Investment Company Compliance. Beyond the Basics

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1 Investment Company Compliance Beyond the Basics

2 Investment Company Compliance - Beyond the Basics

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6 Investment Company Compliance - Beyond the Basics

7 Investment Company Compliance - Beyond the Basics New SEC rules and rule proposals Enhanced reporting Liquidity risk management Derivatives Business continuity

8 Investment Company Compliance - Beyond the Basics New SEC rules and rule proposals Report Modernization Compliance Dates: August 1, 2017 for amendments to Regulation S-X and Form N-1A (SAI) and closed-end fund securities lending reporting on Form N-CSR; June 1, 2018 (larger fund entities) or June 1, 2019 (smaller fund entities) for Form N-PORT (filed monthly) and amendment to certification requirements for Form N-CSR; and June 1, 2018 for Form N-CEN (filed annually) and requirement to file letter reporting a change in auditor with Form N-CSR

9 New SEC rules and rule proposals Report Modernization (continued) New Form N-PORT (replaces Form N-Q) requires monthly reporting of a fund s complete portfolio holdings plus additional risk metric calculations that measure a fund s exposure and sensitivity to changing market conditions (such as changes in asset prices, interest rates, or credit spreads) and standardized enhanced derivatives information not currently reported Filed each month no later than 30 days after month end with a 60-day delay for each quarter being made public Investment Company Compliance - Beyond the Basics Requires a fund to report monthly position-level liquidity classification information and its HLIM on a confidential basis; public on a quarterly basis

10 New SEC rules and rule proposals Report Modernization (continued) Form N-CEN (replaces Form N-SAR) requires annual reporting of censustype information, including securities lending activities Requires a fund to report information regarding the use of lines of credit, interfund lending, and interfund borrowing Requires an ETF to report publicly to the SEC its designation as an In-Kind ETF Requires attachments including: Internal Control Report, changes in auditors, changes in accounting principles, litigation proceedings and provisions for financial support Filed annually 75 days after fiscal year end Investment Company Compliance - Beyond the Basics

11 New SEC rules and rule proposals Report Modernization (continued) Amendments to Regulation S-X, Articles 6 and 12 Investment Company Compliance - Beyond the Basics Standardizes and makes more prominent disclosure regarding fund holdings in certain derivatives Updates disclosure regarding net and total realized gains or losses and changes in unrealized appreciation or depreciation about a fund s affiliated investments Requires rule 6-10 schedules (related to investments in securities of unaffiliated issuers, securities sold short, open option contracts written, open futures contracts, etc.) to be presented together within a fund s financial statements and not in the notes to the financial statements

12 Investment Company Compliance - Beyond the Basics New SEC rules and rule proposals Liquidity risk management Compliance Dates June 1, Amendments to Form N-1A. December 1, 2018 (larger fund entities) or June 1, 2019 (smaller fund entities) for adoption and implementation of written liquidity risk management program approved by a fund s board and for amendments to Form N-PORT and Form N- CEN

13 New SEC rules and rule proposals Liquidity risk management (continued) Program Requirements: Assessment, management, and periodic (at least annual) review of a fund s liquidity risk based on specified factors; Classification of the liquidity of fund portfolio investments; Determination of a highly liquid investment minimum; Limitation on illiquid investments; Board oversight Classifications: Highly liquid investments: cash and any investment convertible into cash (i.e., sold and sale is settled) in 3 business days or less without significantly changing the market value of the investment; Moderately liquid investments: convertible into cash in more than 3 calendar days but in 7 calendar days or less without significantly changing the market value of the investment; Less liquid investments: able to be sold or disposed of in 7 calendar days or less without significantly changing the market value of the investment; but settlement is expected to be more than 7 calendar days; Illiquid investments: cannot be sold or disposed of in 7 calendar days without significantly changing the market value of the investment.

14 New SEC rules and rule proposals Liquidity risk management (continued) Form N-PORT Requires a fund to report, on a non-public basis, the fund s highly liquid investment minimum, whether the minimum has changed during the reporting period, and the number of days the fund was below its minimum during the reporting period. Form N-LIQUID Requires a fund to confidentially notify the SEC within 1 business day if its holdings in highly liquid investments fall below the minimum for more than 7 consecutive calendar days. Board Reporting Board must approve the fund s liquidity risk management program The Board must approve the designation of a program administrator May not be solely portfolio managers, but can be assigned to the investment adviser or group of officers. Board must review, at least annually, a written report that addresses the operation of the program and assesses its adequacy and the effectiveness of its implementation

15 Investment Company Compliance - Beyond the Basics New SEC rules and rule proposals Business Continuity SEC Proposed Rule for advisers: pdf BCP for Registered Investment Companies June

