Alert December 30, 2008

OCIE Director Discusses Potential Role For Surveillance in SEC Mutual Fund Oversight

At a recent Investment Company Institute conference, Lori A. Richards, Director of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”), described measures being discussed at OCIE to incorporate surveillance of registered advisers and mutual funds into OCIE’s risk-based oversight program.  Although the precise details of such a program were not made clear, it appears that the type of surveillance Ms. Richards envisions would entail adviser and mutual fund registrants making available to the SEC staff a broader and more timely range of information in an XML-tagged or other type of structured format designed to facilitate analysis by the SEC staff.  Ms. Richards observed that current filings made by mutual funds are in an unstructured, text-based format, lack certain portfolio-level identifying information and are not timely enough to provide the data needed for a robust surveillance program.  (As an alternative to the filing of surveillance information with the SEC, Ms. Richards indicated that OCIE was also considering an approach under which funds would post the required information in tagged or structured format to a secure space in their information technology environment which the SEC staff could access to both view and download the information.  The SEC staff would use web-crawler type technology to regularly access funds’ posted information.)  Ms. Richards identified as possible goals of a surveillance system detecting indications of issues like mispricing, liquidity concerns, lack of diversification and deviation from stated investment objectives.  For money market funds, it might also be used to identity funds that hold securities of troubled issuers and those that may be at risk of “breaking the dollar”. 

The types of data that might be requested for the surveillance system could include the following:  net asset value, shadow pricing for  money market funds, total net assets and shares outstanding, percentage of the portfolio priced using fair value, percentage of a portfolio that is illiquid, share class descriptions and the primary investment objective or style of the fund; and might also include specific information concerning portfolio securities held by a fund.  For advisers, this data might include the identity of the audit firm used by the adviser, and the custodian of client assets.  Another element of the surveillance program might be a requirement that regulated firms provide the SEC with information concerning any serious violations, or indicia of violations, as mandated by other regulators in the U.S. and abroad. 

Noting that implementing a surveillance program might require rulemaking by the SEC, and possibly legislation, Ms. Richards invited the fund industry to work together with the SEC staff to explore the ideas she had presented.  As readers are aware, the SEC is in the process of reconsidering its rules regarding recordkeeping by advisers and registered funds, partially in response to complaints from the industry regarding the SEC staff’s requests for a variety of documents and communications in electronic format during the sweep examinations related to market timing/late trading and revenue sharing.  Since then, the SEC staff has become accustomed to requesting and receiving information from the fund industry in electronic format, most recently in sweep examinations of money market funds in which the SEC staff received in electronic format structured schedules of portfolio holdings from all money market funds as of a single date.  Given recent criticism of SEC oversight prompted by the Madoff investigation and the fact that the SEC’s adviser and fund recordkeeping rules are designed to facilitate inspection and examination by the SEC staff, it would not be surprising if a surveillance program along the lines described by Ms. Richards were a part of the SEC’s recordkeeping modernization initiative.