RIA Compliance Blog
The Securities and Exchange Commission (“SEC”) settled an administrative proceeding against Simplify Asset Management, Inc. (“Simplify”), a Delaware corporation and registered investment adviser that engages in transactions related to exchange-traded funds (“ETFs”), for multiple violations of the Investment Company Act of 1940 (the “Investment Company Act”). From July 2021 through November 2024, Simplify caused its ETF clients to violate multiple provisions of the Investment Company Act by failing to maintain and implement adequate compliance policies and procedures and by failing to adequately oversee certain regulatory requirements. The SEC has imposed a cease-and-desist order and a $400,000 civil money penalty, which Simplify must pay within 21 days of entry of the order.
First, the SEC found a violation of Section 17(a)(1) of the Investment Company Act through Simplify’s recommendation that SURI, a series ETF in the Simplify Trust, engage in an in-kind transaction that was a “tax-free exchange.” The transaction involved Trust A acting as a seed investor in SURI, even though Trust A was an affiliated person of Simplify by owning approximately 25% equity interest in Simplify and was therefore a second-tier affiliate of SURI. Such transaction therefore raised concerns under the Investment Company’s restrictions on certain transactions between a registered investment company and their affiliated persons and affiliated persons of such persons.
Second, Simplify caused some of its ETF clients to exceed the permissible leverage thresholds under Rule 18f-4 of the Investment Company Act in April and May 2024. Simplify also failed to timely file Forms N-RN with the SEC, which were not filed until August 2024. Simplify also did not communicate the disclosure of such leverage breaches with the board of trustees.
Third, Simplify caused certain ETF clients to violate Section 19(a) and Rule 19a-1 of the Investment Company Act by failing to provide shareholders with the required written notices identifying the sources of certain periodic distributions made from July 2022 to June 2024. Some of these distributions included amounts representing a return of capital rather than fund income. Although Simplify was required to provide these notices, it did not begin doing so until September 2023 and subsequently implemented the notice system across all of its ETF clients by September 2024.
Lastly, Simplify failed to adopt and implement adequate policies and procedures applicable to its ETF clients. Specifically, Simplify did not adopt or implement policies and procedures for providing Rule 19a-1 notices to fund shareholders until August 2024 and lacked controls designed to address specific compliance issues it encountered, including the June 2023 transaction involving Trust A. The SEC also found that, until June 2026, Simplify’s ETF clients lacked adequate policies and procedures to govern any revisions to or deviations from their established custom basket policies and procedures.
Overall, the SEC’s findings reinforce its expectations that adviser and broker-dealers maintain operationally effective compliance controls rather than merely having written policies and procedures on paper. Firms should regularly identify, escalate, and timely remediate regulatory violations. The mere existence of such policies and procedures is insufficient if they are not reasonably designed, properly implemented, effectively monitored, and regularly updated to prevent violations of the Investment Company Act and to mitigate risks that could harm fund investors.
The following checklist provides ETF advisers with a concise summary of the SEC Order and its key compliance considerations.
Compliance Checklist for ETF Advisers:
- Affiliate transactions: Are direct and indirect affiliations identified before the proposed transactions are approved or executed?
- Leverage monitoring: Are Rule 18f-4 thresholds monitored on a timely basis, with clearly defined procedures for escalating and remediating any breaches?
- Distribution notices: Are Section 19(a) and Rule 19a-1 notices generated and delivered contemporaneously, as required?
- Policy deviations: Is there a documented process for identifying, monitoring, escalating, and documenting deviations from the established compliance policies and procedures?
- Remediation: When a violation or control failure is identified, does the firm document the root cause, corrective action, and follow-up testing?
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.