On June 16, 2023, the Securities and Exchange Commission (“SEC”) issued a press release announcing a $2.5 million settlement order of an enforcement action (the “Order”) against a multi-trillion dollar registered investment adviser (the “Registrant”) related to the Registrant’s alleged failure to: (i) waive approximately $27 million in advisory fees consistent with its “fee waiver” agreement with an open-end mutual fund (the “Fund”) managed by the Registrant; and (ii) adopt and implement reasonably designed policies and procedures for the oversight of the Fund’s advisory fee and fee waiver calculation process.[1]

The Order indicates that, from approximately April 2011 to November 2017 (the “Relevant Period”), the Registrant delegated the monthly advisory fee waiver calculations to the Fund’s sub-administrator, who conducted the calculations using a formula and calculation methodology provided by the Registrant at the outset of the engagement.[2]  The Order further notes that, pursuant to the Registrant’s agreement with the sub-administrator (the “Agreement”), the Registrant was responsible for overseeing the sub-administrator’s performance of the calculations and required the sub-administrator to submit its monthly reports to the Registrant for the express approval of one of the Fund’s designated officers prior to application of the final waived amount.[3]

The chief concern, according to the Order, was with the initial formula and calculation methodology the Registrant developed and provided to the sub-administrator during the first year of the engagement.[4] The SEC notes in the Order that such initial formula and calculation methodology, which was used for the duration of the Relevant Period, failed to account for the impact the Fund’s use of leverage could potentially have on the advisory fee and fee waiver calculations, thus leading to the $27 million in underwaived fees.[5] The Order states that the Registrant failed to detect its own incorrect formula during any of its monthly oversight reviews required under the terms of the Agreement during the Relevant Period.[6] The Order notes the sub-administrator, not the Registrant, both identified and reported the potentially miscalculated figures.[7]

Remedial Efforts

Immediately upon being made aware of the issue by the sub-administrator, the Registrant retained a third-party auditor to confirm and assess the scope of the impact of the miscalculations during the Relevant Period.[8] The Order indicates that, while the Registrant timely implemented all such remedial efforts, including a “remediation plan to reimburse the [Fund’s] shareholders over $30 million in unwaived fees, lost performance, and interest and took other steps to enhance its policies and procedures”[9] to prevent, detect and correct similar future occurrences, the SEC nonetheless believes the Registrant could have, and should have, prevented the error by initially providing a correct formula to the sub-administrator and/or having oversight procedures that focused on both the sub-administrator’s calculations and the ongoing adequacy of the Registrant’s own formula and calculation methodology used by the sub-administrator. In other words, while the Registrant had review policies and procedures in place to verify the accuracy of the sub-administrator’s performance, the Registrant’s verification procedures, according to the SEC’s allegations, should have extended to ongoing verification of the tools used in the overall process.

Key Takeaways for Industry Registrants

Prior SEC administrations have championed working with legal and compliance teams to prevent, detect, and correct violations and errors in the interest of investor protection and for purposes of promoting transparency and genuine detection and correction efforts by registrants. This Order, along with other recent SEC activities, however, suggests the current administration has adopted a quasi-strict-liability approach to enforcement of registered investment adviser activities, imposing liability for failures to prevent violations or errors, regardless of a registrant’s remedial efforts or the timeliness of such remedial efforts.

Registrants should be mindful of this new regulatory mindset at the outset of any SEC examination, inquiry, or investigation and should consider involving their legal and compliance teams early in the communication and response processes, regardless of how “routine” or benign an information or document request may seem.

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By the Investment Management and Broker-Dealer Team at Kilpatrick Townsend & Stockton

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