Compliance Matters Q3 2023

Nov 08, 2023

A compendium of regulatory matters for Q3 2023


Private Fund Adviser Reforms

On August 23, 2023, the U.S. Securities and Exchange Commission (the “SEC”) adopted new rules and amendments under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), to enhance the regulation of private fund advisers. The new rules require private fund advisers registered with the SEC to (i) provide investors with quarterly statements detailing information regarding private fund performance, fees, and expenses; (ii) obtain an annual audit for each private fund; and (iii) obtain a fairness opinion or valuation opinion in connection with an adviser-led secondary transaction. In addition, the new rules require that all private fund advisers to: (i) prohibit engaging in certain activities and practices that are contrary to the public interest and the protection of investors unless they provide certain disclosures to investors and, in some cases, receive investor consent; and (ii) prohibit providing certain types of preferential treatment that have a material negative effect on other investors and prohibit other types of preferential treatment unless disclosed to current and prospective investors. A key element of the amendments is that they will require all registered advisers, including those that do not advise private funds, to document in writing the annual review of their compliance policies and procedures.

SEC Adopts Changes to the Registered Fund Names Rule

On September 20, 2023, the SEC issued a release (the “Release”) adopting changes to Rule 35d-1 under the Investment Company Act of 1940, as amended (the “1940 Act”) (the “Names Rule”). The Names Rule expands the applicability of current Rule 35d-1 and includes new disclosure, compliance testing, reporting and recordkeeping requirements. Specifically, the Release:

  • Expands the Names Rule’s 80% investment policy requirement to apply to any fund name containing terms that suggest the fund focuses its investments in a particular type of investment or investments; a particular industry or group of industries; particular countries or geographic regions; or investments that have, or whose issuers have, particular characteristics (e.g., “growth,” “value,” terms indicating that the fund’s investment decisions incorporate one or more ESG (Environmental, Social and Governance) factors, and thematic terms).
  • Amends funds’ prospectus disclosure requirements for funds required to adopt an 80% investment policy to include prospectus disclosure defining the terms used in the fund’s name, including the specific criteria the fund uses to choose the investments described by the terms.
  • Requires a fund to determine at the time it invests whether the investment should be included in the fund’s 80% basket, and to reassess at least quarterly the assets included in the fund’s 80% basket.
  • Retains funds’ flexibility to determine what constitutes other-than-normal circumstances in which a fund may intentionally depart from the 80% investment policy requirement and provides a 90-day period for bringing the fund back into compliance.
  • Generally requires funds to use a derivatives instrument’s notional amount, rather than its market value, when determining the fund’s compliance with its 80% investment policy and specifically addresses the derivatives instruments that a fund may include in this 80% basket.
  • Amends Form N-PORT to incorporate new reporting items and includes new recordkeeping requirements.

Large fund complexes with net assets of over $1 billion as of the end of the most recent fiscal year will be required to comply with the Names Rule by the end of 2025, while smaller fund complexes have six more months to comply.


Exemption for Certain Investment Advisers Operating Through the Internet

On July 26, 2023, the SEC proposed amendments to the rule permitting certain investment advisers that provide investment advisory services through the internet to register with the SEC. The proposed amendments generally would require an investment adviser relying on the internet adviser registration rule to have at all times an operational interactive website through which the adviser provides digital investment advisory services on an ongoing basis to more than one client. The proposed amendments would also eliminate the de minimis exception from the current rule by proposing to require that an internet investment adviser provide advice to all of its clients exclusively through an operational interactive website, and make certain corresponding changes to Form ADV.

The SEC’s Chair noted that a lot has changed since the SEC granted what was intended to be a narrow exception in 2002 allowing internet-based advisers to register with the SEC instead of with the states and that “today’s proposal would modernize the internet advisers exemption to better align registration requirements with modern technology and help the SEC in the efficient and effective oversight of registered investment advisers.”

The proposing release was published in the Federal Register and the public comment period was open until October 2, 2023.

