SEC’s Office of Compliance Inspections and Examinations Issues Risk Alert to Provide Information on Risk-Based Examination Initiatives Focused on Registered Investment Companies

November 14, 2018

On November 8, 2018, the staff (Staff) of the SEC’s Office of Compliance Inspections and Examinations issued a Risk Alert (Risk Alert) indicating that it is conducting a series of examination initiatives focused on matters relevant to certain mutual funds and exchange-traded funds (ETFs). Examinations will target circumstances in which retail investors could be disadvantaged and review whether registrants have met their regulatory and other legal obligations. The Risk Alert notes that the Staff will generally assess the following areas, particularly as they relate to risks and conflicts: (1) policies and procedures of funds and advisers; (2) disclosures by funds to investors and by advisers to fund boards; and (3) the deliberative processes utilized by funds, their advisers and their boards exercising oversight.

The Risk Alert states that examinations will focus on funds and/or advisers that fall into one or more of the following categories:

Index funds that track custom-built indexes.1 The Staff will assess the unique risks and challenges associated with the roles of advisers and index providers as they relate to the selection and weighting of the custom-built or bespoke index components, ongoing index administration, management of the funds, and related performance advertising. The Staff will, among other things, compare the manner in which the funds are managed to fund disclosures to investors; assess conflicts of interest between the index providers and advisers; and review portfolio management compliance programs.

Smaller and/or thinly traded ETFs. The Staff notes that smaller ETFs and/or ETFs that have little secondary market trading volume may present risks to investors including, for example, increases in bid/ask spreads and increasing premiums/discounts to net asset value. These ETFs may also be subject to the risk of being delisted from an exchange and having to liquidate their assets.

Mutual funds with aberrational relative underperformance. The Staff will seek to understand the factors for the funds’ aberrational underperformance relative to their peer groups, including asset allocation and security selection processes. The Staff will review the effectiveness of the compliance programs (particularly with respect to portfolio management processes) and whether fund boards are exercising appropriate oversight of the compliance programs.

Mutual funds with higher allocations to certain securitized assets. The Staff notes that mutual funds investing in certain securitized assets (e.g., securitized auto loans, student loans, credit card receivables, or mortgage-backed securities) may expose retail investors to risks that may not be adequately disclosed to investors, or investment risks not anticipated by the adviser in light of potential changes in market conditions and unexpected market stresses. The Staff will assess whether the funds and/or their advisers have, among other things, appropriate policies and procedures, practices, and related oversight, including those relating to portfolio management, valuation and pricing of investments, and disclosures of investment risk.

Side-by-side management of mutual funds and private funds. The Staff notes there are conflicts of interest associated with advisers who provide advice to both mutual funds and private funds, particularly when managed pursuant to similar strategies and/or by the same portfolio managers, which may present certain risks to retail investors. The Staff will evaluate advisers’ policies and procedures for addressing such conflicts as well as disclosures to investors and fund boards.

Funds managed by advisers that are relatively new to managing registered investment companies. The Staff notes that advisers that are relatively new to managing mutual funds may lack experience or sufficient knowledge regarding the Investment Company Act of 1940. The Staff will, among other things, evaluate the effectiveness of compliance programs related to these advisers and their funds.

Lastly, the Risk Alert encourages registrants to reflect upon their own practices, policies, and procedures and to consider improvements in their supervisory, oversight, and compliance programs.


1 A custom-built or bespoke index is one that is created and/or maintained by an index provider for a single fund or sponsor. It is used to select the fund’s investments and may allow for a more complex or targeted investment strategy than has been traditionally associated with index funds.


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