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Mutual Funds - New SEC Sweep Exams and More

We have heard so much about the SEC's focus on private fund managers, but now attention is turning to include registered funds as well. OCIE Deputy Director Drew Bowden has warned the industry to expect upcoming sweeps. Areas of anticipated focus include 12b-1 fees and alternative investment companies.

The SEC's attention to 12b-1 fees is not unexpected. On July 21, 2010, the SEC proposed new rule and rule amendments (the “proposed rules”) to govern mutual fund distribution and marketing fees, and the SEC Chair at the time, Mary Schapiro, stated that the proposed rules were intended to “provide clarity and fairness to a mutual fund distribution system that has become confusing and potentially anticompetitive.” However, the SEC has not finalized the proposed rules. In a speech, on May 2, 2011 at the Mutual Fund Directors Forum conference, SEC Commissioner (now serving as Chair) Elisse Walker stated the SEC would resume work with “full force” on 12b-1 fees after reaching its July deadline related to Dodd-Frank Act1 rules.2 Last month, we wrote about the the SEC announcing its 2013 examination priorities (the “exam priorities”) including “Payment for Distribution in Guise” as one of its “New and Emerging Issues.” Bowden has shared that the results of the sweep examinations could “possibly” be used to revise the proposed rules.

In addition to the sweep on fees paid to mutual fund distributors, Bowden has shared that the SEC is also planning a sweep on the $200 billion alternative fund industry, and how it is using certain private fund strategies in publically traded investments. This again fits in with another of the SEC’s exam priorities, as “’Alternative’ Investment Companies” is listed as another of its “New and Emerging Issues,” noting focus on the growing use of alternative and hedge fund investment strategies in open-end funds, exchange-traded funds and variable annuity structures and stating the SEC’s plans to assess whether: (1) leverage, liquidity and valuation policies comply with regulations; (2) boards, compliance personnel and back offices are properly staffed, funded and empowered to handle the new strategies; and (3) the funds are being marketed to investors in compliance with regulations.

Bowden indicated that the first of the two sweeps are expected to commence this week.

Custody- Old News? Not if you can still Learn From the Failures of Other Investment Advisers

On March 4, 2013, the SEC’s Office of Compliance Inspections and Examinations issued a National Exam Program (“NEP”) Risk Alert (the “Alert”), stating it “has observed widespread and varied non-compliance with elements of the custody rule.”3 It also issued an Investor Bulletin, noting that the custody rule is “designed to provide additional safeguards for investors against the possibility of theft or misappropriation by investment advisers who are registered with the SEC,” but cautioned that “investors still need to be proactive in ensuring the safety of their investments.” Advisers are urged to consider their policies and procedures and their compliance with the custody rule in light of the deficiencies noted in the Alert. Custody deficiencies noted in the Alert include:

  • Failure by advisers to recognize they have custody;

  • Failure to fulfill the “surprise” exam requirements;

  • Failure to satisfy the “qualified custodian” requirements; and

  • Non-compliance by some advisers relying on the “audit approach” with respect to pooled investment vehicles with all the “audit approach” requirements such as sending financial statements to all investors with 120 days from fiscal year end, preparing such statements in accordance with GAAP or engaging auditors that are not PCAOB-registered or subject to PCAOB inspection.

We find that analyzing whether a firm has custody or not can be trickier than many initially think. We believe advisers would have benefited if the SEC included in the Alert even more examples of when an adviser is deemed to have custody.

The Alert is available here and the Investor Bulletin here.

If you have any questions about upcoming sweeps or the custody rule, please contact Janaya Moscony, This e-mail address is being protected from spambots. You need JavaScript enabled to view it , (212)706-4029, ext. 214.

1 Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111–203, H.R. 4173).

2 See reports by MFWire, Bloomberg and Dow Jones.

3 Rule 206(4)-2 under the Investment Advisers Act of 1940, as amended, 17 CFR 275.206(4)-2.

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