38a-1 Overview and Requirements
Why should a Fund CCO ask a subadviser questions about how it manages and maintains it’s compliance library? Although the Funds adviser is required to monitor compliance with the Investment Company Act and the Fund’s prospectus, the first line of compliance with a mutual fund’s prospectus starts with the subadviser. The adviser and the subadviser may be using different compliance systems, which could potentially produce varying and conflicting results. The adviser and the subadviser could possibly interpret the investment guidelines differently thus resulting in inconsistent coding, therefore influencing the results.
Under Rule 38a-1 of the Investment Company Act, Fund boards oversee a fund’s compliance program as part of their general oversight duties and have specific responsibilities. Among other things, boards must approve the reasonably designed policies and procedures of the fund’s service providers (including any sub-advisers) to ensure the fund does not violate the federal securities laws. Fund boards also must review, at least annually, the adequacy of the policies and procedures of the sub-advisers. The rule makes the fund CCO responsible for administering the fund’s compliance program and for reporting to the board, at least annually, on the operation of the policies and procedures of the fund and each service provider, including any subadvisers.
The board largely relies on the Fund CCO to assist it in overseeing the sub-adviser’s compliance program as it relates to the fund. The fund CCO’s annual report to the board may include an evaluation of the sub-adviser’s policies and procedures sufficiency. There are a myriad of issues an investment adviser should consider in connection with its ongoing oversight and monitoring of sub-adviser compliance, including, but not limited to, the frequency of on-site visits to meet with sub-adviser personnel, sub-adviser compliance with prospectus limitations, including fundamental and non-fundamental investment policies, affiliated transactions (for example, transactions effected in accordance with Rule 12d3-1 and Rule 10f-3) and review of any sales and marketing materials used by the sub-adviser.
Part 2 will cover the top six questions that Fund CCOs should consider when conducting subadvisor due diligence.
References: 17 CFR 270.38a-1 - Compliance procedures and practices of certain investment companies.