Compliance Matters Q4 2021

Jan 31, 2022

Curated for compliance officers of mutual funds and investment advisers, please find summaries and links to headlining compliance and regulatory topics from the fourth quarter of 2021.

As the industry settles into several new major rules (Fund of Funds, Derivatives, and Valuation) approved under the prior Chairman, some have suggested that SEC Chairman Gensler has been off to a slow start. But the latest regulatory flex agenda suggests it may be time to buckle up. The agenda is, unsurprisingly, ambitious – despite a few notable topics absent – and out of the gate, some proposed rules (including yet another stab at money market reform, as well as proxy disclosure discussed last quarter) affecting registered funds have already been introduced. To help shepherd the agenda, the Chairman appointed a new Director of the Division of Investment Management, William Birdthistle, a professor at the Chicago-Kent College of Law. This continuing a recent trend of selecting academics for senior leadership positions, perhaps signaling less industry sympathy. (More recently, Commissioner Elad Roisman announced his impending departure, removing a reliable dissenting voice.) Several exam alerts, including one focused directly on investment companies, and recent enforcement actions likely foreshadow areas of increased regulatory and enforcement activity. Below are highlights of the recent activity and related commentary addressing how this may impact advisers and funds.

SEC Proposed Rules

SEC Regulatory Flex Agenda

The SEC has published its latest semi-annual regulatory flex agenda, which details the Chairman’s priorities for rulemakings in the coming year. This is broken into the short-term (less than 12 months) and long-term agendas. These are not guaranteed to come to fruition (particularly the long-term items), but many of these items are well underway.

Short-term highlights affecting registered funds include:

  • Proxy and Form N-PX – This was proposed in September, and Ultimus has submitted a comment letter seeking relief for smaller funds. (This was discussed in our last quarterly update.)
  • Names Rule (35d-1) – Expected in April, this likely will address ESG naming conventions.
  • ESG Disclosures – Also expected in April, and likely coupled with the Names Rule, this will address ESG and related disclosures.
  • Cybersecurity Risk Governance – Another one scheduled for April, the Commission expects to propose rules to enhance fund and adviser disclosures regarding cyber risks.
  • Liquidity and Dilution Management – Also slated for April, we expect tightening of liquidity requirements, though we would like to see the Commission add an exemption for highly liquid funds.
  • Money Market Reform – Proposed in December, this rule seeks to temper redemptions in times of extreme market volatility. (This is discussed further below.)
  • Third-party service providers – The agency seems poised to seek comments about the use of index and models providers.
  • Settlement Cycle – By April, the Commission may propose rules to shorten the settlement cycle (T+1).
  • Exchange-traded products – Expected late 2022, the Commission is exploring changes to the listing and trading of new products.
  • Board diversity – This is a Corp Fin proposal (affecting reporting companies), but we are monitoring to see if this leaks into the registered fund space, including at least those that are exchange-traded (ETFs, closed-end funds).
  • Transfer Agents – The SEC is planning to modernize transfer agency rules, though it is unclear if this will impact registered funds.

Long-term highlights affecting registered funds:

  • Custody rule – the Commission is exploring changes to the custody rules for both advisers and funds. This could be a welcome change.
  • Fund proxy system – the Commission wants to address the challenges faced by funds seeking shareholder approvals. Hopefully updates to the proxy “plumbing.”
  • Securities lending – the Commission is reviewing fund sec lending practices.

The agenda has a couple of notable absences. Unfortunately, there is no mention of Rule 17a-7, which means that fixed income cross-trading is likely dead as soon as compliance with Rule 2a-5 is required (September 2022) because of the updated definition of “readily available market quotations.” Commissioners Peirce and Roisman had pointed criticism of the Chairman for overlooking that. Surprisingly, there was not even a whisper of rulemaking to address digital assets regulation. That seemed like a priority for the Chairman when he was nominated, but evidently not. Stay tuned for the proposals.

For more information about the agenda, please follow the links to the Office of Information and Regulatory Affairs website.

Money Market Fund Reforms

As if on cue, almost as soon as the SEC released the Fall 2021 regulatory agenda, the SEC issued a proposal, once again, to tame money market redemptions in times of extreme market stress and volatility. The proposal’s main feature is a requirement to implement swing pricing in prime and tax-exempt money funds. Swing pricing means that a fund would adjust its NAV to pass transaction costs onto redeeming shareholders (thereby reducing the incentive to redeem). The operational complexity would be, in a word, unwelcome. The rule also would increase the minimums for one-day liquidity and seven-day liquidity. Significantly, the proposal would remove liquidity fees and redemption gates, which had been part of the last round of MMF reforms to Rule 2a-7. Though no fund ever implemented these tools, it seems the mere threat of using them in times of stress may have incentivized investors to redeem assets even earlier (the exact opposite of the intended design) and fund managers to sell less liquid securities (thus exacerbating market stress) to meet redemptions while holding weekly liquid assets above required thresholds. The proposal would leave intact, however, a fund’s ability to suspend redemptions to facilitate orderly liquidations under rule 22e-3. The rule would require stable NAV funds (government and retail funds) to move to floating NAVs if future market conditions result in negative fund yields.

