Each quarter the UMB Fund Services registered fund accounting, administration and tax teams consolidate the most impactful regulatory and tax developments in the fund industry. To guide your strategic and operational planning, our registered funds servicing team recommends you review and consider these developments from the prior quarter.

Securities Exchange Commission (SEC) issues risk alert regarding investment adviser material non-public information compliance issues

On April 26, 2022, the SEC’s Division of Examinations (EXAMS) issued a risk alert‡ concerning commonly observed deficiencies it had identified related to compliance with Section 204A of the Investment Advisers Act of 1940 (the Advisers Act) and Rule 204A-1 (the Code of Ethics Rule) thereunder.

Why it matters

Section 204A requires investment advisers to establish and enforce policies reasonably designed to prevent the misuse of material non-public information (MNPI) by the adviser and any related persons. Common deficiencies identified by EXAMS with respect to Section 204A compliance included inadequate policies and procedures regarding:

  • The use of data from non-traditional sources (e.g., satellite or drone imagery, social media and internet search data, geolocation data)
  • So-called “value-add investors” such as officers/directors of public companies who may possess MNPI
  • Information obtained from expert networks.

The Code of Ethics Rule requires registered investment advisers to adopt codes of ethics which govern the business conduct expected by the adviser’s supervised persons and establishes personal transactions and holdings disclosure requirements for access persons.

Common Code of Ethics Rule deficiencies identified by EXAMS include:

  • Failures in identification and supervision of “access persons”
  • Access persons’ failure to obtain pre-approval for certain investments
  • Failure to submit or review holdings and transaction reports
  • Failure to obtain acknowledgement of receipt of codes of ethics from covered associates

SEC requests comment on regulation of certain information providers as investment advisers

On June 15, 2022, the SEC issued a “Request for Comment on Certain Information Providers Acting as Investment Advisers‡” (the Request). The Request seeks comment on whether certain information providers, namely index providers, model portfolio providers, and pricing services, meet the definition of investment advisers under the  Advisers Act. Further, the Request seeks comment on whether such providers meet the definition of an investment adviser to investment companies under the Investment Company Act of 1940.

Why it matters

The Request notes that the role of information providers has grown both in size and scope in recent years and that “the development and nature of these services may raise investment adviser status issues under the Advisers Act.”

Among the noted concerns regarding the role of providers are investor protection and market risk. The Request specifically calls out the risk of front-running of trades, particularly “where the providers and their personnel have advance knowledge of changes to the information they generate”, as well as potential conflicts of interest “where the providers or their personnel hold investment they value or that are constituents of their indexes or models.”

Comments were requested by August 16, 2022.

SEC charges Wells Fargo Advisors with anti-money laundering (AML) violations

On May 20, 2022, the SEC announced charges against Wells Fargo Advisors‡ for failing to file Suspicious Activity Reports (SARs) timely.

Why it matters

Per the release, the SEC found that Wells Fargo Advisors’ lack of testing a new version of their AML monitoring system resulted in certain foreign wires not being monitored. The deficient monitoring caused SARs not to be filed timely.

The SEC indicated this enforcement action not only holds Wells Fargo Advisors accountable but is a reminder to the industry of their AML obligations.

Investment sub-advisor fined for pricing issues

A sub-advisor was fined for allegedly allowing its fund’s net asset value (NAV) to be inflated, which was caused by not having proper procedures in place to ensure the fund’s pricing vendor’s methodology was accurate or appropriate.

Why it matters

Garrison Point Capital served as sub-advisor to a multi-billion-dollar fund predominantly comprised of subprime non-agency residential mortgage-backed securities. While Garrison Point used a pricing vendor to value it’s round-lot bonds, it allegedly also used the vendor’s round-lot prices for its odd-lot bonds. These prices caused an inflated NAV for the fund because odd-lot bonds typically sell at a discount to round-lot bonds.

The SEC noted that Garrison Point both failed to comply with its valuation duties under its sub-advisory agreement and failed to follow its own procedures to prevent mispricing. The inflated NAV caused the fund’s marketing and regulatory materials to include inaccurate information that ultimately went to investors and potential investors. Garrison Point paid a $3.5 million fine to settle the charges.

SEC proposes “Names Rule” amendments

In May 2022, the SEC proposed amendments to the “Names Rule.”

Why it matters

Rule 35d-1 of the Investment Company Act of 1940 – coined the “Names Rule” – generally provides that 80% of a fund’s assets must be invested to align with what is suggested by that fund’s name. The SEC’s proposed amendments would broaden the Names Rule impact on funds.

Under the proposed amendments, the Names Rule would, among other things, also:

  • Expand the scope of the rule to include investment strategies, investment types and industries
  • Expand the rule to include descriptive characteristics such as “growth” or “value”
  • Create enhanced obligations for ESG (environmental, social and governance) focused funds
  • Tighten timing restrictions and exemptions for maintaining compliance with the rule

Comments on the proposal were due to the SEC by August 16, 2022.

SEC becoming increasingly involved in environmental, social and governance (ESG) matters

On May 23, 2022, the SEC charged BNY Mellon Investment Adviser, Inc. (BNY) for misstatements and omissions regarding ESG-related considerations purportedly contemplated by BNY when making investment decisions for certain mutual funds it managed. BNY agreed to pay a $1.5 million penalty to settle the charges. Surrounding the timing of this case, the SEC proposed rule changes related to ESG matters‡ and also proposed rules requiring climate-related risks.

Why it matters

The SEC is becoming increasingly interested and involved in the oversight of claims that issuers and investment advisors are making to investors regarding ESG matters. The proposed rule to require certain funds and investment advisers to disclose ESG investment practices, in coordination with changes to the Names Rule, are intended to promote consistent, comparable and reliable disclosures relating to ESG matters.

As highlighted by the BNY case, the SEC intends to explore how investment advisors’ and funds’ processes and procedures compare to these disclosures.

Also related to ESG, the SEC proposed rules that could require certain funds to include certain climate-risk related information‡ in its annual reports and registration statements. Issuers should continue to monitor these proposals because not only would funds have to compile this information, but they may also be required to gather information from other service providers as well to fulfill the disclosure requirements.

Click here for a review of the Spring 2022 registered funds tax and regulatory roundup.

Learn more about how UMB can support your firm’s registered and alternative investment fund administration needs, or contact us to be connected with a fund services team member.

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