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Published: Sep 19, 2020

Updated: Dec 8, 2023

OCIE Risk Alert Cautions Registered Funds to Address Deficiencies

By Andrew David Easler, Esq.

Published: Sep 19, 2020

Updated: Dec 8, 2023

Recently, the Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert listing the deficiencies and weaknesses found most often by the agency while examining registered investment companies (“funds”).[1] The Risk Alert also includes observations that focus on money market funds and target date funds.[2] According to the Risk Alert, the most common deficiencies and weaknesses are those related to the fund compliance rule, disclosure to investors, the board approval process involving advisory contracts, and the fund code of ethics rule.[3]

The Fund Compliance Rule

Under this rule, a fund is required to “adopt and implement written policies and procedures reasonably designed to prevent violations of the federal securities laws by the fund.”[4] The rule also requires that the fund board approve the policies and procedures of the fund’s service providers and annually review the adequacy and effectiveness of the policies and procedures. The most common deficiencies or weaknesses regarding the fund compliance rule are:

  • That funds’ compliance programs did not consider the nature of the business activities or risks specific to the fund;[5]

  • That funds did not follow or enforce their compliance policies and procedures;[6]

  • That funds did not “adopt and implement policies and procedures” to monitor compliance by service providers;[7]

  • That some funds did not “conduct annual reviews of their policies and procedures,” and others had so little documentation that it was unclear whether the reviews had been completed at all;[8] and

  • That certain funds conducted annual reviews but did not address how effective and adequate the fund’s policies and procedures were.[9]    

Disclosure to Investors

“The federal securities laws make it unlawful to make untrue statements of material fact or omit material information necessary to make other statements not misleading in registration statements, reports, and other documents filed with the Commission or otherwise provided to investors.”[10] The most common deficiencies or weaknesses observed involved:

  • Funds that provided “incomplete or potentially materially misleading information in their prospectuses, statements of information, or shareholder reports when compared to the funds’ actual activities.”[11]  

  • Some examples of incomplete or misleading information include not disclosing the payment of fees made to service providers and not disclosing changes to an investment strategy.[12]

1940 Act Section 15(c) Process

Section 15(c) “requires a majority of the fund’s independent directors to approve the fund initially entering into, or renewing, a contract or agreement with a person who undertakes regularly to serve or act as an investment adviser of or a principal underwriter for such fund.”[13] Among other considerations, board members of the fund have a duty to request and asses the information needed to evaluate the terms of the contract and to preserve the documents considered by the board when approving the terms or renewal of the contract.[14] The most common deficiencies or weaknesses involving the Section 15(c) process are:

  • That some fund boards may not have requested or considered information necessary to evaluate the fund’s investment advisory agreement, while others may have received incomplete information and did not request the missing information.[15]

  • That funds’ shareholder reports that did not “discuss adequately the material factors and conclusions that formed the basis for the board’s approval of an investment advisory contract”;[16] and

  • That, in some cases, the funds’ advisory contract review process did not comply with section 15(c).[17]

Fund Code of Ethics

The fund code of ethics requires funds and other entities “to adopt a written code of ethics containing provisions reasonably necessary to prevent their ‘access persons’ from engaging in fraudulent, deceptive, or manipulative acts in connection with the purchase and sale of securities held or to be acquired by the fund.”[18] The most common deficiencies and weaknesses related to the fund code of ethics rule are:

  • Funds that failed to implement procedures necessary to prevent violations of their codes of ethics or had procedures that were inadequate;[19]

  • Funds that failed to follow, enforce or “use reasonable diligence to prevent violations of their codes of ethics”;[20] and

  • Funds that failed to comply with their approval and reporting obligations.[21]

  • In addition, OCIE conducted an examination focusing on Money Market Funds (“MMF”) and Target Date Funds (“TDF”) and found some deficiencies and weaknesses as well.

Money Market Funds

  • When it comes to “eligible securities” and minimal credit risk determinations some MMFs did not maintain adequate records and in their credit files, did not include information required under Rule 2a-7;    

  • When it comes to “eligible securities” and minimal credit risk determinations some MMFs did not have policies and procedures that addressed, among other things, filling accurate and timely information with the Commission, and testing for issuer diversification to ensure that no more than 5% of the funds’ assets were invested in any one issuer.[22]   

  • Some MMFs provided stress test results that “did not include the required summary of significant assumptions used in the stress tests”;[23]

  • Some MMFs had not adopted and implemented policies and procedures to comply with Rule 2a-7;[24] and

  • MMFs did not disclose on their websites information required under Rule 2a-7 and/or the information was inaccurate.[25]

Target Date Funds

The OCIE noted that most of the TDF’s were following the 1940 Act in the areas reviewed, but there were still some deficiencies and weaknesses related to their disclosures and compliance programs.[26] “Some TDS had incomplete and potentially misleading disclosures in their prospectuses and advertisements.”[27] For example, some information in the TDFs marketing materials was different than the TDFs’ prospectus disclosures.[28] In addition, TDFs had incomplete or missing policies and procedures.[29] Some of the missing or incomplete policies and procedures involved monitoring asset allocations and overseeing advertisements and sales literature.[30]   

The key takeaway from this risk alert is that boards of funds need to take a more active role in ensuring compliance with securities regulations. In particular, to avoid non-compliance, funds should review the fund compliance rule, expand disclosure to investors,  improve the board approval process involving advisory contracts, and ensure the thorough implementation of the fund code of ethics rule.


