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Sunday, December 15, 2019

Compliance examinations for Mutual Funds, Advisors, and Target Funds - Risk Alerts

David McNeal, Contributor, My Compliance Blog
Cory Roberson, Principal FIN Compliance

Uptick in Limited Scope examinations of Investment Advisors

December 13, 2019Over the last six months, we’ve seen an uptick in “limited scope” exams for SEC investment advisors in our network.  Most of these firms are either newly registered or those practices that haven’t been reviewed in a significant time period.

What goes on during a limited scope exam? 

Generally, firms with these types of exams: (1) Receive a call (or email) from examiners along with (2) a document request list for information to be sent via a secure portal (ref. request list, form 1661, and form 2389).  

Limited Scope v. Full Exam

The limited scope exam reviews a smaller portion of a firm’s documentation as opposed to the painstaking paperwork gathering process of a full SEC exam that can last for months.   For the commission, this strategy boosts efficiencies in the number of its registrants that are examined in a shorter time period.

On the state examiner side, we haven’t seen any noticeable signs of “limited scope” exam procedures.

Third-Party Advertising and Referral providers can be “Solicitors”

A common exam issue relates to advisors who hire third-party service providers in exchange for referrals (“client solicitations”).  For instance, the SEC (and state securities regulators) requires disclosures for firms who solicit third-party providers and then provide them with compensation for client referrals

These types of arrangements will trigger SEC Rule 206(4)-3 “Solicitor Rule”

Some firms may not adhere to solicitation disclosure requirements that include:

Solicitor Agreements (details of referral arrangement);
Investment advisory agreements (details of client arrangement);
ADV Part 2A/B Brochures (for clients);
Solicitor Disclosure agreements – (sent to clients); and/or
Acknowledgements of disclosure agreements kept on file by the advisor.

In addition, solicitors may be required to register as investment advisor representatives. (depending on jurisdiction).
Based on similar findings, the commission releases its annual examinations priorities report along with a series of risk alerts for its compliance study of investment advisors, business development companies, exchange traded funds, securities products, and registered investment companies (“mutual funds”).

A Look into Registered Funds

On November 2019, the Office for Compliance Inspections and Examinations (OCIE) published a risk alert based on almost 300 staff evaluations of registered investment companies ('funds').

This current report, created over a two year-span, provided guidance for funds to correct its most often cited inadequate policies and procedures as stated by the OCIE

The most frequently mentioned issues related to:

the fund compliance rule (rule 38a-1);
fund disclosures to investors;
the board approval of advisory agreements, and;
rules for the funds’ code of ethics.

Fund Compliance Rule

The Compliance Rule requires that a fund implement written policies and procedures that are adequately designed to ensure adherence to federal securities laws, the oversight for each investment adviser's service providers—key underwriters, managers and transfer agents (ref 38(a) -1).

The Fund Board shall authorize the policies and procedures of financial service providers.  However, the rule requires the fund to — annually —examine the appropriateness, effectiveness and quality of its compliance program and implementation.

Issues concerning the Funds’ conformity rule include:

Compliance programs that do not consider the nature of the funds’ business activities.
Policies and procedures not followed or enforced.
Inadequate service provider oversight.
Annual reviews not conducted, or the adequacy of policies and procedures not addressed.

Disclosure to Investors

The federal securities laws make it unlawful to make untrue statements of a material fact or omit information necessary to make other statements not misleading in registration paperwork, reports, and other documents filed with the Commission) or otherwise provided to investors).

Board Approval of an Investment Advisor to the Fund

Section 15(c) of the 1940 Act requires a majority of the fund’s independent directors to approve initially or renew, a contract or agreement with a person who serves or acts as an investment adviser or a principal underwriter for such fund.

As part of this approval process, all board members have a duty to request and evaluate information that may be reasonably necessary for participants to evaluate the terms of the adviser’s contract.

In addition, the fund is required to preserve any documents or other written information its board considered in approving the terms or renewal of the contract between the fund and the adviser.

Following a board’s approval or renewal of an advisory contract, a fund’s next shareholder report must discuss, in reasonable detail, the material factors and conclusions that formed the basis for the board’s decision.

Shortcomings in connection with Section 15(c) process include:

Reasonably necessary information not requested or considered.
Inadequate discussions forming the basis of board approval.

Fund Code of Ethics

This rule requires funds, in addition to similar entities, to adopt a written code of ethics containing provisions (reasonably necessary) to prevent their “access persons” from engaging in any fraudulent, deceptive, or manipulative acts in connection with the purchase and sale of securities held or to be acquired by the fund.

Its’ stipulations also generally requires access persons to report their personal securities holdings and transactions in “covered securities” to the fund.

Shortcomings in connection with the funds’ code of ethics rule include:

Failure to implement code of ethics;
Failure to follow or enforce code of ethics;
A lack of code of ethics approval and reporting.

