SEC Sets Clear Expectations Regarding Registered Investment Companies’ Compliance Programs

SEC Sets Clear Expectations Regarding Registered Investment Companies’ Compliance Programs

Chief Compliance Officers, Trustees and Service Providers to registered investment companies (RICs) be fair warned … the SEC’s Office of Compliance Inspections and Examinations (OCIE) has issued a Risk Alert identifying the most common deficiencies identified in examinations of RICs and providing observations with respect to money market funds and target date funds.

With respect to RICs, OCIE identified the most commonly cited deficiencies and weaknesses observed during 300 fund examinations over a two-year period. The most common deficiencies fell into the following categories: the compliance program rule for funds, fund disclosures, the 15(c) approval process, and the code of ethics rule.

But before we discuss the specifics of the Risk Alert, let’s consider that the real message isn’t just one or more deficiencies. The deficiencies cited by OCIE suggest one overarching theme: If you are going to sponsor, advise or act as a fiduciary to a RIC, you need to know the regulatory requirements for RICs and ensure that they are part of a fund’s compliance program and evaluated no less frequently than annually.  Here, CSS provides these thoughts on avoiding such pitfalls.

OCIE’s Top Compliance Observations
 Fund Compliance Rule (Rule 38a-1 of the Investment Company Act of 1940, as amended)

SEC Observation: Compliance programs did not address the nature of the funds’ business activities. Examples include valuation and pricing methods for all the instruments traded by the funds or procedures for investment guideline monitoring.

CSS Perspective: One size does not fit all. Funds’ policies and procedures should be customized to address the funds’ operations and activities. They should also be reviewed at least annually to assess whether they continue to address all of a fund’s operations and regulatory requirements.


SEC Observation: Policies and procedures not followed or enforced.

CSS Perspective: Do what you say and say what you do. This motto is as true for investment companies as it is for people. Funds either need to follow and/or enforce their written policies or revise them to reflect what a fund is actually doing related to a particular activity. Having a written policy that is not being followed can be worse than not having a policy.


SEC Observation: Inadequate service provider oversight.

CSS Perspective: Funds outsource nearly all of their activities to service providers. As such, the compliance program must include a comprehensive program for monitoring service providers’ activities and verifying that they are fulfilling their obligations to the funds. The oversight can be accomplished through any combination of attestations, certifications, requests for information, periodic status meetings and/or annual onsite reviews. It should also be documented. Issues that are identified should be escalated to the appropriate party, such as an audit committee or fund board. CCOs should utilize subject matter experts from a fund’s adviser or other resources in the oversight process to assist with evaluating a service provider’s controls.


SEC Observation: Annual reviews were not performed or did not address the adequacy of the fund’s policies and procedures.

CSS Perspective: Rule 38a-1 clearly defines the obligation of a fund’s CCO to provide a written report to the fund’s board no less frequently than annually that addresses:

    • the operation of the policies and procedures of the fund and each investment adviser, principal underwriter, administrator and transfer agent;
    • any materials changes made those policies and procedures since the date of the last report;
    • any materials changes to the policies and procedures recommended as a result of the last review; and
    • each material compliance matter.

It is the responsibility of a fund’s CCO to provide a written report to a fund’s board and a fund’s board responsibility to require that it is provided.


Disclosure to Investors

SEC Observation: Funds provided incomplete or potentially materially misleading information in the fund’s disclosure documents, such as the prospectus, SAI and shareholder reports.

CSS Perspective: Disclosure is at the heart of communicating to investors. The completeness and accuracy of a fund’s disclosure documents needs to be reviewed thoroughly by legal, compliance, operations and marketing personnel.  The review must consider whether a fund’s operations have changed so as to require additional disclosure, particularly relating to fees, expenses and conflicts of interests, or deletion of outdated information.

The review of certain disclosure documents often requires numerous drafts and revisions. In order to allow time for meaningful reviews, the review dates should be included on a fund’s compliance calendar.


Section 15(c) Process

SEC Observation: Reasonably necessary information not requested or considered. The staff observed that certain fund boards did not request information relevant to the adviser while other boards received incomplete information.

CSS Perspective:  Most RICs have fund legal counsel and often a board’s independent trustees have their own legal counsel. Fund boards should seek the advice of counsel respecting their 15(c) obligation and request that it is documented in a memorandum that is reviewed annually by the board in connection with a 15(c) review. Counsel should review the minutes of fund meetings at which the 15(c) review is conducted to verify that the minutes and related resolutions reflect that all 15(c) elements have been considered.


SEC Observation: Inadequate discussion forming the basis for board approval.

CSS Perspective: Counsel should review the minutes of fund meetings at which the 15(c) review is conducted to verify that the minutes and related resolutions reflect that all 15(c) elements have been considered.


Fund Code of Ethics

SEC Observation: Failure to implement code of ethics.

CSS Perspective: Rule 17j-1 requires every fund (other than a money market fund) and each investment adviser and principal underwriter to adopt a written code of ethics. A fund’s compliance program should include regulatory requirements; thus, the implementation of a fund’s code should be a component of its compliance program and reviewed no less frequently than annually.


SEC Observation: Failure to follow or enforce code of ethics.

CSS Perspective: As with any written policy, there must be a mechanism for administering the policy. Fund CCOs need to implement procedures for monitoring compliance with the Rule and process. The administration of the code of ethics should be documented to evidence that the policy has been implemented and is being followed.


SEC Observation: Code of ethics approval and reporting.

CSS Perspective: Similar to a Rule 15(c) process, a fund’s board needs to be aware of its responsibilities to a fund, including what items require review and approval. Fund or trustee counsel can assist a board with fulfilling its obligations by conducting board training and verifying that fund agendas include all the items required to be reviewed and approved by trustees. A fund’s CCO can also assist by incorporating such requirements into the 38a-1 compliance program review.


As noted, the Risk Alert also offered observations on money market funds (MMFs) and target date funds (TDFs). The Staff found MMFs to be in substantial compliance with the October 2016 amendments to MMF rules. Areas where deficiencies were observed included: eligible securities and minimal credit risk determinations; summary of significant stress testing assumptions; failure to adopt 2a-7 policies and procedures; and inaccurate or insufficient disclosure on websites and advertising materials. The Staff also observed the following deficiencies pertaining to TDFs: incomplete or misleading disclosure in prospectuses and advertisements; and incomplete or missing policies and procedures.

CSS Final Perspective: Be knowledgeable about the regulatory requirements for all types of RICs; develop and implement a compliance program that incorporates such requirements; and monitor and periodically assess that the requirements are being followed. Finally, never be afraid to reach out for assistance. If you need help, contact us.