SEC compliance insights for registered investment companies


Keeping up with compliance requirements is always a critical imperative in the highly regulated registered investment company (RIC) sector.


As 2022 comes to a close, four risk alerts published in this calendar year by the SEC’s Division of Examinations staff (Division) provide important guidance for RICs to consider as they work on their compliance initiatives. The risk alerts highlight the results of a series of examinations that focused on private funds advisers to assess industry practices and regulatory compliance in certain areas that may have an impact on retail investors.


The Division refers to this testing as “RIC Initiatives.” The scope of the examinations was generally focused on compliance policy and procedure effectiveness, disclosure by the funds to investors, and fund governance practices.


The results of the SEC’s risk alerts highlight deficiencies that affect all private fund advisers. The Division believes the observations should be reviewed to assist all funds and their advisers in assessing compliance risks. In response to these observations, organizations should consider revising their compliance policies and procedures, amending disclosures, and updating practices.




What the SEC addressed


The four risk alerts published throughout the course of 2022 addressed the following:


January 2022

  • Private fund adviser deficiencies regarding conduct inconsistent with disclosures within limited partnership agreements and misleading/inaccurate marketing practices
  • Insufficient policies and procedures and lack of due diligence investigating underlying investments or funds
  • Potentially misleading hedge clauses inconsistent with Section 206 and 215(a) of the Advisers Act of 1940 (Advisers Act)


April 2022

  • Compliance issues related to Section 204A of the Advisers Act, which requires advisers to establish policies and procedures to prevent misuse of material non-public information
  • Compliance issues related to the Code of Ethics rule, which requires advisers to adopt a code of ethics for their business


August 2022

  • Observations regarding municipal advisers’ disclosure requirements


September 2022

  • Upcoming review areas focused on amended Advisers Act Rule 206(4)-1 (the Marketing Rule), as the amendment came into effect on Nov. 4, 2022
  • Consideration for advisers to update policies and procedures as necessary as required by Rule 206(4)-7 of the Advisers Act


We have outlined below key takeaways for all compliance professionals within the private fund space.




Examining your organization’s compliance health


In regard to private fund advisers’ overall compliance program, the Division noted that funds and their advisers did not establish, maintain, update, follow 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. The Division found that advisers were not disclosing conflicts of interest with clients, inadequate documentation of relationships, and untimely documentation or disclosure of conflicts of interests with clients. The Division also found that advisers failed to properly disclose fund-level management fees, failed to invest in accordance with the fund’s investment strategy, and failed to adhere to “recycling practices.”


Grant Thornton observation: We have observed similar trends after SEC Rule 2a-5 established a new principles-based valuation framework and standards that set new requirements for boards and valuation designees in the management of asset valuations. To facilitate this, the SEC requires detailed reporting to the board regarding various aspects of the valuation designee’s fair value determination process. The boards should request, and valuation designees should provide trend dashboards and other analytical tools such as portfolio holdings whose price has changed outside of pre-determined ranges over time, stale prices, and pricing trend analysis.


The four-step framework noted above can be deployed to assist in any of the Division’s highlighted oversight issues.


The Division also highlighted the following as areas of concern with respect to private fund adviser compliance programs:

  • The Division observed issues with funds’ policies and procedures relating to their marketing and due diligence practices. Specifically, funds were observed lacking in the following areas:
    • Misleading material about a track record
    • Inaccurate performance calculations
    • Portability — failure to support adequately, or omissions of material information about, predecessor performance
    • Misleading statements regarding awards or other claims
    • Lack of a reasonable investigation into underlying investments or funds
    • Inadequate policies and procedures regarding investment due diligence



Focus on Code of Ethics


In addition to observations related to compliance programs, the Division highlighted several areas of focus related to advisers’ Code of Ethics. The Division noted the following observations:

  • Advisers did not appear to adequately memorialize diligence processes or follow them consistently and instead engaged in ad hoc and inconsistent diligence of alternative data service providers.
  • Advisers did not appear to have policies and procedures regarding the assessment of the terms, conditions, or legal obligations related to the collection or provision of the data, including when advisers became aware of red flags about the sources of such alternative data.
  • Advisers did not appear to consistently implement their policies and procedures related to alternative data service providers.
  • Advisers did not have or did not appear to implement adequate policies and procedures regarding investors (or in the case of institutional investors, key persons) who are more likely to possess material nonpublic information (MNPI), including officers or directors at a public company, principals or portfolio managers at asset management firms, and investment bankers.
  • Advisers did not appear to have or did not appear to implement adequate policies and procedures regarding their discussions with expert network consultants who may be related to publicly traded companies or have access to MNPI.


The Division also noted funds which did not comply with the Code of Ethics Rule. Examples included:

  • Advisers did not identify and supervise certain employees as access persons in accordance with the Code of Ethics Rule.
  • Access persons did not obtain required pre-approval for certain investments.
  • Advisers could not produce evidence of supervisory review of holdings and transaction reports.
  • Instances where employees traded investments that were on the adviser’s restricted list.
  • Situations where the adviser or its employees purchased securities at a better price, ahead of the adviser’s clients in contravention of the adviser’s code.


Grant Thornton observation: Recently we have observed various trends with respect to investor disclosure and disclosure practices. Grant Thornton has noticed that additional regulatory scrutiny pushes companies to be more transparent on compression of fees for investors. Automation of disclosure and reporting will allow management to focus on what is really important. Grant Thornton has identified that disclosure reporting is a task that is automation-ready. The benefits are massive for organizations that fully automate disclosures. Automation would allow for real-time capturing of deficiencies as well as accurate reporting to senior management, regulators and clients. This can be deployed to capture disclosure issues highlighted by the Division, specifically, board reporting regarding fund performance, changes to investment strategies, changes in indexes used for benchmarking, and overall fund expenses.




Disclosure best practices


The Division also noted areas of focus for compliance disclosure practices, specifically that certain funds and their advisers adopted and implemented compliance programs that provided for the following:

  • Review of compliance policies and procedures for consistency with practices
  • Conducting periodic testing and reviews for compliance with disclosures
  • Adopting and implementing policies and procedures to address compliance with applicable regulations, executive orders, and undisclosed conflicts of interest
  • Review of policies and procedures for consistency with the updated Marketing Rule


Grant Thornton observation: We have increasingly seen executives highlight the need for an efficient compliance program to ensure the accuracy of disclosures. In 2021, Grant Thornton conducted a survey of over 400 C-suite executives, including chief compliance officers, and the results indicated that organizations see compliance as critical, and the need to consider automation for testing as a necessity — not a luxury. Grant Thornton can be consulted by your organization to perform a robust review of your organization’s environment to identify all areas of compliance controls that are currently performed with manual tasks. Getting compliance right is the baseline for any asset manager, as it creates the net advantage of decreasing potentially disabling fines and penalties and gives your organization the ability to focus on the future.




4 key takeaways

  1. RIC initiatives by the Division encourages all registered funds and their advisers to review practices, policies, and procedures across compliance functions.
  2. The Risk alert(s) are intended to highlight areas for firms to focus on.
  3. The Division advises funds and their advisers to assess their supervisory, compliance, and/or risk management systems in response to the defined risks, and make any changes as needed or strengthen current systems.
  4. The Division encourages funds and their advisers to consider improvements to their compliance programs and disclosure practices.



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