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(Article from Registered Funds Regulatory Update, July 2022)

For more information, please visit the Registered Funds Resource Center.

On April 19, 2022, FINRA issued a Regulatory Notice reminding member firms of their sales practice obligations for alternative mutual funds (“Alt Funds”), which FINRA defined in the Notice as open-end registered investment companies that seek to achieve their objective through investments in non-traditional investments or asset classes. The Notice summarized FINRA’s recent observations and enforcement actions related to Alt Fund sales practices and reminded member firms of previous FINRA guidance on this topic.

FINRA noted that recent examinations revealed inadequate written supervisory procedures, inadequate oversight, and insufficiently reviewed public communications related to Alt Fund sales. FINRA also conducted several recent enforcement actions related to sales of Alt Funds, finding that member firms failed to:

• conduct reasonable diligence regarding the risks and features of Alt Funds;
• maintain reasonably designed supervisory systems to review recommendations of Alt Funds;
• provide reasonable guidance to representatives regarding Alt Funds; and
• maintain written supervisory practices advising firm principals how to supervise recommendations of Alt Funds.

The Notice also provided a list of effective practices that some member firms have used to address the risks and characteristics of Alt Funds, including:

• implementing policies and procedures that require review and approval of new Alt Funds;
• documenting and maintaining records of diligence of Alt Fund strategies and metrics;
• restricting recommendations of Alt Funds based on Alt Fund strategy or investor category;
• applying a heightened level of review to Alt Fund transactions through existing or new monitoring systems and triggering exceptions at lower concentration levels for Alt Funds;
• requiring enhanced principal review for Alt Fund transactions;
• reevaluating approved funds lists to identify whether any product should be categorized as an Alt Fund;
• training staff members on Alt Funds and providing relevant regulatory guidance; and
• voluntarily filing proposed retail communications concerning new Alt Funds with FINRA and incorporating FINRA feedback prior to using the communications.

FINRA Reminds Firms of Their Sales Practice Obligations for Alternative Mutual Funds, FINRA Regulatory Notice 22-11, available at: https://www.finra.org/rules-guidance/notices/22-11.