maintaining compliance policies and procedures that address a Fund’s regulatory obligations.
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