Credit the SEC for trying (try again), but this proposal will no doubt generate debate and controversy. Comments will be due 60 days from publication in the Federal Register. For more information about this proposal, please visit the SEC’s website at the link below:

SEC Guidance and Alerts

Risk Alert: Registered Investment Companies

The Division of Examinations issued a new risk alert that directly addresses the fund industry and follows previously announced exam priorities. It particularly focused on funds that track custom indexes, small ETFs, funds with high allocations to securitized investments, those with aberrational or poor performance, those with new advisers, and those with advisers managing private funds with similar strategies. The broad subject areas cover policies and procedures, disclosures, and fund governance – familiar topics – but it is a fairly far-ranging alert that arguably says so much as to say almost nothing. Areas of interest and observations include:

  • Compliance programs – policies and procedures not tailored to address various business practices, including:
    • portfolio compliance, trade aggregation, allocation, best execution, and senior securities;
    • monitoring for investment restrictions and names rule;
    • monitoring for specific risks, such as asset classes or other operational risks;
    • liquidity risk management and oversight of related vendors;
    • oversight of thinly-traded ETFs and “oversight of their liquidation, as applicable, including communications with their shareholders”;
  • Valuation – policies and procedures should address
    • valuation processes and controls, including oversight of pricing vendors and process for reviewing stale prices and making price challenges;
    • potential conflicts of interest, especially when the adviser has input on a fair value committee;
  • Trading Practices
    • allocation practices, including ensuring there is oversight for potential conflicts;
    • preventing prohibited principal transactions (which would include cross trading with private funds where the adviser is a general partner);
    • cross trading monitoring and controls (which will be severely restricted upon compliance with Rule 2a-5);
    • soft dollars and whether clients are being disadvantaged;
  • Conflicts with affiliated index providers, which includes possible revenue sharing or misuse of MNPI;
  • Fees and expenses – ensuring the allocation of fees between advisers and funds, and waivers or expense limitations are properly calculated;
  • Advertising
    • advertising should be fair and balanced and disclosures accurate;
    • affiliated index provider websites should be evaluated as to whether they constitute fund advertising;
  • Board oversight
    • policies and procedures for monitoring and board reporting of fees paid to intermediaries and shareholder servicing, pricing exceptions, adviser recommendations for fund liquidations, and compliance with senior securities and asset coverage requirements;
    • 15(c) review should address adviser financial condition and ability to meet contractual obligations;
    • completing an annual review, including ensuring the adviser has policies and procedures to address specific risk areas and to address matters that have been delegated to advisers;
  • Disclosures
    • omitted disclosures regarding strategies, risks, conflicts, and change of indexes;
    • inaccurate net assets and expenses (including limitation agreements), standing committees, number of accounts, etc.;
    • inaccurate sales information. The staff recommended testing for consistency with stated investment objectives and conflicts. The staff also commended policies that provide for ensuring websites get updated at the same time as prospectus updates and testing of fees and expenses for accuracy and completeness; and
  • Vendor oversight, including pricing vendors.

Compliance officers are well-advised to conduct a gap analysis to ensure that the compliance house is in order as these topics likely will sever as an informal checklist for upcoming examinations. For more information, please visit the SEC’s website:

Risk Alert: Advisory Fee Calculations

The Division of Examinations cannot throw a risk-alert party for investment companies without inviting advisers. This alert, by contrast, is laser focused, essentially supplementing a 2018 risk alert that addressed advisory fees and expenses, this time providing more details on observations from recent exams. The new alert addresses failures to follow procedures, or in some cases not having procedures, governing billing and fee calculations. Many of the observations seemed to reflect simple errors or sloppiness. The staff cited miscalculated fees, double billing, rebates that were not provided, and inaccurate disclosures. Some mistakes found their way into adviser financial statements. In addition to the usual entreaty for good policies and procedures, the staff seemed to recommend having a centralized billing process to reduce errors. The staff also suggested there should be a process for reviewing fee calculations and ensuring all fees assessed and received are accurately recorded. Advisers definitely should review their ADVs to make sure they are accurate (including accurately stating whether fees are negotiable).