SEC Proposes New Requirements to Address Risks to Investors from Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker-Dealers and Registered Investment Advisers

Predictive Data Analytics (“PDAs”), often enhanced by Artificial Intelligence (“AI”), are used by many broker-dealers and investment advisers to mine and process investor data and to manage investments and investor relationships. Regulators fear that advisers (“robo-advisers,” in particular) and broker-dealers may use this technology in a way that places their interests before those of their investor clients. On July 26, 2023, the SEC proposed rules intended to address conflicts of interest associated with the use of PDAs that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes. The proposed rules would require broker-dealers and advisers to address conflicts of interest associated with their use of PDAs and similar technologies to interact with investors, to prevent firms from placing their interests ahead of investors’ interests. The proposed rules would apply even if the interaction with the investor does not rise to the level of a “recommendation.” The record-keeping and reporting requirements would be substantial.

Under the proposed rules, firms would be required to:

(1) evaluate the use (or reasonably foreseeable potential future use) of any covered technology in any investor interaction to identify any conflicts of interest associated with that use;

(2) determine whether any such conflict of interest results in placing the interest of the broker-dealer or investment adviser ahead of the investor’s interests;

(3) eliminate or “neutralize” the effect of such conflict of interest; and

(4) adopt and maintain written policies and procedures reasonably designed to prevent violations of (investment advisers) or achieve compliance with (broker-dealers) the proposed rules, including a documented annual review of the adequacy and effectiveness of such policies and procedures.

On October 10, 2023, the Investment Company Institute sent a 62-page comment letter urging the SEC to withdraw the proposed rules, stating, among other things, that “the Proposed Rules are confusing, unworkable, and overreaching and would harm the very investors the Commission seeks to protect” and “would broadly change existing regulation without adequate explanation or appropriate notice and comment, and therefore are arbitrary and capricious.” The ICI further stated that the proposal fails to demonstrate any potential benefits to outweigh its tremendous costs.


Why Did the Regulators Choose My Firm to Be Examined?

In September 2023, the SEC’s Division of Examinations (the “Division”) published a risk alert to provide additional information regarding the Division’s examination selection process. The risk alert also included a sample initial request list for investment adviser exams and an explanation of the examination process. Given the size and variety of the adviser population, the Division utilizes a risk-based approach for both selecting advisers to examine and in determining the scope of risk areas to examine. The Division’s risk-based approach is dynamic; it adapts to changes in market conditions, industry practices, and investor preferences. Some of the reasons the Division may select an adviser to examine include, but are not limited to, one or more of the following: the firm’s risk characteristics (as discussed above); a tip, complaint, or referral; or the staff’s interest in a particular compliance risk area.

There are also firm-specific risk factors that the staff considers when selecting advisers for examination, such as those related to a particular adviser’s business activities, conflicts of interest, and regulatory history. For example, the staff may consider: (1) prior examination observations and conduct, such as when the staff has observed what it believes to be repetitive deficient practices during more than one review of a firm, significant fee- and expense-related issues, and significant compliance program concerns; (2) supervisory concerns, such as disciplinary history of associated individuals or affiliates; (3) tips, complaints, or referrals involving the firm; (4) business activities of the firm or its personnel that may create conflicts of interest, such as outside business activities and the conflicts associated with advisers dually registered as, or affiliated with, brokers; (5) the length of time since the firm’s registration or last examination, such as advisers newly registered with the SEC; (6) material changes in a firm’s leadership or other personnel; (7) indications that the adviser might be vulnerable to financial or market stresses; (8) reporting by news and media that may involve or impact the firm; (9) data provided by certain third-party data services; (10) the disclosure history of the firm; and (11) whether the firm has access to client and investor assets and/or presents certain gatekeeper or service provider compliance risks.

SEC Announces 2024 Exam Priorities

In October 2023, the Division announced its examination priorities for the 2024 fiscal year (the “Report”). In general, the Report demonstrates the Division’s continued commitment to core principles and enhanced scrutiny of compliance policies and procedures for all market participants to ensure transparency and accuracy in reporting to regulatory agencies and the market.

Investment Advisers

Ensuring that advisers are adhering to their dual duties of care and loyalty remains an utmost priority for the Division. In particular, the Division is focused on investment advice involving complex products (e.g., ETFs), high cost and illiquid products (e.g., real estate investment trusts), and products with “unconventional” investment strategies. The evaluation of customer suitability, best execution, costs and risks, and conflicts of interest will also be top-of-mind for examiners.

