OCIE Risk Alert Flags Deficiencies in Boards' 15(c) Processes

November 18, 2019

A Risk Alert from the SEC’s Office of Compliance Inspections and Examinations reflects the most often cited deficiencies and weaknesses observed in nearly 300 fund examinations over a two-year period. According to OCIE, the most often cited deficiencies and weaknesses related to the fund compliance rule, disclosure to investors, the board approval process involving advisory contracts, and the fund code of ethics rule. Even though many of the funds examined were not cited for a deficiency or weakness, OCIE believes the following information can assist all funds in assessing compliance risks. Below are the most often cited deficiencies or weaknesses OCIE staff observed in connection with the Section 15(c) process:

The staff observed that fund boards may not have requested or considered information reasonably necessary to evaluate the fund’s investment advisory agreement. For example, certain boards did not appear to consider relevant information such as information related to the profitability of the fund to the adviser, economies of scale, or peer group comparisons for the advisory fee. The staff also observed fund boards that received incomplete materials, but did not request the omitted information, such as performance data for the fund and other accounts managed by the adviser and profitability reports.

The staff observed funds’ shareholder reports that did not appear to discuss adequately the material factors and conclusions that formed the basis for the board’s approval of an investment advisory contract. In addition, staff observed instances in which boards’ advisory contract review process may not have complied with Section 15(c). In some instances, funds did not keep copies of written materials the board considered in approving advisory contracts. In other instances, because of the lack of supporting documentation, such as board minutes, it was unclear what information fund boards requested and considered.

OCIE staff also examined money market funds for compliance with the amendments to the money market rules that became effective in October 2016. The staff observed instances of deficiencies or weaknesses related to money funds’ portfolio management practices, compliance programs, and disclosures. With respect to policies and procedures, OCIE staff found that some money funds did not have policies and procedures that addressed: (1) periodic board oversight of the money fund’s written guidelines and procedures under which the adviser, when delegated by the fund board, analyzes credit risks and makes minimal credit risk determinations. (2) periodic board oversight of certain money fund information, including the money fund’s net asset value deviation methods and the amount of the deviation.

The Risk Alert covered other deficiencies, notably on fund compliance programs. Some of these deficiencies involved board oversight. For example:

The staff observed funds that did not follow or enforce their compliance policies and procedures. For instance, even where funds’ policies and procedures required the fund’s board to approve or ratify the fair valuations determined by the valuation committee, certain funds did not follow or enforce these policies and procedures.
Similarly, staff observed funds that did not follow their policies and procedures regarding the funds’ obligations to obtain multiple broker quotes in connection with cross trades to allow the fund’s board to properly evaluate whether the trades had complied with the exemptions under the affiliated transaction rule.
OCIE staff observed certain policies and procedures did not provide for any ongoing monitoring or due diligence of service providers’ services relating to pricing of portfolio securities and fund shares. Additionally, the staff observed funds where the policies and procedures of the funds’ sub-advisers had not been approved by the fund’s board.