Money Market Funds (MMFs)

The amendments to the rules governing MMFs became effective in October 2016.  In doing so, the SEC made significant changes to the way these MMF’s operate and the matters for which fund boards have oversight responsibility.

MMF Initiatives span across a wide range of fund categories, including Government, Prime, and Tax-Exempt funds, as well as entities that were also designated as Retail MMFs, which are required to limit their beneficial owners to natural persons.

Guidance on shortcomings related to MMFs’ portfolio management, compliance programs, and disclosures include:

“Eligible securities” and minimal credit risk determinations.

Include in credit files one or more of the factors required under Rule 2a-7.
Adequately document the periodic update of credit files to support the eligible security determination.
Maintain records that adequately support repurchase agreements with non-government entities that have been fully collateralized by cash or government securities (for Government MMFs).
Provide a summary of significant stress testing assumptions.

Policies and procedures for Rule 2a-7

Adopt and implement compliance policies and procedures designed to address certain requirements under Rule 2a-7 and other areas.
Oversee written guidelines and procedures under which the adviser analyzes credit factors and makes minimal risk-based determinations.
Oversee policies and procedures of net asset value deviation and the amount of variance.
Limit investors in Retail MMFs to natural persons.
Test to ensure that no more than 5% of the funds’ assets were invested in any one issuer.
Incorporate all required elements for considering, imposing and lifting liquidity fees and/or gates (redemption limits or halts) if the funds’ weekly liquid assets are less than 30% of their assets.
File accurate and timely information with the Commission, such as Form N-MFP.
Ensure that the master fund makes the fee and gate determinations in ‘master/feeder fund’ arrangements.

Websites and advertising materials.

Post accurate information on websites of all information required under Rule 2a-7.
Include all required legends in their advertising materials.

Target Date Funds (TDFs)

TDFs’ must invest according to the asset allocations stated in the funds’ prospectuses, and whether the associated investment risks were consistent with fund disclosures (including representations made in marketing materials).

Best practices on shortcomings related to TDFs’ disclosures and compliance programs:

Incomplete and potentially misleading disclosures in prospectuses and advertisements

Disclose all asset allocations, both current and prospective over time.
Disclose all glide path changes (calculation of asset allocation of portfolio) and the impact of these glide path changes on asset allocations.
Disclose all conflicts of interest, such as those that may result from the use of affiliated funds and similarly structured investment advisers.

Incomplete or missing policies and procedures

Monitor asset allocations, including on-going monitoring.
Oversee implementation of changes to their current glide path asset allocations.
Oversee advertisements and sales literature, which resulted in disclosures that were inconsistent with prospectus disclosures and were potentially misleading.
Monitor whether disclosures regarding glide path deviations were accurate.


Funds should review their practices, policies, and procedures in these areas and to consider improvements in its compliance programs, as may be appropriate.

Firms should:

Assess supervisory, compliance, and other risk management systems.
Make any changes, as may be appropriate, to address or strengthen such systems.

Other risks, besides those described above, may be appropriate to consider, and some issues discussed above may not be relevant to a firm’s business. The adequacy of supervisory, compliance, and other risk management systems can be determined only with reference to the profile of each specific firm and other facts and circumstances.

FIN Compliance Products and Services 

RIA Registration Services:  New/existing firms.
RIA Compliance Consulting:  Ongoing/annual services.
Compliance Management System: Online portal.
Business Management System: Online portal. 
Advisor Transition Support:  RIA Matchmaking/continuity services.

Business/Referral Network: Inquire about advertising/consulting projects. 

Our Approach

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Needs Analysis Workflow - We work with firms in determining their compliance management priorities.  During/after a need’s analysis, we provide firms with compliance/business service options to address those needs and will provide firms with sample workflows for task delegation purposes.

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Regulatory Changes - We research regulatory updates from state, SEC, and/or FINRA jurisdictions. We’re here to help as some rules/regulations may be amended over time.

About FIN Compliance 

FIN Compliance  (FinCompliance.iois a consortium of compliance, consulting, and business management solutions designed to help boutique investment firms to structure, maintain, and develop their internal regulatory review programs.  

Our product line consists of:  RIA Consults-Roberson Consults Group, a compliance consulting firm, RIA Review, a compliance-management system, B-D Review, a Hybrid-management system (est. in 2020)*, and FIN Lancer, a Business/Task Management system. 


FIN Ventures focuses on business strategy consulting for impact-based projects (  

FIN Missions ( provides business/vision support group sessions for other entrepreneurs and youth mentoring.  In addition, Cory has volunteered for more than fifteen youth programs in locations such as like S. Korea, China, S. Africa, Thailand, and India.

Contact:  Cory Roberson - 

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