For more information, please visit the SEC’s website:

Staff Statement on LIBOR Transition

LIBOR is dead (or perhaps reports of its demise are greatly exaggerated!). Hence, the SEC staff has issued a statement concerning obligations tied to the LIBOR transition. Significant LIBOR reference rates (the one-week and two-month USD LIBOR maturities and non-USD LIBOR maturities) no longer will be published after December 31, 2021; all other maturities will cease after June 30, 2023. The SEC has issued several statements about this transition, and by now market participants should have made arrangements for using alternative rates, such as SOFR. This latest statement is yet another reminder and spells out some specific considerations for different market segments. As it pertains to advisers and funds, the staff observes the following:

  • Advisers must continue to assess their investment recommendations to ensure they have considered risks and benefits, volatility, likely performance, time horizon, and cost of exit for LIBOR-linked investments.
  • Advisers should consider whether LIBOR-linked investments have fallback language (to trigger an alternative reference rate) and how that impacts the investment profile.
  • Registered funds should consider disclosures. If there are significant LIBOR-linked investments in the fund, there should be risk disclosures concerning the cessation of LIBOR.
  • Valuation, to the extent tied to LIBOR, may need to be reassessed.
  • Advisers may need disclosure around performance fees if, for example, they tie fees to exceeding a LIBOR-linked hurdle

All market participants and service providers also should be mindful of operational or IT changes that may be required to handle the LIBOR transition. Please visit the SEC’s website to view the Staff Statement:

Staff Statement Regarding Form CRS

The SEC staff issued a statement discussing observations (good and bad) about firms’ Form CRSs (ADV part 3). The form is a client relationship summary designed to help retail investors make informed choices about the type of relationship (brokerage, advisory, or both) that best suit’s the investor’s objectives. Although Form CRS is not required for mutual funds, advisers who also serve retail clients must file the form with the Commission, deliver a copy to retail investors, and post it on the firm’s website. The staff reminds registrants that the relationship summary should be written in plain English, avoiding technical jargon and disclaimers. Firms are permitted to summarize information while pointing investors to more detailed disclosures (e.g., by using hyperlinks or other means to access detailed summaries in the Form ADV). The Form CRS also requires certain disclosures while prohibiting extraneous information. Advisers are encouraged to review the staff’s statement as well as other resources for further guidance, which are available on the SEC’s website:


Other Guidance

Cybersecurity Directive

The Cybersecurity and Infrastructure Security Agency (CISA) issued a “Binding Operational Directive, “Reducing the Significant Risk of Known Exploited Vulnerabilities,” that orders federal agencies (including the SEC) to conduct immediate reviews of their cybersecurity programs to address 290 CISA-identified cybersecurity risks. While not binding on private entities, CISA recommends that private entities do the same.

The SEC has been sounding the alarm on cybersecurity, it is a perennial exam topic, and it has been a featured subject in recent enforcement actions. Hardly a day goes by without an announcement of a new cyber threat – even the SEC’s investor alert system was recently spoofed – and registrants can ill afford the business disruption or reputational harm that attends a cyber intrusion. All market participants and their service providers must remain vigilant.

For more information about the CISA directive, please visit CISA’s website:

Enforcement Actions

SEC Enforcement: Recordkeeping Failures

The SEC’s Division of Enforcement settled an interesting enforcement action for recordkeeping violations by a broker-dealer subsidiary of JPMorgan Chase & Co (“JPM”). In short, JPM admitted that “its employees often communicated about securities business matters on their personal devices, using text messages, WhatsApp, and personal email accounts. None of these records were preserved by the firm as required by the federal securities laws.” A few things about this matter stand out: First, JPM admitted wrongdoing, along with agreeing to a $125 million penalty and appointing a compliance monitor. This is not your typical neither-admit-nor-deny settlement. Second, this is a stand-alone books-and-records case. Uncommon, if not unique. Third, there is no reason that similar recordkeeping obligations cannot be divined in another enforcement action in a different context (i.e., nothing suggests the SEC’s ire is limited to recordkeeping of communications or actions only by broker-dealers). Finally, the SEC’s press release expressly invited other registrants (at least in the broker-dealer community) to come clean: “SEC has commenced additional investigations of record preservation practices at financial firms. Firms that believe that their record preservation practices do not comply with the securities laws are encouraged to contact the SEC at” That may foreshadow an initiative that pads the enforcement statistics for the foreseeable future. Thus, while superficially unrelated to the fund business, all registrants should take heed.

To review the SEC’s Enforcement Order, please visit the SEC’s website:

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