Securities and Exchange Commission will Target Mutual Funds and ETFs in Exams

On November 8, 2018, the U.S. Securities and Exchange Commission announced a launching of a series of exam initiatives focused on mutual funds and exchange-traded funds (ETFs).

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The agency’s Office of Compliance Inspections and Examinations released a Risk Alert stating that the exams will focus on funds and/or advisors that fall into one or more of the following 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 assets;
  • Funds with aberrational underperformance relative to their peer groups;
  • Advisors relatively new to managing mutual funds; and
  • Advisors who provide advice to both mutual funds and private funds that have similar strategies and/or are managed by the same portfolio managers.

Pete Driscoll, head of OCIE, at the American Law Institute Continuing Legal Education life insurance products conference, also said the alert highlights issues that are among priority areas the exam division will focus on.

Driscoll said that OCIE “finds value” in releasing Risk Alerts because they give firms “a heads up” on compliance issues.

The exams, the alert states, will target circumstances in which retail investors could be disadvantaged and review whether registrants have met their regulatory and other legal obligations, OCIE states.

SEC examiners intend to focus on certain mutual funds and exchange-traded funds, the activities of their advisors and boards of directors’ oversight.

Other exam priorities for next year, Driscoll said, include a “Cyber 3 Initiative,” which will assess, in part, how firms that have merged have combined their cybersecurity processes.

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OCIE will also look at the cryptocurrency space, Driscoll said.  OCIE has identified “over 100 private fund advisors that are invested in such arrangements.

Advisors borrowing from clients will also be a 2019 focus.  “People get over their skis” and they may borrow from clients, Driscoll stated.  OCIE will be “doing some loan initiatives where [OCIE will look at] principals that have a lot of liens and filed for bankruptcy,” which may indicate that they need to borrow from clients.  “Often times there’s misrepresentation” involved, he said.

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