In reviewing advisers’ compliance programs, the Division plans to carefully consider:

  • Marketing practices, including compliance with reforms to Rule 206(4)-1 under the Advisers Act, and the disclosure of such marketing information on Form ADV, with additional scrutiny on advertisements;
  • Compensation arrangements focusing on fiduciary obligations of advisers, alternative means of maximizing revenue, and fee breakpoint calculation processes;
  • Valuation assessments of investment recommendations for illiquid or difficult to value assets, such as commercial real estate or private placements;
  • Adviser controls to protect clients’ material nonpublic information; and
  • Disclosure assessments to review filings, including Form CRS, especially considering inadequate or misleading disclosures and registration eligibility.

As with the previous year’s examination priorities, the Division also indicates that it will continue to focus on examinations of investment advisers to private funds, focusing on portfolio management risks, adherence to contract requirements for limited partnerships, calculation and allocation of fees and expenses, due diligence policies, conflicts and disclosures for funds managed alongside registered investment companies, compliance with Advisers Act requirements regarding custody, and procedures for reporting on Form PF.

Registered Investment Companies

Registered investment companies—which include mutual funds and ETFs—remain an area of focus for the Division in 2024 due to their importance to retail investors. The Report recognizes the importance of robust compliance programs for investment companies. Consistent with recent messaging from SEC representatives, the Report states that examinations of investment companies may focus on policies and procedures concerning calculation of advisory fees and fee waivers, including boards’ approval of advisory fees and investment advisory contracts.

The Division is also focused on valuation practices, risk management assessments in line with Rule 18f-4 under the 1940 Act (the fund derivatives rule), and compliance with exemptive order conditions. For both investment companies and investment advisers, the Division will continue its prior practice of prioritizing entities that have never been examined or have not been examined in several years.


The Report’s primary focus for broker-dealers is compliance with the standard of conduct set forth under Regulation Best Interest (“Reg BI”), including in connection with investment recommendations, disclosures of conflicts of interest, conflict mitigation, processes for reviewing alternatives, and consideration of factors related to an investor’s investment profile. Examinations will focus in particular on compliance with Reg BI in recommending products that are high cost, complex, or illiquid.

Other Key Risk Areas

The Report also highlights three key risk areas applicable to market participants: (1) Information Security and Operational Resiliency, (2) Crypto Assets and Emerging Financial Technology, and (3) Anti-Money Laundering (“AML”). The first two are reprised from the most recent iteration of the exam priorities. Notably, environmental, social and governance (“ESG”) investing was not mentioned as an examination priority for 2024.These risk areas for 2024, elaborated on in relevant part below, focus on the need for strong compliance policies and procedures, especially concerning cybersecurity and emerging technology.

Information Security and Operational Resiliency

The Division is prioritizing the review of policies and controls related to cybersecurity and will focus on a firm’s cybersecurity policies and procedures, internal controls, oversight of third-party vendors, governance practices, and responses to cyber-related incidents. Such reviews will consider employee training programs concerning identity theft prevention and whether written policies and procedures adequately address the protection of customer information, including across multiple offices. The Division will also review how firms identify and assess risks to essential operations in connection with their engagement of third-party vendors. In addition, the Division notes that it will assess how broker-dealers are preparing for the new rule shortening the settlement cycle between execution and settlement. By shortening the transaction cycle, this new rule, with a compliance date of May 28, 2024, aims to reduce risk, protect investors, and increase efficiency.

Crypto Assets and Emerging Financial Technology

With continued volatility in the crypto markets, the Division notes that it will continue to monitor and examine registrants to ensure that registrants meet and follow standards of conduct when recommending or advising customers and clients regarding crypto assets, with a focus on an initial and ongoing understanding of the products by retail-based investors and that registrants routinely review, update, and enhance their compliance practices, risk disclosures, and operational resiliency practices, if required. A brief mention of artificial intelligence was included as an area of emerging technologies that the Division is focused on—along with automated investment tools and trading algorithms or platforms.


