Proposed Rules Requiring Investment Companies and Investment Advisers to Adopt "Compliance Programs"
The Securities and Exchange Commission is proposing new rules that would require each investment company and investment adviser registered with the Commission to adopt and implement policies and procedures designed to prevent the violation of federal securities laws and to protect fund investors. The proposals, if adopted, would:
- Require mutual funds and investment advisers to adopt a system of controls that promote compliance with securities laws;
- Require mutual funds and investment advisers to review policies and procedures annually for adequacy and effectiveness; and
- Require mutual funds and investment advisers to designate a chief compliance officer responsible for administering the compliance programs.
Adoption and Implementation of Policies and Procedures
The SEC regularly conducts examinations of mutual funds and investment advisers as part of its investor protection program. During these examinations, SEC staff visits the offices of a fund or adviser to review business records and interview personnel to determine its level of compliance with federal securities laws. However, due to the large and growing number of registered funds and advisers, the SEC is unable to conduct compliance examinations of each fund and adviser more than once every five years. As a result, the SEC has determined that the establishment of internal compliance programs administered by competent personnel would complement the SEC's examination program and provide the first line of investor protection while decreasing the risk of federal securities laws violations. While many funds and advisers have established compliance programs, neither the current federal securities laws nor SEC rules require funds and advisers to adopt and implement such programs.
The SEC is proposing new Rule 38a-1 under the Investment Company Act and new Rule 206(4)-7 under the Investment Advisers Act, collectively referred to as the "Proposed Rules," which would require all registered investment companies and registered investment advisers to adopt and implement internal compliance programs reasonably designed to prevent the violation of federal securities laws. A mutual fund's program must be designed to prevent violation of the securities laws by its investment adviser, principal underwriter and administrator in connection with their provision of services to the fund. An investment adviser's policies and procedures must be designed to prevent violations of the Investment Advisers Act by the adviser and its supervised persons. Such policies and procedures must be written and, in the case of a mutual fund, must be approved by the fund's board of directors. Although the Proposed Rules do not indicate the specific elements that funds and advisers must include in their policies and procedures, each fund and adviser should take into consideration the nature of its operations. Thus, according to the SEC policies and procedures should address:
- Portfolio management processes;
- Trading practices;
- Proprietary trading;
- The accuracy of disclosures made to investors;
- Safeguarding of client assets from conversion or inappropriate use by advisory personnel;
- The accurate creation of required records and their maintenance;
- Processes to value client holdings;
- Safeguards for the protection of client records and information; and
- Business continuity plans.
- Additional areas that mutual fund procedures might cover include:
- Pricing of portfolio securities and fund shares;
- Processing of fund shares;
- Identification of affiliated persons with whom the fund cannot enter into certain transactions;
- Compliance with fund governance requirements; and
- Prevention of money laundering.
Chief Compliance Officer. The Proposed Rules would require each fund and adviser to designate an individual responsible for administering its compliance program. The chief compliance officer should be competent and knowledgeable regarding the applicable federal securities laws and will be authorized and responsible for developing and enforcing appropriate policies and procedures for the adviser of the fund.
With respect to a mutual fund, the fund's board of directors, along with a majority of the independent directors, would need to approve the chief compliance officer who would have additional duties in overseeing fund compliance with federal securities laws. Proposed Rule 38a- 1 would require the chief compliance officer to provide the board of directors with a written annual report on the operation of the fund's policies and procedures, including (i) any material changes to the program since the last report; (ii) any recommendations for material changes to the program as a result of the annual review; and (iii) any material compliance matters requiring remedial action since the last report.
Annual Review. The Proposed Rules would require each fund and adviser to annually review its policies and procedures for accuracy and overall effectiveness.
Recordkeeping. The SEC is also proposing to require mutual funds and investment advisers to maintain copies of their policies and procedures, as well as the chief compliance officer's annual written report on the operation of a mutual fund's policies and procedures and records documenting the annual review of an adviser's policies and procedures. These required documents would need be kept for five years.
Please contact Charles Weber (414/277-5107 or email@example.com), Conrad Goodkind (414/277-5305 or firstname.lastname@example.org) or Fred Lautz (414/277-5309 or email@example.com) if you have any questions about the matters discussed in this Update.