SEC Risk Alert Issued on Fund Exam Findings

The SEC’s Division of Examinations (formerly known as OCIE) has issued a new Risk Alert (the “Alert”) on findings from fund examinations over the past few years. The Alert covers examination weaknesses and best practices discovered from the Division’s inspections of over 50 fund complexes, 200 funds and close to 100 advisers since late 2018. The fund exams focused on policies and procedures, investor disclosures, and fund governance issues. While the focus of the Alert is primarily investment companies, some findings from the exams are also relevant for advisers.

The Alert first discussed deficiencies identified, such as:

  • Boiler plate or incomplete written policies and procedures
  • Lack of portfolio monitoring for proper trade allocations, best execution, senior security holdings/asset segregation (Section 18f), and generally weak investment and portfolio oversight
  • Valuation problems that ranged from poor controls over pricing vendor issues to allowing too much input from portfolio managers which caused conflicts
  • Unfair trade allocations, use of prohibited transactions, soft dollar conflicts
  • Particular conflicts between index providers and index fund managers when the two entities were affiliated
  • Missteps regarding fund expense allocations and fee calculations
  • Misleading marketing and advertising materials through the improper use of back-tested index returns
  • Failures to provide accurate information to fund boards
  • Lack of adequate due diligence when conducting Section 15(c) adviser reviews
  • Ineffective Rule 38a-1 practices and reports

Disclosures in marketing materials and fund filings were especially highlighted in the Alert. The list of filing concerns included:

  • The omission of material information in marketing materials (as to deem them misleading)
  • Inaccurate disclosure around funds’ NAV, expense ratios, and expense limitations
  • Fund SAI’s with poor disclosures and missing information as required
  • Generally, some funds did not comply with the various current SEC no-action letters regarding the use of predecessor performance, overall performance disclaimers and disclosures, touting restrictions, and use of benchmarks

The SEC went on to cover certain findings that represented industry best practices, such as:

  • Written policies and procedures that matched actual fund practices
  • Funds that conducted periodic testing and reviews for compliance and adherence to fund policies; specifically, fees and expenses (as disclosed in prospectuses) and performance advertising review and testing
  • Compliance programs that included oversight of key fund vendors
  • Policies that covered various conflicts of interest between fund related parties and/or advisers
  • Compliance programs that covered specific requirements needed to rely upon exemptive orders
  • Board materials that included complete and accurate disclosures on fund fees, expenses, and performance
  • Evidence of board reporting to prove adequacy of the funds’ compliance program in accordance with Rule 38a-1
  • Written policies for the review and amendment of prospectuses, SAIs, shareholder reports and other required fund disclosures
  • Review and update of funds’ website at the same time as other disclosure updates

While this Alert covered activity as performed under the previous SEC administration, the fact that the current administration still released the exam findings shows that they are applicable to the industry today. The SEC expects funds and advisers to follow the best practice guidelines and to beware of the pitfalls as described in the Alert.

View Risk Alert, “Observations from Examinations in the Registered Investment Company Initiatives,” October 26, 2021