On November 4, the Securities and Exchange Commission's (SEC) Division of Examinations (Division) published an analysis of the most common deficiencies identified across its three core registered investment company (RIC) examination areas: effectiveness of compliance programs, accuracy of disclosures and adherence to good corporate governance practices. Many of the deficiencies relate to failures by RICs to adhere to or implement compliance policies, correctly complete necessary disclosure filings, or ensure that boards fulfill their responsibilities under the Investment Company Act of 1940 (Investment Company Act) or a respective RIC's compliance program. The Division's analysis provides a valuable guidepost for RICs and investment advisers to determine how better to prepare themselves in the event of an examination.
To conduct this analysis, the Division reviewed deficiency letters sent to RICs over the last four years and observed certain patterns in each core RIC examination area. The most common weaknesses in each of the three core RIC examination areas are summarized below:
- Compliance Programs. When examining RICs from a compliance perspective, the Division noted that many RICs did not have compliance programs in place to ensure that federal securities laws were being adhered to, particularly with respect to proper valuation of assets, effective derivatives and liquidity risk management programs and broker-dealer execution capabilities. Of the RICs that did have compliance programs in place, many did not adhere to the required compliance reviews outlined in their compliance programs or did not narrowly tailor their compliance procedures to the most relevant risks associated with their respective investment model. The Division also noted many instances of RICs not adopting or properly complying with codes of ethics, resulting in risks of unreported conflicted transactions or non-reporting of covered trades or trades in restricted securities by certain access persons. Finally, the Division identified instances of certain RICs not appointing a chief compliance officer (CCO) or CCOs not adequately informing RIC boards of compliance risks by transmitting written annual compliance reports as further examples of RICs' failure to adhere to compliance procedures properly.
- Regulatory Disclosure. When analyzing RIC disclosure and filing procedures, the Division found many necessary disclosure documents, including registration statements, fact sheets and annual reports, to be incomplete, filed in an untimely manner, not filed at all or filed with information that could potentially be misleading. The Division further noted that advertising information issued by RICs oftentimes included untrue statements or omissions of material fact. In particular, the improper reporting of the role environmental, social and governance factors played in a RIC's investment decision-making process was identified by the Division as an example of untrue or misleading information contained in advertising material.
- Corporate Governance. The Division's review of good corporate governance from a RIC perspective focused on how effectively RIC boards were organized to oversee RIC activities both substantively and procedurally. Substantively, the Division noted instances of RIC boards not adhering to compliance program procedures or Investment Company Act regulations as examples of RICs' failure to instill good corporate governance. Procedurally, many RIC boards either did not perform their necessary responsibilities by adopting written policies and procedures specifically tailored to their respective RIC's business model or by not fully memorializing significant board actions, such as approval of liquidity risk management programs or advisory agreements. In other cases, RIC boards were not provided with the relevant information necessary to carry out their duties to RICs, which also resulted in a failure to promote good corporate governance. The Division identified RICs' failure to notify boards of information related to illiquid investments and compliance program changes as examples of relevant information that had not been provided to boards.
The above weaknesses noted by the Division provide a helpful metric for RICs and investment advisers to assess their likelihood of adherence to these three core areas in the event of an examination. In order to further provide guidance to market participants on this topic, the Division also included a useful attachment at the end of its analysis outlining the documents that the Division typically requests for review in an examination. This attachment includes organizational and operational information that the Division generally requests, such as information on the RIC's adviser(s) and affiliated entities, shareholder complaints and any pending or settled litigation. Also included are valuation policies and procedures, compliance program information, conflicts of interest policies and RIC financial information that the Division typically requests during an examination. Accordingly, RICs and investment advisers may utilize this information as an informative compliance tool.
The entire SEC Division of Examinations Risk Alert is available here.
Washington, DC
