## Facts

- Two registered open-end “series trust” mutual funds used a turnkey structure with many unaffiliated advisers and sub-advisers, a single five-member board, a shared administrator (Gemini Fund Services, LLC (GFS)), and an outsourced chief compliance officer provider (Northern Lights Compliance Services, LLC (NLCS)).
- During January 2009 through December 2010, the trusts collectively had up to 71 series, requiring repeated advisory contract approvals and related shareholder report disclosures.
- GFS prepared shareholder reports and drafted board minutes used to support disclosures describing the board’s approval of advisory contracts under Investment Company Act § 15(c).
- Multiple shareholder reports contained boilerplate or otherwise materially misleading statements, including suggesting the board relied on peer-fee or performance comparisons that were not obtained, were incomplete, or were not evaluated as described.
- Some series’ shareholder reports omitted the required discussion of the board’s evaluation of advisory contracts.
- GFS failed to ensure that all materials provided to and considered by the trustees in connection with advisory contract approvals were preserved in fund records.
- NLCS, acting as outsourced CCO, and the trustees approved certain advisers’ compliance programs based on cursory or generic information rather than adviser-specific policies and procedures, contributing to a trust compliance program not reasonably designed to prevent violations.

## Issues

1. Whether materially misleading or omitted disclosures in mutual fund shareholder reports concerning advisory contract approvals violate the Investment Company Act’s reporting and anti-misstatement provisions.
2. Whether a fund administrator that drafts minutes and shareholder report disclosure can be liable for causing reporting and recordkeeping violations when the disclosures do not match the actual § 15(c) process or records are incomplete.
3. Whether trustees and an outsourced CCO provider cause Rule 38a-1 violations by approving advisers’ compliance programs based on insufficient information and maintaining a compliance program not reasonably designed to prevent violations.
4. What remedial sanctions are appropriate in an SEC administrative settlement addressing failures in § 15(c) disclosure, recordkeeping, and fund compliance oversight.

## Decision

- The SEC instituted and resolved an administrative cease-and-desist proceeding by accepting offers of settlement from NLCS, GFS, and five trustees, with consent to findings and sanctions without admitting or denying the findings (except jurisdiction).
- The SEC found the trustees were a cause of violations of Investment Company Act § 34(b) based on materially misleading statements or omissions in fund reports.
- The SEC found GFS caused violations of Investment Company Act §§ 30(e) (shareholder reporting) and 31(a) (recordkeeping) and related rules by preparing misleading disclosures and failing to maintain required records of materials considered for advisory contract approvals.
- The SEC found NLCS and the trustees caused violations of Rule 38a-1 by failing to implement and oversee a compliance program reasonably designed to prevent, detect, and correct securities law violations.
- The SEC ordered all respondents to cease and desist from committing or causing violations or future violations of the cited provisions.
- The SEC imposed civil penalties of $50,000 each on NLCS and GFS and required respondents to retain an independent compliance consultant to review and recommend improvements to compliance, disclosure, reporting, and recordkeeping policies and procedures.

## Legal Principles

- Fund boards must request and evaluate information reasonably necessary to approve or renew advisory contracts under Investment Company Act § 15(c), and shareholder reports must accurately describe the material factors and the actual basis for the board’s approval.
- Boilerplate narrative in shareholder reports can be materially misleading when it states or implies analyses, comparisons, or deliberations that did not occur or were materially incomplete.
- Administrators and other service providers involved in drafting fund reports and maintaining books and records may be liable for causing violations when their conduct results in misleading disclosures or failures to preserve required records.
- Recordkeeping obligations under Investment Company Act § 31(a) function as a governance control by requiring preservation of materials considered in advisory contract approvals, supporting the integrity and reviewability of the § 15(c) process.
- Rule 38a-1 requires a fund compliance program reasonably designed to prevent, detect, and correct violations; trustees and a CCO (including an outsourced CCO) must obtain and review sufficient, adviser-specific information to approve advisers’ compliance programs.

## Conclusion

The SEC’s settled order imposed cease-and-desist relief, penalties on the administrator and outsourced CCO provider, and an independent consultant review after finding that misleading or omitted advisory-approval disclosures, inadequate recordkeeping of § 15(c) materials, and cursory compliance-program approvals caused violations of the Investment Company Act and Rule 38a-1 in a turnkey series-trust setting.


In re Northern Lights Compliance Servs., LLC, Investment Company Act Release No. 30502 (May 2, 2013)