SEC Settles Charges Against Investment Adviser for Affiliate Transactions, Derivatives Compliance Failures and Shareholder Disclosure Violations

Who may be interested: Registered Investment Companies; Directors of Registered Investment Companies; Investment Advisers; Exchange Traded Funds

Quick Take: On July 27, 2026, the SEC announced settled charges against a registered investment adviser to exchange-traded funds, finding that the adviser caused violations to multiple provisions of the Investment Company Act of 1940, as amended, involving affiliated transactions, derivatives risk management, shareholder disclosures, and fund compliance policies and procedures.

According to the SEC’s Order (the “Order”), between July 2021 and November 2024, the registered investment adviser (the “Adviser”) caused multiple exchange-traded fund (“ETF”) clients to violate provisions of the Investment Company Act of 1940, as amended (the “1940 Act”). Specifically, the Order alleged that the misconduct included facilitating prohibited affiliate transactions involving one exchange-traded fund (“ETF”) client, causing another ETF client to fail to comply with conditions under Rule 18f-4 of the 1940 Act related to derivatives transactions and to make the required SEC filings, and causing multiple ETF clients to omit required shareholder notices concerning return of capital distributions.

Affiliate Transactions

A significant portion of the Order focused on two in-kind ETF creation transactions involving a trust that the SEC determined was an “affiliated person” of the Adviser under Section 17(a) of the 1940 Act due to its ownership interest in the Adviser. Section 17(a)(1) of the 1940 Act generally prohibits an affiliated person of a registered investment company, or an affiliated person of such person, acting as principal, from knowingly selling securities or other property to the fund unless an exemption is available or exemptive relief has been obtained from the SEC pursuant to Section 17(b).

According to the Order, the trust transferred securities to an ETF advised by the Adviser in exchange for fund shares through in-kind transactions that constituted prohibited affiliate transactions under Section 17(a)(1) of the 1940 Act. No exemptive relief was obtained under Section 17(b). The SEC further alleged that the Adviser recommended and facilitated the transactions, presented them to the ETF’s board and represented that the transactions did not involve affiliates. The SEC concluded that the Adviser’s actions caused violations of Section 17(a)(1).

Derivatives Compliance Failures

The SEC also identified deficiencies in the administration of an ETF’s derivatives risk management program under Rule 18f-4 of the 1940 Act. According to the Order, the ETF established a significant options position that increased its leverage exposure and caused the ETF to exceed the rule’s applicable Value at Risk (“VaR”) limits on two separate occasions in 2024. During these periods, the ETF’s VaR remained above the permitted 200% threshold for multiple business days and, at times, substantially exceeded the threshold permitted under the rule.

Although personnel of the ETF and the Adviser attempted to reduce the position and return the ETF to compliance, the SEC alleged that the Adviser failed to satisfy certain procedural requirements triggered by the extended VaR breaches. In particular, the ETF’s board was not notified of the breaches until several months after they occurred and the ETF failed to timely file required reports with the SEC disclosing the breaches.

Return of Capital Disclosure Failures

The Order also alleges that several ETFs advised by the Adviser failed to provide shareholders with notices required by Section 19(a) of the 1940 Act and Rule 19a-1 thereunder when distributions included amounts characterized as returns of capital rather than income.

According to the SEC, the disclosure failures occurred over a period of several years and affected multiple funds. During the relevant periods, portions of certain distributions were sourced from shareholder capital, but the required contemporaneous notices were not provided to investors. In some instances, returns of capital represented a substantial percentage of the distributions paid by the ETFs.

Although the ETFs ultimately disclosed the character of their distributions in shareholder reports, the SEC emphasized that these later disclosures do not satisfy the requirement to provide a separate notice at the time the distribution is made.

Compliance Program Deficiencies

The SEC also found that the ETFs’ compliance programs, which were reviewed and, in part, drafted by the Adviser, were not reasonably designed to prevent violations of the federal securities laws. Among other deficiencies, the ETFs lacked policies and procedures addressing the delivery of required return of capital notices and ETF custom basket transactions under Rule 6c-11 of the 1940 Act. As a result, the SEC concluded that the Adviser caused violations of Rule 38a-1 under the 1940 Act.

Penalties

Without admitting the findings, the Adviser agreed to a cease-and-desist order from committing or causing any future violations, as well as the payment of a civil monetary penalty in the amount of $400,000.

Takeaways

This enforcement action serves as a reminder that the SEC continues to focus on core fund compliance obligations, including identifying and managing affiliate relationships prior to engaging in fund transactions, maintaining effective controls surrounding Rule 18f-4 derivatives risk management and reporting obligations, providing timely Section 19(a) notices, and adopting Rule 38a-1 compliance policies and procedures that are adequately tailored to a fund’s operations. More broadly, the Order underscores the SEC’s continued emphasis on safeguards intended to prevent conflicts of interest, reduce risks to fund investors, and promote transparency regarding the sources of fund distributions.

The Order can be found here.