Key Takeaways

  • On October 26, 2021, the SEC released a Risk Alert from the Division of Examinations which provides observations from recent examinations of mutual funds, exchange-traded funds ("ETFs") and investment advisers, including their regulatory compliance in areas that may have a direct impact on retail investors ("RIC Initiatives").  A link to that Alert can be found HERE.
  • As summarized below, the SEC highlights frequent deficiencies and weaknesses identified within compliance programs including, but not limited to, references to familiar themes in recent SEC pronouncements – inadequate processes and controls, unfair trading practices, undisclosed conflicts of interest, inadequate or omitted disclosures, inappropriate fees and expenses, and unfair, imbalanced, and misleading fund advertisements and sales literature.
  • Also summarized herein, the SEC provides examples of various best practices that are effectively utilized by funds and advisers to mitigate risks.
  • As this area has been a focus of the SEC for several years, registered investment companies and investment advisers would be best advised to review their compliance programs to ensure compliance with the raised concerns.


The SEC's alert summarizes observations made during the examinations of more than 50 funds complexes, covering more than 200 funds and/or series of funds, and nearly 100 investment advisers.  While carrying out its RIC Initiatives, the SEC focused on fund companies and investment advisers that fell within one or more of the following 6 categories:

  • index funds that track custom-built indexes;
  • smaller ETFs and/or ETFs with little secondary market trading volume;
  • mutual funds with higher allocations to certain securitized investments;
  • mutual funds with aberrational underperformance relative to their peer groups;
  • mutual funds managed by advisers that are relatively new to managing such funds; and
  • investment advisers that provide advice to both mutual funds and private funds, both of which have similar strategies and/or are managed by the same portfolio managers.

In conducting its examinations, the SEC assessed the effectiveness of policies and procedures in addressing risks, disclosures made to investors and fund boards, and fund governance practices.  

Frequently identified compliance deficiencies

The following are frequent compliance deficiencies observed by the SEC in its review:

 Investments and Portfolios:

  • Failures to monitor for compliance with policies and procedures.
  • Failures to monitor for adherence to investment restrictions set out in prospectuses and fund disclosures.
  • Failures to monitor for risks associated with asset classes that present unique risks.
  • Failures to monitor for adherence to the "Fund Name Rule," namely that the fund concentrates its asset allocation in at least 80% of the securities that its fund name would suggest.
  • Failures to assess the administration of the fund's liquidity risk management program.
  • Failures to provide appropriate oversight of vendors that provide liquidity classifications of holdings.


  • Failures to maintain adequate policies and procedures to provide for the fair and accurate valuation of portfolio securities, including due diligence into, and oversight of, vendors that provide pricing and accounting services in the calculation of the fund's daily net asset value.
  • Failures to maintain controls to ensure that the valuations of fund securities are fair, accurate, and address potential conflicts of interest, such as when a portfolio manager provides input into pricing securities for the calculation of the fund's daily net asset value.

Trading Practices:

  • Failures to ensure appropriate and fair allocations of securities among client accounts when trades are aggregated.
  • Failures to prevent prohibited principal or joint transactions with affiliates.
  • Failures to prevent violations of the legal requirements for cross and principal trading.
  • Failures to ensure clients are not disadvantaged during the sharing of soft dollar commissions among clients.

Conflicts of Interest:

  • Failures to address adviser's potential conflicts of interest with funds and their service providers such as in instances when the adviser to an index fund also acts as the index provider.
  • Failures to address adviser's potential conflicts of interest with index providers such as when they share personnel, are affiliated or have contractual relationships, or in instances in which they share material non-public information.

Fees and Expenses:

  • Failures to monitor allocation of expenses between funds and their advisers, subject to fee waivers.
  • Failures to review fee calculations for any inconsistencies between a fund's contractual expense limitation and its expense related disclosures.

Advertisements and Sales Literature:

  • Failures to review and file appropriate fund advertisements and sales literature.
  • Failures to ensure expense disclosures are fair, balanced and not misleading.
  • Failures to ensure that the comparison of back-tested index returns to actual fund returns are fair, balanced, and not misleading.
  • Failures to review affiliated index provider's websites to assess whether information contained thereon may be deemed sales literature that requires filing with the SEC or FINRA

Policies and Procedures for Board Oversight

  • Failures to ensure appropriate policies and procedures for funds and advisers to report accurate information to their boards.
  • Failures to ensure appropriate processes for the fund's board to conduct an annual review and approval of the fund's investment advisory agreement.
  • Failures to conduct annual reviews of the fund's compliance programs to ensure adequacy and effectiveness.
  • Failures to ensure the annual report prepared by the fund's chief compliance officer addresses whether the fund has adequate policies and procedures to address specific risk areas.
  • Failures to design and implement policies and procedures for the fund's board to exercise appropriate oversight.


  • Failures to ensure adequate disclosures regarding principal investment strategies, risks of investing in the funds, potential conflicts of interest, and changes in the overall indexes used for fund performance comparisons.
  • Failures to ensure adequate disclosures related to the fund's net asset and expense ratios, contractual expense limitations and operating expenses subject to the contractual expense limitations.
  • Failures to ensure adequate sale-literature disclosures related to:
    • investment strategies and portfolio holdings;
    • the differences in investment objective between predecessor and successor funds;
    • inception dates;
    • funds' expenses, contractual expense limitations, and/or expense ratios;
    • average total returns and/or gross expenses and net expenses;
    • performance information not disclosed with the required legends;
    • awards received for fund performance;
    • weighting of index constituents in the benchmark index;
    • methodologies for calculating the performance of the benchmark index;
    • differences in holdings, risk, and volatility between the broad-based and bespoke indexes used for performance comparisons; and/or
    • composition of index used for performance comparisons.

Best practices adopted by funds and advisers

  • Conduct periodic reviews to ensure policies and procedures are consistent with actual practices.
  • Conduct periodic reviews to ensure funds are complying with their published investment strategies, objectives, restrictions and other published directives and limitations.
  • Conduct periodic reviews to ensure appropriate oversight of vendors, including pricing vendors.
  • Design, implement and review policies and procedures to ensure compliance with applicable regulations, laws and exemptive orders.
  • Design, implement and review policies and procedures to address and disclose potential conflicts of interest.
  • Conduct periodic reviews to verify information communicated to fund's board is accurate, including the fund's fees, expenses, investment strategies, changes to investment strategies and risks associated to the investment strategies.
  • Conduct periodic reviews to ensure funds are adhering to their processes for board reporting.
  • Conduct periodic reviews of amendments to the fund's prospectus, SAIs, shareholder reports and other investor communications to ensure such are fair, accurate and properly disclosed to investors.
  • Conduct periodic reviews to ensure the funds and the boards are acting consistent with fund disclosures.
  • Conduct periodic reviews to ensure that disclosures published on websites are appropriately reported and amended and remain fair and accurate.
  • Conduct periodic reviews to ensure that fees and expenses disclosed in fund's filings and communications are fair, accurate and complete.
  • Conduct periodic reviews to ensure that the fund's performance advertising and comparison's to indexes are accurate, fair and complete.


The topic of regulatory compliance related to mutual funds has appeared in the SEC's annual examination priorities every year going back to 2018.  The concepts addressed herein were also the subject of a Risk Alert released by the SEC on November 8, 2018.  A copy of that Alert can be found HERE.  Given the regulator's ongoing focus on these issues, registered investment companies and investment advisers would be best advised to review their compliance programs to ensure adequate compliance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.