SEC Division of Investment Manager Director Speaks on Complex Products

October 29, 2014

Norm Champ, the SEC’s Director of the Division of Investment Management, spoke at the SIFMA Complex Products Forum in New York on specialized products. He began by noting that his Division views the exemptive application process as the laboratory where it examines new ideas from market participants, most recently including a proposed non-transparent ETF structure. In addition, he stated that the Division’s role of reviewing disclosure and fund financial reporting also affords its staff the opportunity to identify and monitor industry-wide risks. For example, last year, the disclosure review staff noticed an increase in the number of funds using the word “protected” in their fund names. In response, the staff raised concerns because the fund’s name suggests safety or protection from loss.

He next spoke about the Division’s senior level engagement program. Through this outreach initiative, senior leadership of the Division has met and continues to meet with senior management and fund boards at several of the country’s large asset managers.  These engagements give the Division a “finger on the pulse” of registrants, which has proved invaluable when an issue arises in the industry. These meetings further allow the Division to obtain a focused and informed view of the systems, controls, and personnel of an individual firm.

He then reviewed the Division’s Industry Monitoring Program. He gave an example of how this Program helps the Division protect investors. In 2013, an ongoing analysis of money market fund data led to an enforcement action against Ambassador Capital Management.  During the Division’s review of the gross yield of funds as a marker of risk, it identified the Ambassador Money Market Fund as consistently different from the rest of the market. The Division brought this to the attention of OCIE, the matter was referred to the Enforcement Division’s Asset Management Unit for further investigation, and then the SEC brought fraud charges against the advisory firm and portfolio manager.

He next covered the Division’s access to and use of data. He stated that the Division staff now has access to a new analytical tool called “MIDAS (Market Information Data Analytics System),” which collects about 1 billion daily records from the proprietary feeds of each of the 13 national equity exchanges time-stamped to the microsecond. In addition to MIDAS, the Quantitative Analytics Unit in the SEC’s National Exam Program has also developed new technology that allows examiners to access and systematically analyze massive amounts of trading data from firms in a fraction of the time it would have taken in years past.

Director Champ concluded his speech with a discussion about alternative mutual funds. He mentioned the recent statement by Andrew Bowden, the Director of OCIE, that alternative mutual funds are “bright, shiny objects—bright, shiny objects that are sharp.” Director Champ stated his belief that several areas—such as valuation, liquidity, and leverage—present heightened risks for mutual funds when they pursue alternative investment strategies. These heightened risks and the complex nature of the investment strategies employed by alternative mutual funds can make the goal of clear, concise disclosure more difficult to attain.

He stated that the Division staff generally believes that all funds that use or intend to use alternative investment strategies should assess the accuracy and completeness of their disclosure, including whether the disclosure is presented in an understandable manner using plain English. Disclosure of principal investment strategies should be tailored specifically to how a fund expects to be managed and should address those strategies that the fund expects to be the most important means of achieving its objectives and that it anticipates will have a significant effect on its performance. In determining the appropriate disclosure, a fund generally should consider the degree of economic exposure the alternative investment strategy creates, in addition to the amount invested in that strategy.

The Division staff also generally believes that the risk disclosure in the prospectus for each fund should provide an investor a complete risk profile of the fund’s investments taken as a whole, rather than a list of various investment strategies, and reflect anticipated alternative investment or asset usage. An alternative mutual fund should, for example, disclose material risks relating to volatility, leverage, liquidity and counterparty creditworthiness that are associated with trading and investments in alternative investment strategies, such as derivatives, that are engaged in, or expected to be engaged in, by the fund.

Lastly, he emphasized that the Division staff generally believes that a fund should assess on an ongoing basis the completeness and accuracy of alternative investments-related disclosures in its registration statement in light of its actual operations. The Division’s staff has been reviewing data to compare the actual use of alternative investment strategies with what has been disclosed in fund disclosure documents. Based on these reviews, the staff believes that a fund generally should assess, based upon its actual operations, whether it is meeting the requirements to completely and accurately disclose its anticipated principal investment strategies and risks. A fund generally should review its use of alternative investment strategies when it updates its registration statement annually and assess whether it needs to review the disclosures in its registration statement that describes its principal alternative investment strategies and risks. A fund should also generally consider the accuracy and completeness of marketing materials related to its investment objectives and performance.

Click to access the speech.


Investment Advisers, Investment Companies