References:

[1] Top Compliance Topics Observed in Examinations of Investment Companies and Observation from Money Market Fund and Target Date Fund Initiatives, Office Compliance Inspection & Examinations (Nov. 7, 2019), https://www.sec.gov/files/Risk%20Alert%20-%20Money%20Market%20Fund%20and%20Target%20Date%20Fund%20Initiatives.pdf [hereinafter Top Compliance Topics]. 2] Id. [3] Id. [4] Id. [5] Id. at 5. [6] Top Compliance Topics, supra note 1, at 5. [7] Id. [8] Id. [9] Id. [10] Id. at 3. [11] Top Compliance Topics, supra note 1, at 3. [12] Id. [13] Id. [14] Id. [15] Id. [16] Top Compliance Topics, supra note 1, at 3. [17] Id. at 3-4. [18] Id. at 4. [19] Id. [20] Id. [21] Top Compliance Topics, supra note 1, at 4. [22] Id. at 5. [23] Id. [24] Id. at 6. [25] Top Compliance Topics, supra note 1, at 6. [26] Id. [27] Id. [28] Id. at 7. [29] Id. [30] Top Compliance Topics, supra note 1, at 7.  

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A real estate attorney specializes in property law, helping clients navigate the complexities of buying, selling, and managing real estate, ensuring that transactions comply with state laws and regulations, and providing protection and peace of mind.

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Attorneys who practice business law provide legal advice for starting, managing, and expanding businesses, ensuring compliance with applicable laws. Their expertise covers various duties, including drafting and reviewing contracts, advising on corporate governance, facilitating business transactions such as mergers and acquisitions, forming partnerships, LLCs, and other business entities like DBAs, drafting and reviewing LLC Operating Agreements, and assisting with strategic planning.

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Probate attorneys actively manage the estate administration process following an individual's death, ensuring the distribution of assets aligns with the will or state law, and handle Formal Probate Administration for complex cases, Summary Administration for smaller estates, and Ancillary Administration for assets in other states.

Responsibilities of probate attorneys include filing petitions, appointing personal representatives to manage estate affairs, notifying interested parties to ensure transparency and prevent disputes, helping conduct an inventory and appraisal of the estate's assets, overseeing the payment of debts and expenses, handling probate litigation to resolve any disputes that arise.

They also assist in distributing the assets and formally closing the estate, ensuring all legal and financial responsibilities are met, simplifying the complex probate process, honoring the decedent's wishes, and providing clarity and support to the beneficiaries.

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Wills & Trusts

Will and trust attorneys help draft legal documents to ensure their clients' wishes for asset distribution are executed correctly. They draft personalized and legally compliant wills to designate beneficiaries, appoint executors, and establish trusts for asset management and distribution. It is important to note that wills and trusts are an integral part of the estate planning process.

Responsibilities of wills and trust attorneys include providing legal advice and guidance related to asset protection, minimizing tax obligations, facilitating efficient wealth transfer to designated heirs, offering advice on appointing guardians for minor children, and drafting healthcare directives for unforeseen circumstances.

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Estate Planning

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Experienced attorneys offer personalized legal advice, tailoring strategies to meet individual client needs, and assist clients in navigating complex laws and regulations affecting asset management, taxation, and inheritance.

End-of-life planning safeguards wealth and secures a lasting legacy for heirs and charitable causes. Whether estates are modest or substantial, these plans provide invaluable peace of mind and financial security for future generations.

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Civil litigation attorneys manage disputes and represent their clients effectively with various legal matters and issues. They provide clear legal advice and handle all aspects of a case, from preparing documents to gathering evidence and preparing for trial. They also offer guidance and experience to help clients navigate the legal system efficiently, ensuring that cases are managed effectively and lead to timely outcomes.

Civil litigators are also skilled negotiators, often resolving disputes outside of court to save time and maintain relationships, which is particularly vital in business and probate matters.

When trials are necessary, they present and argue cases effectively to minimize losses and secure favorable outcomes. They offer continuous support and guidance throughout the litigation process, simplifying complex legal issues for their clients in both personal and business contexts.

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