On Nov. 7, 2019, the Office of Compliance Inspections and Examinations of the Securities and Exchange Commission released a Risk Alert outlining common compliance observations among investment companies, money market funds, and target date funds. The alert outlines general weaknesses and deficiencies that OCIE staff noticed during recent examinations.
Investment Company Compliance
OCIE examined more than 300 funds over the period of two years. In this Risk Alert, OCIE focuses on weaknesses observed regarding the fund compliance rule, disclosure, the board approval of advisory contracts, and the fund code of ethics rule.
The fund compliance rule requires that a fund have policies and procedures in place “designed to prevent violations of the federal securities laws by the fund,” including measures to designed oversee service provider compliance. Other requirements of the rule state that policies and procedures must be approved by the fund board and that an annual review must occur, among other things. Examiners identified several common compliance issues with the rule:
- Specific fund business activities were not considered in policies and procedures; for example, some funds did not have provisions in place to ensure that advertisements were not misleading
- Policies and procedures were in place, but not enforced
- No due diligence process was in place to ensure ongoing compliance of third-party vendors
- Annual review of policies and procedures was not performed, or documentation did not exist to prove an annual review was completed
With regard to disclosure to investors, some funds provided incomplete or misleading information in fund documents. For example, some funds failed to disclose payments to vendors or did not explain changes to an investment strategy when required.
Some funds were observed to have deficiencies or weaknesses in their Section 15(c) process. The provision requires independent directors of a fund to approve contracts and agreements entered into with investment advisers or principal underwriters. In order to approve these contracts, board members must request and review information about the adviser’s contract, as outlined in the 1940 Act. At times, funds neglected to request the information necessary to evaluate an adviser. In other cases, board members did not properly discuss adviser contracts before approving the agreement.
Funds are required to adopt and implement a code of ethics to ensure access persons cannot commit any fraudulent, deceptive, or manipulative acts related to securities of the fund. Several common deficiencies were observed by OCIE. In some cases, funds did not have procedures in place to ensure the code of ethics was being followed; for example, some companies did not appoint a separate access person to assess the CCO’s personal securities holdings and transactions. At times, a code of ethics was put in place, but not properly enforced. Some fund boards had gaps in the code of ethics approval process at the outset, or reviewed incorrect reports of code violations.
The exam initiatives affecting MMFs and TDFs were designed to evaluate possible risks to retail investors and those saving for retirement.
Money Market Fund Exam Observations
Since amendments were made to MMF rules in Oct. 2016, OCIE examined over 70 funds to assess compliance with the new provisions. Though MMFs were found to generally be in compliance, several common deficiencies were found.
Regarding “eligible securities” and minimal credit risk determinations, examiners found that some funds provided inadequate information in credit files or did not complete periodic updates of the files. Some MMFs were found to exclude the summary of significant stress test assumptions, which is required under the rule.
Other MMFs did not have policies and procedures in place to ensure compliance with the rule. For example, some funds did not address the requirement to limit Retail MMF investors to natural persons or made no mention of form filing deadlines in policies and procedures. Among some funds, insufficient or inaccurate information was published on websites.
Target Date Fund Exam Observations
OCIE examined more than 30 TDFs to measure whether information in prospectuses and fund disclosures were consistent with actual fund practices. Like MMFs, TDFs were generally observed to be in compliance, but a few deficiencies were noticed among the funds.
Some TDFs included disclosures in prospectuses or marketing materials which could be misleading; for example, some funds had asset allocation information that was mismatched between documents or did not properly disclose potential conflicts of interest. In addition, examiners found that many TDFs had lacking policies and procedures, including those for tracking asset allocation or for moderating disclosures on marketing materials.
WHAT DOES THIS MEAN FOR ME?
If your firm or company is subject to any of the aforementioned rules, make sure to take OCIE’s guidance seriously. This Risk Alert makes mention of many compliance issues with writing, adopting, and implementing compliant policies and procedures and conducting proper vendor management.
Fairview Investment Services is here to manage maintenance of your firm’s compliance policies and procedures and code of ethics. Fairview Cyber is available to assist with vendor management and can conduct due diligence reviews of your third-party service providers. Reach out to Fairview with questions about how this Risk Alert may affect your firm.