SEC Warns About Exemptive Order Compliance

by Morgan Lewis
Contact

Division of Investment Management's guidance reminds firms to comply with conditions and representations in exemptive orders and notes that consequences for noncompliance may be "severe."

In early May 2013, the Division of Investment Management of the Securities and Exchange Commission (SEC) released guidance reminding firms of their obligation to comply with applicable SEC exemptive orders. The guidance suggests that firms adopt and implement policies and procedures reasonably designed to ensure ongoing compliance with each representation and condition in any such order.[1]

The SEC staff's guidance follows both a June 2011 report from the SEC's Office of Inspector General (OIG),[2] which noted repeated instances of noncompliance with exemptive order requirements, and the publication of the Office of Compliance Inspections and Examinations' (OCIE's) 2013 examination priorities, which noted compliance with exemptive orders as an examination priority.[3] Given the SEC staff's focus, investment companies and investment advisers should review their exemptive orders alongside their compliance policies and procedures in order to avoid regulatory violations and pitfalls during an SEC exam.

OIG Report and OCIE Examination Priorities

The SEC may issue exemptive orders to applicant firms relieving such firms from compliance with specific provisions of the federal securities laws and/or regulations. These exemptive orders are issued in reliance on one or more provisions of the federal securities laws.[4] In order to receive exemptive relief, a firm typically makes certain representations and warranties in its application and agrees to comply with certain conditions. Based on its review of a sample of OCIE examination reports, the OIG determined in its 2011 report that many firms failed to comply with the representations and conditions of SEC exemptive orders and no-action letters they have received.

Examples of noncompliance cited in the OIG report include failing to conduct an annual review by the board, failing to include certain performance data disclosures, failing to recall loaned securities to vote proxies, and failing to adhere to fund marketing requirements. The OIG report further notes that the SEC divisions that issue such relief do not have a process for confirming whether firms subsequently comply with the conditions set forth in the relief.[5] The OIG report also set forth five recommendations intended to enhance the SEC's oversight of exemptive order compliance. These recommendations include increased oversight and cooperation by and between SEC divisions. The OIG also recommended that OCIE include compliance with exemptive order conditions in OCIE's risk considerations as part of its examination efforts.[6]

Presumably in response to the OIG report, the priorities that OCIE issued on February 21, 2013 include investment company and investment adviser compliance with exemptive orders. Specifically, OCIE stated that it will "focus on compliance with previously granted exemptive orders, such as those related to closed-end funds and managed distribution plans, employee securities companies, ETFs and the use of custom baskets, and those granted to fund advisers and their affiliates permitting them to engage in co-investment opportunities with the funds."[7]

Additional Policies and Procedures Firms Should Consider

The Division of Investment Management's guidance suggests that firms may address the risk of noncompliance with exemptive order conditions by adopting policies and procedures in accordance with Rule 206(4)-7 under the Investment Advisers Act or Rule 38a-1 under the Investment Company Act. The policies and procedures should be reasonably designed to ensure ongoing compliance with each representation and condition of any exemptive order(s) the entity has received. The guidance discusses the following two approaches a firm could use to ensure compliance:

  • Adopt a specific policy or procedure to address the required representations and conditions of any applicable order.
  • Consider whether any existing policy or procedure relating to other matters sufficiently incorporates the required representations and conditions.

The guidance also includes a reminder to firms that the adequacy and effectiveness of all policies and procedures should be reviewed on an annual basis.

Interestingly, the SEC guidance does not specifically address compliance with SEC no-action letter requirements, although firms should generally apply the same types of policies, procedures, and oversight processes to ensure compliance with no-action letters as they do to ensure compliance with exemptive orders. The guidance also does not address another closely related area: compliance with exchange-listing requirements and other rules by exchange-traded funds (ETFs) and closed-end funds.[8] ETFs, for example, must comply with exchange-listing standards and, in some cases, specific representations and conditions made by a securities exchange in connection with proposed rule changes to list the ETFs shares pursuant to Rule 19b-4 under the Securities Exchange Act of 1934. As with exemptive orders and no-action letters, firms should adopt appropriate policies, procedures, and oversight processes to comply with these standards.