16 Investment Company Compliance - Beyond the Basics Intermediary oversight and the SEC s distribution in guise The SEC first publicly identified a concern with the wide variety of payments made by advisers and funds to distributors and intermediaries, the adequacy of disclosure made to fund boards about such payments, and boards oversight of the same in its Examination Priorities for 2013 From 2013 to 2015, the SEC initiated sweep exams, seeking to determine whether some mutual fund advisers were improperly using fund assets to pay for distribution by masking the payments as sub-transfer agency (sub-ta) payments Enforcement Cases

17 Intermediary oversight and the SEC s distribution in guise SEC Communications: The SEC issued an IM Guidance Update in January 2016 to outline its views related to the sweep examination findings The Guidance Update emphasizes that fund trustees bear substantial responsibility for determining whether fees paid by a mutual fund are used to pay for distribution-related activities Further, fund trustees should focus on understanding the overall distribution process to allow them to make an informed reasonable business judgment about whether subaccounting and other fees paid by a mutual fund represent direct or indirect payments for distribution-related activities Associate Director of IA/IC Exam Program SEC NY Regional Office (At PLI s Investment Management Institute 2016) I can t get the information is not a valid excuse. There is no carve out in the federal securities law for I can t find the information or They won t give it to me.

18 Intermediary oversight and the SEC s distribution in guise Develop and/or revise Policies and Procedures related to intermediary payments. Distinguish between distribution and non-distribution fee payments. Establish/re-establish processes for new or modified sub-ta fee payments. Review/revise and test intermediary payment processes. (Rule 38a-1 program). Board reporting related to intermediary fee payments. Enhance information presented to provide clear distinctions between distribution-related payments and all non-distribution-related payments to intermediaries. Considerations to attempt to determine the quality of the services by the intermediaries. Questionnaires and request FICCA reports of the intermediary Agreement Onboarding and Amendment Review and Approval Defined process, record keeping, interdepartmental coordination to fit your firm Board Reporting and Education Beyond Fees Presentation on TA functions, relation to Sub-TA arrangements, the rationale for fee structures and relevant controls

19 The Players Sponsor: Organizes and promotes the Fund; arranges service providers Investment Advisor/Manager: Manage the portfolio and invest the assets Investment Managers may retain sub-advisors Directors: > 50% independent Administrator: Accounting, NAV calculation May be affiliated with Advisor Distributor: Broker-dealer activities Custodian: Certain banks Transfer Agent: Keep shareholder records Auditors: Annual audit and opinion on financials Fund Counsel: Registration statement, filings, opinions, board meetings, advice Chief Compliance Officer: Annual report to board re: compliance with securities laws

20 Conflicts of Interest Affiliate: investment adviser, officers, directors, partners, etc. (n.b. complex definition) An Affiliate may not: Sell any security to the Fund Purchase any security from the Fund Borrow money from the Fund Exception for exchange-traded securities at the current market price (Rule 17a-7) E.g. seeding of GOBF fund An affiliate may not engage in a joint enterprise with a fund (e.g. securities purchases, kickbacks from service providers, trade allocation) An affiliate may not act as agent for compensation in a transaction with the Fund (e.g. broker) Rule 17e-1: permissible affiliated brokerage

21 Code of Ethics Reports by Access Persons Holdings and Transaction reports Must be reviewed by management or compliance Access Person: any director, officer, general partner of adviser who, with respect to any Fund, makes any recommendation, participates in the determination of which recommendation will be made, or whose principal function or duties relate to the determination of which recommendation will be made, or who, in connection with his or her duties, obtains any information concerning recommendations made by the investment adviser to any Fund Pre-approval of participation by investment personnel in IPOs and private placements Recordkeeping: Code, violations, certifications, access persons, holdings reports Disclosure about personal trading policies in prospectus Filing of Code of Ethics w/ SEC

22 Compliance Fund must adopt and implement policies and procedures reasonably designed to prevent violations of the securities laws Portfolio management, trading, disclosures, recordkeeping, valuation, privacy, market timing Oversight of Fund service providers Board approval of written policies and procedures Consider recent compliance experience Best practices Annual review of adequacy and effectiveness Includes testing Consider changes in business, regulations, compliance Presentation to Board Designate responsible Chief Compliance Officer (competent, senior, independent) Record-keeping

23 Summary Investment Company Compliance - Beyond the Basics Mutual Funds are highly regulated Consult your Legal or Compliance Professional Questions? Dave Banerjee CPA RND Resources Inc Compliance Audits Registration for BD s, RIA s, Funds Em: dave@finracompliance.com Ph: James Butz, SVP Compliance US Bancorp Fund Services Chief Compliance Officer ETF Series Solutions Em: james.butz@usbank.com Ph: