The SEC is increasingly active in reviewing investment adviser and investment company compliance and commenting on the types of policies and procedures that should exist and how they should operate. This guidance is largely informal and dynamic as the SEC’s views evolve in response to market events, regulatory and political pressure, and the development of new financial products. In response to these developments, investment advisers and investment companies need to ensure that their compliance programs and boardroom practices stay abreast of changes in the regulatory climate.
Compliance teams for investment companies and investment advisers should review compliance policies and board practices with fresh eyes by re-reading relevant statutes, rules, and other recent guidance to confirm that the language in the policies and procedures is accurate, comprehensive, and current. Here is a summary of some of the recent SEC developments to consider when reviewing compliance policies and board practices:
Division of Investment Management Guidance Updates
The Division of Investment Management issues “Guidance Updates” to set forth the Division's views on issues of interest. These updates are a window into the Staff's current thinking, both in terms of areas of focus as well as how they view particular issues.
- Compliance With Exemptive Orders. An investment company that relies on any exemptive order that contains conditions and representations should adopt policies and procedures specifically designed to facilitate compliance with the representations and conditions in the order.
- Risk Management in Changing Fixed Income Market Conditions. Fixed income managers should consider subjecting their portfolios to a “stress test” and monitor liquidity in market conditions where there are fewer market makers, and appropriately disclose liquidity risks to investors. Investment advisers and investment companies should review existing policies and procedures to more fully address liquidity risk.
- Guidance on the Testimonial Rule and Social Media. The interactive nature of social media raises concerns as to whether comments about an investment adviser on its website or through social media sites would constitute an impermissible “testimonial” in violation of the Investment Advisers Act. Investment advisers should review and update their policies and procedures to take into account the most recent SEC guidance.
- Cybersecurity Guidance. Investment advisers and investment companies may mitigate exposure to risks associated with cyber threats through compliance policies and procedures that are reasonably designed to prevent violations of the federal securities laws.
- Acceptance of Gifts and Entertainment by Fund Advisory Personnel. While many firms are satisfied that their current gifts and entertainment policies remain reasonably designed to protect against violations of federal securities laws, including Section 17(e) of the Investment Company Act, investment advisers and investment companies should understand how this guidance could impact their current practices regarding gifts and entertainment and make an informed decision on how to address the SEC’s concerns.
Enforcement Actions and Speeches
Another area of guidance is found in SEC enforcement actions and speeches, as they demonstrate current regulatory focus, and particular areas of interest or concern on the part of the SEC.
- Auditor Independence. Investment companies should ensure that their trustee and officer questionnaires expressly cover business relationships with the auditor’s affiliates, and provide sufficient training to assist the board members in the discharge of their responsibilities as to auditor independence.
- Broken Windows. The SEC is looking to hold deficient “gatekeepers” including boards of investment companies and auditors accountable for even small violations.
- Conflicts, Conflicts Everywhere. For investment companies, the SEC is taking a close look at the 15(c) process and compliance with issues regarding fund distribution, including compliance with Rule 12b-1. The SEC is also focused on the issue of conflicts by investment advisers and breaches of fiduciary duty. Investment companies and investment advisers must be sure to identify potential conflicts, disclose them to clients, including fund boards, and take steps to either eliminate or mitigate the conflicts.
Another area of guidance is found in SEC rule releases.
- Valuation Guidance. The SEC's adopting release to the new money market fund rules also contained guidance relating to valuation that went beyond money market funds with respect to the use of amortized cost for instruments that mature in less than 60 days and with respect to SEC expectations relating to the use of pricing services that provide evaluated prices for fixed income funds.
- Liquidity Risk Guidance. The SEC recently released a rule proposal on liquidity risk management for mutual funds and exchange-traded funds (ETFs). The rule proposal also contains guidance that the SEC has provided to help mutual funds and ETFs manage their liquidity risk.