Compliance Tips

The following are some practical tips and approaches designed to ensure compliance:

  • If they haven't already, firms should compile a list of exemptive orders they rely upon. Although not addressed by the guidance, firms also should compile a list of any no-action letters they rely upon and any applicable listing requirements.
  • Firms should create a checklist containing the key terms and conditions of such exemptive relief, as well as the material representations made in the applications for such orders. A similar process should be followed for no-action letters and listing requirements.
  • Firms should compare their current policies and procedures against this checklist to determine if changes are warranted or if new policies and procedures should be adopted. Deficiencies should be addressed and discussed with a firm's chief compliance officer (CCO) and fund boards, as warranted.
  • Firms should designate specific individuals on the compliance or legal teams who are responsible for ensuring that the requirements of each exemptive order and no-action letter are fulfilled. The guidance notes that, as with all policies and procedures under the compliance rules, the adequacy and effectiveness of the implementation of policies and procedures with respect to exemptive order compliance should be reviewed on at least an annual basis. The same process should be used for no-action letter and exchange listing compliance. Fund compliance officers should consider building this process into their periodic reports to fund boards.
  • For activities that require reliance on exemptive orders issued to service providers or issuers (e.g., affiliated securities lending, ETF 12(d)(1) relief), firms should make sure they understand the process used by such service providers and issuers to ensure compliance and should obtain certifications of compliance from such service providers and issuers on a regular basis.
  • A common theme in recent SEC enforcement actions has been board responsibility and oversight.[9] Boards should take an active role to help ensure compliance with applicable requirements. Boards should be aware of their responsibilities pursuant to exemptive orders and no-action letters and periodically review such responsibilities and methods of compliance with trustee counsel and the funds' CCO.

Because of the extent to which the investment industry has come to rely on exemptive orders and no-action letters, well-developed policies and procedures, along with effective oversight of such policies and procedures, are increasingly important. The OIG report, the OCIE examination priorities, and now the Division of Investment Management's guidance indicate that this is a focus area for SEC staff and an area of significant regulatory and compliance risk. However, a thoughtful approach to these issues that takes into account the Division of Investment Management's guidance and that is consistent with the practices outlined above should help firms remain compliant.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis attorneys:

New York
Richard F. Morris
Kaitlyn L. Piper

Philadelphia
Timothy W. Levin
David W. Freese
Sean Graber
John J. "Jack" O'Brien


[1]. SEC Division of Investment Management, Guidance Update No. 2013-02 (May 2013), available here.

[2]. U.S. Securities and Exchange Commission Office of Inspector General, Oversight of and Compliance with Conditions and Representations Related to Exemptive Orders and No-Action Letters, Report No. 482 (June 29, 2011), available here.

[3]. National Examination Program, Examination Priorities for 2013 (Feb. 21, 2013), available here.

[4]. See, e.g., section 6(c) of the Investment Company Act of 1940 (Investment Company Act) and section 206A of the Investment Advisers Act of 1940 (Investment Advisers Act).

[5]. More specifically, the OIG's report found that the "SEC's Divisions that issue exemptive orders and no-action letters to regulated entities do not have a coordinated process for reviewing those entities' compliance with the conditions and representations contained in the orders and letters, and instead rely on OCIE to review compliance as part of its examinations." See U.S. Securities and Exchange Commission Office of Inspector General, Oversight of and Compliance with Conditions and Representations Related to Exemptive Orders and No-Action Letters, Report No. 482 (June 29, 2011), at vi available here.

[6]. The OIG's report recommended that "OCIE should include compliance with conditions and representations in significant exemptive orders and no-action letters issued to regulated entities as risk considerations in connection with its compliance efforts." Id. at vii.

[7]. National Examination Program, supra note 2, at 6.

[8]. This is not surprising as exchange listings and listing standards are under the purview of the SEC's Division of Trading and Markets and not the Division of Investment Management.

[9]. See, e.g., In the Matter of Northern Lights Compliance Services, LLC, et al., Admin. Proc. File No.3-15313 (May 2, 2013); In the Matter of J. Kenneth Alderman, CPA, et al., Admin. Proc. File No. 3-15127 (Dec. 10, 2012).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morgan Lewis | Attorney Advertising

Written by:

Morgan Lewis
Contact
more
less

Morgan Lewis on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!