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SEC Identifies Compliance Deficiencies in the Registered Fund Space

Nov 30, 2021

On October 26, 2021, the Division of Examinations (the Division) of the SEC released a risk alert (the “Risk Alert”) of its observations relating to the examinations of mutual funds and exchanged-traded funds (collectively, the “Funds”). 

The Risk Alert was intended to highlight risk areas and assist funds and their advisors in developing and/or enhancing their compliance programs and practices. This Risk Alert should be utilized by funds, their advisors and their boards as a useful tool in underscoring certain areas that may be lacking in their compliance programs or current practices and procedures. The Risk Alert contained a fairly detailed list of areas where deficiencies or weaknesses were observed. The SEC found that funds and their advisors failed to establish, maintain, update, follow or appropriately tailor their compliance programs to address various business practices in numerous areas. Below is a short list of some of the areas highlighted in the Risk Alert:

  • Monitoring for adherence to a fund’s specific investment restrictions.
  • Monitoring for compliance with the “Fund Names Rule” (Rule 35d-1), where applicable.
  • Providing oversight of the viability of smaller and/or thinly traded ETFs, including oversight of their liquidation.
  • Monitoring compliance with trade aggregation, trade allocation and best execution, senior securities and asset segregation.
  • Monitoring for specific investment risks such as asset classes presenting certain operational or other risks.
  • Processes for providing due diligence and oversight of pricing vendors.
  • Providing oversight of third-party vendors providing liquidity classifications of investments for purposes of a fund’s liquidity risk management program.
  • Maintaining policies, procedures and controls over valuation of securities including provisions addressing any potential conflicts of interest.
  • Procedures over trade allocations among client accounts, cross trading, prohibited transactions and sharing of soft dollar commissions.
  • Expense allocations between funds and their advisor and the review of fee calculations.
  • Compliance over the review of fund advertisements and sales literature. The Division also observed inaccurate, incomplete or omitted disclosures relating to a wide range of advertising and sales literature-related topics.
  • Providing appropriate processes to ensure boards do not receive incomplete or inaccurate information.
  • Incomplete, inaccurate or omitted disclosures in fund filings, such as Form N-1A.

The Risk Alert contains more details than the summarized topics above so it would be a worthwhile read for all fund advisors, officers and board members.

The Office of Compliance Inspections and Examinations (OCIE) announced back in November 2018 that it would be conducting a series of examination initiatives focused on mutual funds and exchange-traded funds (ETFs) to assess industry practices and regulatory compliance in certain areas that may have an impact on retail investors (the “RIC Initiative”). The six examination focus areas of the funds and/or their investment advisors were as follows:

  1. Index funds that track custom-built indices.
  2. Smaller ETFs and/or ETFs with little secondary market trading volume.
  3. Mutual funds with higher allocations to certain securitized assets.
  4. Funds with aberrational underperformance relative to their peer groups.
  5. Advisors relatively new to managing mutual funds.
  6. Advisors who provide advice to both mutual funds and private funds that have similar strategies and/or are managed by the same portfolio managers.

The RIC Initiative included the examination of more than 50 fund complexes which encompassed over 200 funds and/or series of funds and approximately 100 investment advisors. The RIC Initiative did reveal numerous deficiencies or weaknesses related to funds and their advisor’s compliance programs, as well as board oversight of the funds’ compliance programs. Some firms received deficiency letters relating to the Division’s findings. The observations derived from the RIC Initiative were summarized and disclosed in the Risk Alert.

Although the Risk Alert painted a bleak picture of the compliance programs and practices of the funds, all is not lost as the SEC staff also observed compliance and disclosure practices that certain funds and their advisors had implemented that others should find helpful in designing and implementing their compliance programs. Below is a sample of these observations:

  • Reviewed compliance policies and procedures for consistency with practices.
  • Conducted periodic testing and reviews for compliance with disclosures, such as reviewing whether funds are complying with their stated investment objectives, strategies or restrictions and assessing procedures in place to address potential conflicts of interests.
  • Compliance programs that adequately address the oversight of key vendors, such as pricing vendors.
  • Fund boards were assessing whether funds were adhering to their processes for fund reporting, including an annual review of the funds’ compliance programs as well as assessing the accuracy and completeness of the information provided to the board, such as fund fees, expenses and performance as well as the funds’ investment strategies, risks associated with the strategies and any changes to the strategies.
  • Funds adopted and implemented policies and procedures regarding disclosures relating to:
    • A review of disclosures in funds’ prospectuses and other reports consistent with the funds’ investment policies and restrictions or actions taken by the funds’ boards.
    • Update of funds’ website disclosures for consistency with the funds’ prospectuses and other reports.
    • Review and testing of fees and expenses disclosed in the funds’ prospectuses and other reports.
    • Review and testing of funds’ performance advertising for accuracy and appropriateness of presentation, as well as the applicable disclosures.


It’s probably a safe bet that the Division  will be scrutinizing the specific areas where they pointed out deficiencies on mutual funds and ETFs in examinations going forward so it would be in the best interest of funds, advisors and boards to review their existing compliance programs and policies to determine if they adequately address the observations raised in this Risk Alert.

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Frank Attalla

Frank Attalla is a Partner in the Financial Services Group, with over 30 years of experience in the field of public accounting and 20 years focused in the financial services sector.

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