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SEC Issues FAQs on Liquidity Risk Management Rule

The staff of the SEC’s Division of Investment Management has released FAQs for the new Liquidity Risk Management Rule for open-end funds and ETFs (Rule 22e-4).  Most significantly, the staff will allow funds to delegate liquidity program responsibilities to a sub-adviser either in whole or in part “subject to appropriate oversight” including relevant policies and procedures.  The staff also clarifies that the same investment may carry different liquidity classifications by different advisers or funds, provided the liquidity program properly supports the classification.  The FAQs address several technical issues for in-kind ETFs.

OUR TAKE: Many industry participants acknowledged the broad policy goals of the liquidity rule but questioned the rule’s practical implementation.  The FAQs help that process by addressing some of the outstanding questions.

https://www.sec.gov/investment/investment-company-liquidity-risk-management-programs-faq

Wrap Sponsor Failed to Update Compliance Policies for Lower Share Classes

The IA/BD subsidiary of a large bank agreed to pay almost $1.3 Million in disgorgement and a $1.1 Million fine for putting wrap fee clients in funds that paid a 12b-1 fee back to the selling reps.  The SEC faults the firm for failing to recommend that clients move assets into lower-fee share classes as those classes became available over time.  Although the firm disclosed that it may receive 12b-1 fees, it did not disclose that it actually received those fees and that lower classes were available.  The SEC noted that the IA/BD made changes to qualified accounts but failed to implement similar changes to non-qualified accounts.  In addition to best execution, fiduciary, and disclosure violations, the SEC criticized the firm’s compliance program because the respondent failed to update its compliance policies and procedures as institutional share classes became available.

OUR TAKE: A compliance program is not a static exercise that you can set and forget.  As the markets and the business changes, firms must continuously review policies and procedures to determine if they still make sense given new realities.   In this case, the wider availability of institutional share classes necessitated changes to the firm’s compliance practices.

https://www.sec.gov/litigation/admin/2017/34-81611.pdf

RIA Did Not Offer Lowest Share Class Available

An RIA was censured and agreed to pay disgorgement for failing to offer the lowest-fee mutual fund share classes available and failing to adequately disclose compensation paid to its affiliated broker-dealer.  The RIA recommended third party mutual funds to 403(b) and IRA clients, who directed the investments.  The SEC faults the respondent for recommending Class A shares that paid 12b-1 fess to its affiliated broker and failing to make available lower-fee institutional shares.  The SEC also cites the insufficiency of various disclosures that generally discussed payment of 12b-1 fees but failed to specifically explain that an affiliate would receive the trailers.  The SEC charges the RIA with violations of the compliance rule (206(4)-7) for failing to adopt and implement adequate policies and procedures around conflicts of interest, disclosure, and mutual fund share class selection.

OUR TAKE: We believe that the SEC wants advisers to offer the lowest share class available and refrain from accepting any form of revenue sharing compensation.  We think that the SEC will find inadequate even the most robust disclosures and procedures because of the inherent conflict of interest.

https://www.sec.gov/litigation/admin/2017/ia-4764.pdf