The Securities and Exchange Commission (SEC) recently announced settled allegations against an investment adviser to exchange-traded funds (ETFs) for alleged violations of multiple provisions of the Investment Company Act of 1940.
The SEC’s order addressed affiliated transactions, leverage risk management, shareholder disclosures, and fund compliance programs.
Prohibited Affiliated Transactions
According to the SEC, the adviser caused its affiliate to engage in two prohibited transactions with an ETF in violation of Section 17 of the Investment Company Act. The transactions resulted in tax benefits to the adviser’s affiliate.
First Rule 18f-4 Enforcement Action
The SEC also found that the adviser caused an ETF to exceed the leverage limits permitted under Investment Company Act Rule 18f-4 and failed to timely notify the fund’s board and the SEC of those breaches.
According to the order, the ETF exceeded the applicable value-at-risk (VaR) test under Rule 18f-4 on multiple occasions. The adviser did not provide the required notifications and written reports after the fund remained out of compliance with the VaR test for more than five business days.
Notably, this is the SEC’s first enforcement action alleging violations of Rule 18f-4, signaling increased scrutiny of funds’ leverage risk management programs and compliance with the rule’s reporting and oversight requirements.
Shareholder Notices and Compliance Policies
The SEC found that, from 2021 through 2024, the adviser caused seven ETFs to fail to provide required notices informing shareholders that a portion of certain distributions represented returns of capital rather than income.
The SEC also determined that certain adviser-managed ETFs lacked compliance policies and procedures reasonably designed to prevent violations of federal securities laws.
Penalty and Takeaways
The ETF adviser agreed to a cease-and-desist order and a $400,000 civil penalty.
This enforcement action underscores the SEC’s continued focus on ETF compliance, including affiliated transaction restrictions, leverage oversight, shareholder disclosures, regulatory reporting, and compliance program effectiveness.
Your Alston & Bird Investment Funds Group is ready to help with any questions concerning this recent enforcement action.
If you have any questions, or would like additional information, please contact one of the attorneys on our Investment Funds team.
You can subscribe to future advisories and other Alston & Bird publications by completing our publications subscription form.