New on this year’s list of priorities are AML procedures and compliance with the Bank Secrecy Act. The Division will review AML programs to determine if firms are tailoring such programs to unique AML risks associated with their business models, conducting independent testing, establishing a customer identification program, and meeting suspicious transaction report (SAR) filing obligations. Additionally, the Division will review whether broker-dealers and advisers are complying with Office of Foreign Assets Control sanctions. The SEC has recently demonstrated its commitment to policing this area through enforcement actions asserting AML-related charges, including an unusual case against a registered representative for failing to elevate red flags of suspicious transactions in a customer account which resulted in his firm failing to file required SARs.


The Report provides insight into the Division’s priorities for the upcoming fiscal year, with the intention that the accelerated publication at the start of the fiscal year will cause firms to be proactive in their preparations. While many of the priorities echo those of years past, a unifying theme is an overall focus on strong compliance and controls across all areas and regulated entities. Firms should evaluate their compliance policies and procedures for potential areas of enhancement.


Fund Administrator Settles SEC Charges Over Missing ‘Red Flags’

A Florida-based fund administrator has settled SEC charges that it failed to live up to its gatekeeper responsibilities and distributed inaccurate capital account statements to investors despite clear red flags.

The SEC said that during the administrator’s tenure the fund suffered “significant losses” due to trading by the advisor. The SEC alleged that the administrator did not recognize the losses when calculating the fund’s net asset value (“NAV”), but rather took direction from the advisor and recognized an expense reimbursement as a receivable due from the advisor, an asset of the fund, which offset the effect of the losses. As a result, there was no decrease to the fund’s NAV. The SEC alleged that the administrator recorded this asset to the financial statements without evaluating whether it was appropriate and despite the existence of “red flags,” which caused the investors to be provided with inaccurate capital account statements.

Without admitting or denying the SEC’s findings, the administrator agreed to a cease-and-desist order, and agreed to pay a civil penalty of $100,000, in addition to disgorgement of $18,000 and prejudgment interest of $4,271.

Transfer Agent Enforcement Action May Impact Registered Funds’ Disclosure

On August 17, 2023, the SEC settled an administrative proceeding with a registered transfer agent (“Transfer Agent”), regarding the Transfer Agent’s failure to exercise reasonable care to determine the correct addresses of lost shareholders as required by the Rule 17Ad-17 under the Securities Exchange Act of 1934, as amended, thereby putting those shareholders’ assets at risk of being escheated to state governments as unclaimed assets (the “Order”).

Without admitting or denying the SEC’s findings in the Order, the Transfer Agent agreed to be censured and to pay a civil monetary penalty of $500,000. The Transfer Agent also agreed to:

1. Request that its mutual fund clients periodically send out notifications to their client shareholder base informing them of the risk of escheatment and educating them on steps to avoid dormancy, including updating their addresses and establishing contact with the funds or the Transfer Agent.

2. Additionally, the Transfer Agent agreed to provide written certification annually for five years, that its written policies and procedures complied with the Rule’s requirements, and that it had followed those written policies and procedures. The required certification must include, among other things, “written evidence of compliance in the form of a narrative and be supported by exhibits sufficient to demonstrate compliance.”

SEC Commissioners Peirce and Uyeda (the “Dissenting Commissioners”) issued a dissent from the Order arguing that the Order’s undertakings effectively impose a substantive new disclosure requirement on mutual funds.

The Dissenting Commissioners observes that the Order includes conditions disguised as a “request” from the Transfer Agent to its mutual fund clients, which require said clients to make additional disclosures referenced in the undertaking, which are effectively a requirement imposed by the SEC.

According to the Dissenting Commissioners, if a mutual fund receives a request from its transfer agent that the SEC requires the transfer agent to make, fund counsel reasonably will view it as equivalent to an SEC requirement. Thus, the Dissenting Commissioners argue that while the Order addresses only one transfer agent, its reach is broader and implies that all mutual funds, with prompting from their transfer agents, should send periodic escheatment notices and conduct escheatment education for their shareholders.

The Dissenting Commissioners noted that many mutual funds already include voluntary registration statement disclosure regarding escheatment. They observe that while the Order implies that mutual funds’ existing disclosures regarding escheatment are inadequate, it offers no guidance about what would be adequate and leaves the following questions unanswered:

  • Is an annual disclosure enough to satisfy the Order’s undertaking to send out notifications periodically?
  • How detailed should the disclosure be to educate fund shareholders appropriately?
  • What documents should include the disclosure?
  • Can such disclosure be satisfied using the layered disclosure approach currently used for prospectuses and annual and semi-annual reports?

