Rule 38a-1 under the Investment Company Act of 1940 (the 1940 Act) requires funds to review their compliance programs, as well of those of their service providers, including their investment advisers (advisers), annually. Funds must verify that they have adopted and implemented programs that are tailored to their business practices and are reasonably designed to prevent violation of federal securities laws. In connection with this annual review, funds and advisers should confirm that their compliance programs address relevant risks identified by the Securities and Exchange Commission subsequent to their most recently completed reviews. 

On October 26, 2021, the Securities and Exchange Commission’s Division of Examinations (the Division) published a Risk Alert with observations from examinations focused on funds and their advisers. The examinations included more than 50 fund complexes – covering more than 200 funds and/or series of funds – and nearly 100 advisers, and was focused on industry practices and regulatory compliance in certain areas that may have an impact on retail investors. Although the series of examinations targeted funds with certain business models, the Division’s observations can assist all funds in assessing their compliance risks and enhancing their compliance programs.

The Risk Alert

The Division’s focus was primarily on:

1. Effectiveness of compliance policies and procedures - Rule 38a-1 under the 1940 Act and Rule 206(4)-7 under the Investment Advisers Act of 1940 (the Advisers Act) require that funds and their advisers adopt and implement written policies and procedures reasonably designed to prevent violation of federal securities laws. These policies and procedures should be tailored to address risks of funds and their advisers’ business practices.
2. Oversight of funds’ compliance programs - Rule 38a-1 under the 1940 Act requires a fund to establish and maintain procedures for board oversight of its compliance programs, including approval of the fund’s policies and procedures and those of its services providers, and to annually review the adequacy of those policies and procedures. 
3. Disclosures in filings and shareholder communications - Federal securities laws prohibit funds from including materially false or misleading information in documents filed with the SEC or provided to investors. Funds should establish controls to review and amend disclosures included in filings, advertisements, sales literature and/or other investor communications. 

The Division observed the following common deficiencies or weaknesses:

1. Compliance policies and procedures - Funds and advisers did not adopt, implement, and/or appropriately tailor their compliance programs to address various business practices, including portfolio management, valuation, trading, conflicts of interest, fees and expenses, and advertising. Examples cited by the staff included the following:

• Inadequate policies and procedures for valuation of portfolio securities including controls for due diligence and oversight of pricing vendors and potential conflicts and issues; and
• Inadequate policies and procedures for oversight of allocation of expenses and review of inconsistencies between the contractual expense limitation and expense disclosures. 

2. Oversight of funds’ compliance programs - Funds did not adopt and/or implement policies and procedures for board oversight of the funds’ compliance programs. Examples cited by the staff included the following:

• Non-completion of required annual reviews of their compliance programs;
• Lack of  processes for their board’s annual review and approval of the fund’s investment advisory agreement under Section 15(c) of the 1940 Act, specifically with respect to the investment adviser’s financial condition; and
• Lack of policies and procedures for board oversight in instances where the funds’ delegated responsibilities to their advisers that were not reflected in the advisers’ compliance programs.

3. Disclosures in filings and shareholder communications - Funds had inaccurate, incomplete and/or omitted disclosures in their filings and advertising and sales literature. Examples cited by the staff included the following:  

• Omitted disclosures regarding certain principal investment strategies and/or risks of investing in the funds; and 
• Inconsistent and/or inaccurate disclosure concerning the funds’ net assets and net expense ratios, contractual expense limitations, and/or operating expenses subject to the contractual expense limitation.

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