The SEC’s Office of Compliance Inspections and Examinations has announced a sweep of certain mutual funds and ETFs. The OCIE staff will target smaller ETFs and funds/ETFs that use custom indexes, allocate to securitized assets, exhibit aberrational underperformance, or employ inexperienced managers or private fund sponsors that manage a similar mutual fund. The SEC will assess compliance policies and procedures and fund oversight of risks and conflicts, disclosures to shareholders and the Board, and oversight processes. Among some of the issues of concern to the OCIE staff include bid/ask spreads for secondary market trading of smaller ETFs, portfolio management for underperforming funds, the effect of unexpected market stresses on securitized assets, and side-by-side allocations for private and public funds. OCIE is encouraging fund sponsors and boards “to consider improvements in their supervisory, oversight, and compliance programs.”
Compli-pros and fund lawyers should mobilize to review policies and procedures for affected advisers and boards, consult about changes, and implement enhanced oversight and processes. We recommend taking action before the OCIE staff arrives for its examination.
The SEC fined a large IA/BD $8 Million because it failed to implement compliance policies and procedures for the sale of single-inverse ETFs. Following warnings from FINRA and SEC OCIE staff, the respondent adopted policies and procedures requiring (i) every client to sign a Client Disclosure Notice and (ii) a supervisor to review all recommendations for suitability. However, over a 5-year period thereafter, the SEC maintains that 44% of clients did not sign a Disclosure Notice and most did not undergo adequate supervisory reviews. Consequently, the firm made several unsuitable recommendations including to retirement account clients. The SEC cites violations of the Adviser’s Act’s compliance rule (206(4)-7), which requires advisers to adopt and implement policies and procedures reasonably designed to ensure compliance with the Advisers Act.
OUR TAKE: The SEC will severely punish recidivists who were notified of deficiencies during a prior exam. In this case, the IA/BD specifically undertook to fix the identified suitability concerns but failed to implement those policies, thereby allowing the violative conduct to continue.