SEC Charges Marketing Rule Violations Against Investment Advisers

On September 11, 2023, the SEC announced charges against nine registered investment advisers for advertising hypothetical performance to the general public on their websites without adopting and/or implementing policies and procedures required by the Marketing Rule. The nine firms agreed to settle the SEC’s charges and agreed to pay $850,000 in combined penalties. Under the Marketing Rule, adopted by the SEC in December 2020, registered investment advisers are prohibited from including any hypothetical performance in their advertisements unless they have adopted and implemented policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement.

On August 21, 2023, the SEC charged a New York-based FinTech investment adviser for using hypothetical performance metrics in advertisements that were misleading. The SEC also charged the adviser with multiple compliance failures that led to misleading disclosures about custody of clients’ cryptocurrency assets, the use of improper “hedge clauses” in client agreements, the unauthorized use of client signatures and the failure to adopt policies concerning cryptocurrency asset trading by employees. Without admitting or denying the SEC’s findings, the adviser agreed to a cease-and-desist order, a censure, and to pay $192,454 in disgorgement, prejudgment interest and an $850,000 civil penalty that will be distributed to affected clients.

SEC Charges Registered Investment Adviser for Disclosure and Policies and Procedures Failures

On June 16, 2023, the SEC announced that a registered investment adviser (“RIA”) will pay $9 million to settle two enforcement actions relating to disclosure and policies and procedures violations involving two funds the RIA advises.

In the first action, the SEC found that, from September 2014 to August 2016, the RIA failed to disclose material information to investors concerning the use by one of its funds of interest rate swaps and the material impact of the swaps on the fund’s dividend.

In the second action, the SEC found that, from April 2011 to November 2017, the RIA failed to waive approximately $27 million of advisory fees as required by its agreement with another fund. Additionally, until at least 2018, the RIA did not have adequate written policies and procedures concerning its oversight of advisory fee calculations and related fee waivers. The RIA has since disbursed to investors the $27 million in fees that should have been waived, plus interest and a performance adjustment.

The SEC’s Co-Chief of the Enforcement Division’s Asset Management Unit noted that “These cases highlight our continued focus on ensuring that firms adequately disclose material information and implement reasonably designed policies and procedures.”

In the action concerning the first fund, the SEC’s order found that the RIA violated Section 206(4) of the Advisers Act and Rule 206(4)-8 and Section 34(b) of the 1940 Act. In the action concerning the second fund, the SEC’s order found that the RIA violated Section 206(4) of the Advisers Act and Rule 206(4)-7. Without admitting or denying the SEC’s findings, the RIA agreed to a cease-and-desist order and a censure in each action and to pay a combined $9 million penalty.


Firms File for Exemptive Relief for a Mutual Fund Share Class of an ETF

On August 22, 2023, two firms filed for exemptive relief to permit an offering of a class of mutual fund shares (“Mutual Funds Shares”) in addition to the funds’ existing exchange-traded shares (“ETF Shares”). The Firms filed under Section 6(c) and 17(b) of the 1940 Act for an exemption from Sections 2(a)(32), 5(a)(1), 17(a)(1), 17(a)(2), 18(f)(1), 18(i), 22(d), and Rule 22c-1 of the 1940 Act.

The Firms cited the precedent of the SEC’s grant of exemptive relief to The Vanguard Group, Inc. (“Vanguard”). In 2000, the SEC permitted Vanguard to offer certain index-based, open-end management investment companies with both Mutual Fund Shares and ETF Shares. In 2003, the SEC twice amended that original exemptive relief to expand the relief to cover domestic equity index funds and international equity index funds with both Mutual Fund Shares and ETF Shares. In 2007, the SEC again granted an exemptive order to permit Vanguard’s bond index funds to offer both Mutual Fund Shares and ETF Shares.

Further, the firms’ legal analysis sought two broad categories of exemptive relief; (1) ETF Operational relief, which is the relief to continue standard ETF operations consistent with Rule 6c-1, and (2) Share Class Relief, which is the relief necessary to offer a Mutual Fund Class. Additional information regarding the details of the firms’ legal analysis can be found at the link below.

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