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OCIE Announces Risk-Based Sweep Exam of Funds, ETFs and Advisers

On November 8, 2018, the SEC’s Office of Compliance Inspections and Examinations (OCIE) published a risk alert announcing a series of risk-based examination initiatives focused on mutual funds, ETFs and advisers to assess industry practices and regulatory compliance in specific areas that the staff believes may have an impact on retail investors. The Risk Alert states that the sweep exam will focus on funds and/or advisers that fall into one or more of the following categories:

• Index funds that track custom-built or bespoke indexes. OCIE will seek to assess the risks and challenges associated with an index provider constructing and maintaining an index for a single fund or sponsor that may allow for a more complex or targeted investment strategy than traditional index funds. OCIE will seek to understand the roles of the adviser and index provider in selecting and weighting index components and ongoing index administration and will assess whether any conflicts of interest are appropriately addressed. OCIE will also review portfolio management practices for consistency with fund disclosures and will assess the adequacy of disclosures to the fund board about the services provided by index providers.

Smaller or thinly traded ETFs. OCIE will evaluate the adequacy of investment risk disclosures to investors concerning smaller or thinly traded ETFs, including the potential for a rapid decline in the ETF’s market price or an exchange delisting and risks relating to liquidating an ETF, including costs to investors. OCIE will also assess whether board oversight incorporates an ETF’s ability to continue as an ongoing concern and whether tracking error is effectively monitored.

Funds with aberrational underperformance relative to their peer groups. OCIE will seek to understand the reasons for a fund’s “aberrational underperformance” relative to its peer group, including asset allocation and security selection. In assessing fund compliance programs, OCIE will focus on portfolio management processes and consistency with disclosed investment objectives and strategies, as well as the accuracy and completeness of marketing materials, the allocation of investment opportunities and adherence to applicable leverage requirements.

• Mutual funds with higher allocations to certain securitized assets. OCIE will assess whether mutual funds investing in certain securitized assets, such as securitized auto loans, student loans, credit card receivables or mortgage-backed securities, or their advisers, have appropriate policies and procedures, and related oversight processes, specifically those addressing portfolio management activities and investment risks. OCIE will also evaluate valuation and pricing policies and procedures related to these investments.

• Side-by-side management of mutual funds and private funds with similar strategies and/or common portfolio managers. OCIE will assess advisers’ policies and procedures for addressing conflicts of interest and other risks associated with side-by-side management, including those related to portfolio management practices. In addition to practices related to the allocation of investment opportunities, OCIE will review allocation practices for various fees and expenses and disclosures to investors and fund boards.

Funds managed by advisers that are relatively new to managing registered investment companies. For these funds, OCIE will evaluate fund governance to ensure that boards are provided with sufficient information to perform their duties, the effectiveness of advisers’ and funds’ compliance programs and marketing and distribution efforts.

OCIE’s announcement and a link to the risk alert are available at: https://www.sec.gov/ocie/announcement/ocie-riskalert-registered-investme...

© 2019 Vedder Price


About this Author

Vedder Price P.C. attorneys provide a full range of services to a diverse financial services clientele. Attorneys practicing in the firm’s Investment Services Group are experienced in all aspects of investment company and investment adviser securities regulations, broker-dealer regulatory and compliance matters, derivatives and financial product matters, and ERISA and tax matters. Clients include mutual fund complexes, hedge and other private funds, money managers, broker-dealers, independent directors, and many other types of institutions such as banks, savings and loans,...