Risk Alert Focused on RICs | Division of Examinations
SEC RELEASES
Introduction
On November 4th, 2024, the Division of Examinations (EXAMS) released a risk alert for Registered Investment Companies (RICs).
Risk alerts are an essential tool for compliance professionals to understand how successful their programs may be under SEC scrutiny.
For RICs, EXAMS is primarily focused on the effectiveness of the written policies and procedures, the accuracy and clarity of disclosures, and the prompt handling of compliance concerns when applicable.
The approach to examination for any specific Fund can vary; there may be a focus on the SEC’s overall assessment of a Fund’s Compliance Program or a more targeted review of Funds that have certain characteristics that make them higher risk.
Examination Selection and Scoping
- Factors for selecting Funds to examine:
- Does the Fund’s Investment Strategy and/or Portfolio Holdings meet criteria relevant to the focus areas described in the Division of Examinations priorities?
- Are there any new regulatory requirements that would be applicable to the Fund?
- Previous examination history, including time since last exam.
- The risks for a Fund or Adviser’s business activities that could cause conflicts of interest.
- External information such as tips, complaints, and referrals from other departments.
- Risk factors based on data submitted including:
- Portfolio Composition
- Investment Strategies
- Fee Structures
- Fund Performance vs Competitors
- Distributions Activities
- Disclosures
- Service Providers
- Governance Practices
- Media Coverage
- Three Core Focus Areas During Examinations:
- Compliance Programs
- Policies and procedures of Funds and their Service Providers.
- Effectiveness at addressing certain risks, such as those associated with the allocations of expenses.
- Fund Governance
- The processes and efficacy of Board Oversight.
- Are Boards getting information necessary?
- Do the Boards request relevant information to have a strong understanding of vital Fund issues including disclosure, fees, expenses, performance, conflicts of interest, etc.?
- The Investment Advisory Agreement Approval Process.
- Did the Board thoroughly review Fund fees for consistency with disclosures?
- Did the Board compare their Investment Advisory Agreement to other Agreements of similar clients or peer groups?
- The processes and efficacy of Board Oversight.
- Disclosure and Regulatory Reporting
- Disclosures in Regulatory Filings and Investor Communications must be consistent and appropriate based on:
- Fund Operations.
- Conflicts of Interest.
- Actual Portfolio Management Activities.
- Disclosures in Regulatory Filings and Investor Communications must be consistent and appropriate based on:
- Compliance Programs
- Common Staff Observations of Deficiencies
- Fund Compliance Programs failed to:
- Perform the required oversight or reviews as stated in their policies and procedures, and evaluate the overall effectiveness of their program.
- Examples include failing to conduct Annual Compliance Reviews, failing to document Annual Compliance Reports, and failing to review policies and procedures of Third-Party Vendors.
- Adopt, implement, update, and/or enforce their policies and procedures.
- Funds did not adopt or implement policies in compliance areas that are considered “critical areas”.
- Critical areas can include custody requirements, fee billing, derivatives and liquidity risk management, valuation of portfolio assets, portfolio management, shareholder complaints, distribution of fund shares, trade allocations and errors, affiliated transactions, execution capabilities of Broker-Dealers.
- Policies and procedures would not reasonably prevent violations of law, were not consistent with actual business practices, and/or were not tailored to the Funds’ business model.
- Code of Ethics were not adopted, implemented, followed, enforced, and/or adequate.
- CCOs did not provide written Annual Compliance Reports to the Fund Boards.
- Funds did not adopt or implement policies in compliance areas that are considered “critical areas”.
- Perform the required oversight or reviews as stated in their policies and procedures, and evaluate the overall effectiveness of their program.
- Fund Disclosures and Filings
- Important information contained incomplete, outdated, or potentially misleading statements affecting Fund Registration Statements, Fact Sheets, Annual Reports, and/or Semi-Annual Reports.
- Examples include omission of information regarding in-kind transactions, payments to affiliates in their prospectus, and disclosed investment processes.
- Sales literature appeared to contain untrue statements or omissions of material facts in violation of the Marketing Rule.
- Fund Filings were not made or were filed significantly late.
- Important information contained incomplete, outdated, or potentially misleading statements affecting Fund Registration Statements, Fact Sheets, Annual Reports, and/or Semi-Annual Reports.
- Fund Governance Practices
- Fund Board approvals of Advisory Agreements did not involve:
- A timely review of Advisory or Sub-Advisory Agreements.
- The requesting, obtaining, and/or consideration of important information to evaluate the Agreements before approval.
- Any consideration of material changes from previous Agreements.
- Fund Boards did not receive vital information to provide effective oversight.
- Fund Boards did not make certain required determinations and did not adopt policies and procedures required to address Fund operations such as Liquidity Risk Management, AML, and Rule 12b-1 Plans.
- Fund Board minutes did not fully document Board actions.
- Fund Board approvals of Advisory Agreements did not involve:
- Fund Compliance Programs failed to:
- Typical Initial Information Requested by Examiners by Topic
- Organizational and Operational Information
- General information for the Fund, including information regarding: Adviser(s) and affiliated entities; offices and operational locations; officers, employees, and supervised persons; committees; Service Providers, including Securities Lending Agents; other business arrangements; Fund Agreements, whether written or informal; and the uniform resource locater (URL) for the Fund’s and its associated Adviser’s websites.
