A newly released Risk Alert from the Securities and Exchange Commission reviews several deficiencies and weaknesses observed from its examinations of target date funds and money market funds.
The Nov. 7 Alert by the SEC’s Office of Compliance Inspections and Examinations (OCIE) explains that most TDFs appeared to be in “general compliance” with the 1940 Act in the areas reviewed, but staff did find issues related to disclosures and compliance programs. In addition, it notes that the MMFs examined appeared to be in “substantial compliance” with the amended rules, but the staff did observe shortcomings related to portfolio management practices, compliance programs and disclosures.
The Alert also reviews the most often cited deficiencies and weaknesses observed in nearly 300 fund examinations over a two-year period, which include those related to the fund compliance rule, investor disclosures, the board approval process involving advisory contracts and the fund code of ethics rule.
TDF Initiative
OCIE staff examined over 30 TDFs – including both “to” and “through” funds – to review whether the TDFs’ assets were invested according to the asset allocations stated in the funds’ prospectuses and whether the associated investment risks were consistent with fund disclosures, including representations made in marketing materials.
According to the Alert, some TDFs had “incomplete and potentially misleading” disclosures in their prospectuses and advertisements, including, for example, disclosures regarding:
- asset allocations, both current and prospective, where TDFs had marketing materials with asset allocation disclosures that differed from the TDFs’ prospectus disclosures;
- glide path changes and the impact of these changes on asset allocations; and
- conflicts of interest, such as those from the use of affiliated funds and affiliated investment advisers.
The Alert further observes that many TDFs had incomplete or missing policies and procedures, including those for:
- monitoring asset allocations, including on-going monitoring;
- overseeing implementation of changes to their current glide path asset allocations;
- overseeing advertisements and sales literature, which resulted in advertising disclosures that were inconsistent with prospectus disclosures and were potentially misleading; and
- monitoring whether disclosures regarding glide path deviations were accurate.
MMF Initiative
The OCIE staff examined more than 70 MMFs for compliance with the amendments to the rules governing MMFs that became effective in October 2016. The examination spanned across a range of fund categories, including Government, Prime and Tax-Exempt funds, as well as MMFs that were also designated as Retail MMFs.
In the area of “Eligible securities” and minimal credit risk determinations, the staff observes that some MMFs did not:
- include in their credit files one or more of the factors required to be considered when determining whether a security presents minimal credit risks and is an eligible security, as defined under Rule 2a-7;
- adequately document the periodic updating of their credit files to support the eligible security determination; or
- maintain records that adequately support their determination that investments in repurchase agreements with non-government entities were fully collateralized by cash or government securities (for Government MMFs).
The Alert further emphasizes that some MMFs provided stress test results to their boards that did not include the required summary of significant assumptions used in the stress tests.
Additionally, some MMFs had not adopted and implemented compliance policies and procedures reasonably designed to address certain requirements under Rule 2a-7 and other areas. As examples, the OCIE notes that some funds did not have policies and procedures that addressed:
- periodic board oversight of the MMFs’ written guidelines and procedures under which the adviser, when delegated by the MMFs’ board, analyzes credit risks and makes minimal credit risk determinations;
- periodic board oversight of certain MMF information, including net asset value deviation methods and the amount of the deviation;
- limiting investors in Retail MMFs to natural persons;
- testing for issuer diversification to ensure that no more than 5% of the funds’ assets were invested in any one issuer;
- incorporating all required elements for considering, imposing and lifting liquidity fees and/or gates if the funds’ weekly liquid assets were less than 30% of their assets;
- filing accurate and timely information with the Commission, such as Form N-MFP; and
- providing that the master fund shall make the fee and gate determinations in master/feeder fund arrangements.
The staff also observed instances in which MMFs did not post on their websites all information required under Rule 2a-7 and/or posted inaccurate information, as well as instances in which MMFs did not include all required legends in their advertising materials.
