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Compliance Lessons We Can Learn from an ETF Enforcement Case

The recent SEC enforcement action against Van Eck Associates Corporation (VEAC) offers several valuable compliance lessons for registered investment advisers, even those who do not manage or sub-advise on ETFs. The core of this case revolves around disclosure failures, conflicts of interest, and inadequate policies, which are relevant concerns for all advisory firms.

In 2021, VEAC launched the VanEck Social Sentiment ETF (BUZZ ETF), which tracks an index of stocks with “positive insights” based on social media and other data. VEAC obtained an exclusive license to use the BUZZ NextGen AI US Sentiment Leaders Index (BUZZ Index) from an index provider. This index provider involved a controversial social media influencer to promote the BUZZ Index. To incentivize the influencer, the index provider requested a licensing fee structure change, which VEAC accepted without properly disclosing the details to the independent trustees of the VanEck ETF Trust (the Board).

From December 2020 until June 2021, VEAC misrepresented and omitted material information to the Board, including details about the licensing arrangement and the influencer’s involvement. VEAC also failed to adopt and implement policies and procedures designed to prevent such violations. As a result, the SEC found VEAC had violated sections of both the Investment Company Act of 1940 and the Investment Advisers Act of 1940.

The SEC's findings indicated that VEAC failed to disclose the sliding scale fee structure to the Board, which provided the Index Provider with a larger percentage of the fee when the BUZZ ETF's assets under management met certain thresholds. Additionally, VEAC did not inform the Board about the influencer's involvement, the compensation paid to him, and the controversies surrounding him. This lack of disclosure impaired the Board's ability to make fully informed decisions about the BUZZ ETF and its advisory contract.

The SEC charged VEAC with willfully violating Section 15(c) of the Investment Company Act, which requires investment advisers to furnish necessary information for directors to evaluate advisory contracts. Additionally, VEAC was found to have violated Section 206(2) of the Advisers Act, which prohibits fraudulent practices, and Section 206(4) of the Advisers Act and Rule 206(4)-7, which require advisers to adopt and implement written compliance policies and procedures.

In response to these violations, VEAC undertook remedial efforts, including revising its policies and procedures to enhance compliance and disclosure practices. Despite these efforts, the SEC imposed significant penalties on VEAC. The firm was ordered to pay a civil money penalty of $1,750,000 and was censured. VEAC was also required to cease and desist from committing further violations and to enhance its compliance framework.

This case highlights several critical lessons for firms. Even though VEAC does not receive 12b-1 fees, conflicts of interest can arise if mutual fund shares from a specific broker are used to gain additional services not available to others. This conflict must be transparently disclosed and managed. Firms like VEAC must ensure that all material information related to compensation and potential conflicts of interest is disclosed to the board, executive management, clients, and prospects. Transparency is crucial in maintaining trust and complying with fiduciary duties.

For firms, particularly in the context of mutual fund share class selection, it is essential to disclose any arrangements that might affect the adviser’s impartiality. For instance, if a firm selects mutual fund share classes that do not charge 12b-1 fees but chooses funds from a specific broker to receive other benefits, this must be clearly communicated to all stakeholders. This parallels the disclosure requirements in the VEAC case, where transparency about the influencer's involvement and the licensing fee structure was necessary.

In managing mutual funds, firms must meticulously review and disclose all potential conflicts of interest. This practice not only ensures regulatory compliance but also reinforces the adviser’s fiduciary duty to act in the client's best interests. For more detailed information on best practices in mutual fund share class selection and disclosure requirements, refer to the article by Coulter Strategic Services on  "Mutual Fund Share Classes: Don't Forget to Review for Proper Share Classes as an Advisor."

Furthermore, firms must ensure that all material factors, such as the costs of services, economies of scale, and any potential conflicts, are fully disclosed and documented when presenting information to the board or executive management. Implementing comprehensive policies and procedures to prevent such violations is essential. These policies should be regularly reviewed and updated to adapt to new situations and regulations.

There are several ways VEAC could have avoided these violations. Firstly, VEAC should have fully disclosed all details of the licensing fee structure and the influencer's involvement to the Board from the beginning. Transparency would have allowed the Board to make informed decisions regarding the advisory contract and the launch of the BUZZ ETF. Additionally, VEAC should have developed and implemented robust policies and procedures to ensure all material information was communicated to the Board. Regular training for staff on these policies and the importance of full disclosure could have further mitigated the risk of omissions.

To avoid similar violations, firms should enhance their disclosure practices, ensuring all material information is transparent to stakeholders. This includes disclosing any compensation arrangements and conflicts of interest. Developing and maintaining detailed policies and procedures that address the identification, disclosure, and management of conflicts of interest is crucial. Regular compliance reviews and audits should be conducted to identify potential issues early, and clear communication channels should be maintained with the board, executive management, and clients.

By learning from the VEAC case, firms can strengthen their compliance frameworks, enhance transparency, and better manage conflicts of interest, ultimately fostering greater trust and integrity in their advisory services. This case underscores the importance of meticulous compliance practices and the need for continuous improvement in how information is disclosed and managed within advisory firms.

If you would like specific compliance education, training, and services to help with your compliance program or project, please contact Coulter Strategic Services. 

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All information provided is for educational purposes and shall not be construed as specific advice.  The information does not reflect the view of any regulatory body, State or Federal Agency or Association.  All efforts have been made to report true and accurate information. However, the information could become materially inaccurate without warning. Not all information from third-party sources can be thoroughly vetted.  Coulter Strategic Services and its staff do NOT provide legal opinions or legal recommendations. Nothing in this material shall be considered as legal advice or opinion.  

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