On June 19, 2007, the staff of the Office of Compliance Inspections and Examinations of the Securities and Exchange Commission (“SEC”) introduced a new “Compliance Alert” publication (the “SEC Alert”) directed at investment advisers, investment companies and broker-dealers. The first SEC Alert indicates that the staff will publish these alerts periodically to provide chief compliance officers (“CCOs”) with guidance about common deficiencies and weaknesses that SEC examiners are finding during compliance examinations. We believe that SEC Alerts will be a valuable tool for CCOs to use to correct or improve their firm’s policies and procedures and avoid serious deficiencies. The initial SEC Alert is posted on the Internet at http://www.sec.gov/about/offices/ocie/complialert.htm .
While we encourage you to read the first SEC Alert in its entirety, we have also summarized the key topics for you below:
Investment Advisers/Investment Company Issues
Investment Advisers’ Performance Advertising Deficiencies. The SEC Alert notes that SEC examiners are concerned that performance advertisements do not include sufficient disclosures to prevent them from being deemed misleading under Section 206 of the Investment Advisers Act of 1940 and Rule 206(4)-1(a). The most notable failures include the failure to (1) deduct advisory fees from performance results; (2) disclose whether results reflected dividends; (3) disclose differences from the particular index used as a benchmark for performance claims; (4) appropriately advertise partial lists of past specific recommendations; and (5) have sufficient compliance policies and procedures governing marketing and advertising.
Advisers’ Disaster Recover Plans (“DRPs”). The SEC examined a number of advisers that were located in close proximity to the damage caused by Hurricane Katrina and detailed their recommendations for DRPs based on these firms’ experience. These recommendations included having: (1) a remote location for use in case of disaster; (2) remote access to business records; (3) periodic tests and evaluations of disaster preparedness plans; and (4) sufficient insurance and liquidity to prevent an interruption of services.
Mutual Fund “As-Of” Transaction Practices. The SEC Alert noted the SEC’s concerns that policies and procedures regarding “as of” transactions may not be sufficient for the amount of risk involved in such transactions. The SEC Alert noted that “as-of” trades “may serve as a vehicle for improperly executing transactions at an earlier day’s more favorable NAV.” Insufficient policies and procedures for “as of” trades may trigger the SEC to note deficiencies under Investment Company Act Rules 38a-1 and 22c-1.
Closed-End Fund Distribution. The SEC Alert indicated that some of the staff’s recent examinations have uncovered funds that have failed to send a written “Rule 19a-1” notice when paying a return of capital to their shareholders. Rule 19a-1 generally requires closed-end investment companies to send shareholders a disclosure of the sources from which distribution payments are made.
The SEC Alert also covered a number of broker-dealer issues. The SEC noted certain deficiencies including: (1) inadequate supervisory procedures, suitability issues and training related to sales of section 529 college savings plans; (2) inadequate disclosures, filing issues and supervisory procedures related to sales of collateralized mortgage obligations; (3) issues related to sales of unlisted public real estate investment trusts; (4) inadequate supervisory procedures and trading issues related to compliance with regulation SHO; (5) overcharges related to separately managed accounts; (6) problems with outsourced financial and operations principals; and (7) net capital and documentation issues related to expense-sharing agreements. The SEC Alert reviews each of the foregoing issues in detail.
While the SEC did not indicate how frequently SEC Alerts will be published, we recommend that firms check the SEC’s website periodically for new SEC Alerts. We will continue to monitor the SEC’s website as well, and we may publish future KS Legal Alerts on material topics covered in the SEC Alerts.