- Organizational structure and information regarding each RIC and each portfolio thereunder that is being examined (e.g., Fund name, Edgar Series Identification, SEC Registration Number, Ticker Symbol, Sub-Advisers, current and former Portfolio Managers, total net assets and Net Asset Value (“NAV”) per share, portfolio turnover rate, commencement date of operations, portfolio classification, number of shareholders, and shares outstanding).
- Information regarding Fund shareholder complaints, threatened, pending or settled litigation, arbitration, or administrative proceedings involving the Funds, their Adviser(s), and affiliates.
- Filings and regulatory correspondence, including Prospectus and SAI, Shareholder Reports, No-Action Letters and Exemptive Relief relied upon by the Fund and/or its Adviser(s).
- ETF-specific information, such as Index Licensing Agreements, Exchange Notices, and related disclosures.
- Compliance Program
- Fund compliance policies and procedures and inventories of compliance risks, testing, and compliance exception reports.
- Reviews conducted regarding Fund compliance, including internal audit reports, Third-Party compliance reviews, and the annual reviews and reports by the Fund’s CCO under Investment Company Act Rule 38a-1 and annual reviews and reports by the CCO of the Funds’ Investment Adviser under Adviser Act Rule 206(4)-7.
- Information regarding tools or systems used to carry out compliance-related oversight functions and reporting, and compliance training or guidance provided to personnel.
- Information regarding due diligence on, and oversight of Service Providers.
- Portfolio Management and Trading
- Fund Trade Blotter (i.e., purchases and sales journal) and initial and month end positions for a specified period.
- Executing Broker-Dealers and commission/fees applicable to Fund trades.
- Information regarding Trade Allocation Practices, Best Execution, and trade errors.
- Soft dollar arrangements.
- Performance information, including comparable returns of Funds’ Prospectus benchmarks.
- Valuation
- Valuation policies and procedures of any Third-Party Providers (e.g., Third-Party Administrators) that are directly or indirectly involved in reviewing of valuations of the Funds’ portfolio holdings.
- Information detailed by asset class regarding reports and/or recommendations from Pricing Services, Quotation Services, Third-Party Valuation Firms, and externally acquired portfolio accounting systems used in the valuation process.
- Information regarding valuation processes (e.g., use of indicative bids for fair valuation, practices for comparing securities’ prices against prior day’s prices, review of securities’ prices against relevant market indices, use of data or models, changes in valuation methodologies).
- Valuation reports and recommendations provided by Third-Party Valuation Firms.
- Communications with Auditors, Third-Party Valuation Firms, or other Third Parties regarding valuations of the Funds’ portfolio holdings.
- Prices provided by a pricing Service or Third-Party Valuation Firm that were overridden or stale (e.g., prices for a given security have not changed over time).
- Conflicts of Interest
- Code of Ethics policies and procedures for the Fund and its Adviser(s), employee trading restricted lists, and corresponding attestations.
- Reports of securities transactions reported by access persons.
- Information related to revenue sharing arrangements, cross trading activities, and soft dollar commissions.
- Information regarding trade aggregation and allocation of trades among the Fund and the Adviser’s other client accounts.
- Fees and Expenses
- Information regarding any expense caps and fee waivers, including management fee waivers in whole or in part.
- Information regarding expenses of the Adviser, Sub-Adviser, or any of their affiliates that were reimbursed by a Fund and/or a Portfolio Company held by the Fund.
- Information regarding any direct or indirect compensation received by the Fund, its Adviser(s), any Sub-Adviser(s), or any of their affiliates from any of the Fund’s Service Providers.
- Fund Advertisements and Sales Literature
- Information regarding advertising materials and sales literature for the Fund, including newspapers, periodicals, television and radio ads, websites, Fund Fact Sheets, form letters, and Portfolio Manager commentaries.
- Fund Board Governance
- General information regarding Board Members and Board Committees (e.g., election, composition, independence, and compliance with Fund Governance requirements under the Investment Company Act).
- Calendar and agendas of the Board and Board Committee Meetings.
- Minutes and materials from meetings of the Board, the Independent Directors/Trustees of the Board, and Board Committees.
- Information about any claim(s) made by the Fund or an affiliate under the Fund’s Directors and Officers/Errors and Omissions Insurance Policies.
- Approval of the Investment Advisory Contract under Investment Company Act Section 15(c), including information regarding any expense caps and/or fee waivers.
- Selection of the Fund’s Auditors and matters related to an Audit of the Fund’s Financial Statements.
- Board’s oversight of the Fund’s Compliance Program, including review of Annual Report(s) provided the Fund’s CCO and its Adviser’s CCO.
- Information regarding Service Provider relationships and related information provided to the Board, including direct or indirect compensation received from Service Providers.
- Information provided to the Board for evaluation of Brokerage Arrangements and Best Execution, 12b-1 Plans, and Multi-Class Plans.
- Disclosures
- Prospectus, SAI, Annual Shareholder Report and Semi-Annual Report for the Fund (in PDF format). This includes Tailored Shareholder Reports that are now required for Mutual Funds and ETFs that are registered on Form N-1A (compliance date – July 24, 2024).
- Financial Records
- The Fund Adviser’s balance sheet, income statement, general ledger, and cash receipts and disbursements journal.
- Information about any Fund NAV errors.
- Organizational and Operational Information
Vigilant’s Conclusion
Funds should carefully use the information in this summary to evaluate the effectiveness of their compliance programs.
Vigilant provides tailored and end-to-end Compliance Solutions that includes an on-boarding gap analysis with a full analysis of your compliance program.
We also offer Mock SEC Exams, which have the potential to identify high risk areas and remediate prior to being examined.
Reach out to us today with any questions or concerns you have.