The SEC imposed a $400,000 civil penalty against Simplify Asset Management, Inc. in a settled enforcement action involving several Investment Company Act violations. (Read the SEC’s administrative order.) Among the SEC’s findings were failures related to the derivatives risk management and reporting requirements associated with Rule 18f-4. The penalty resolved the full range of conduct described in the order, not only the Rule 18f-4-related failures.
What Happened
The Simplify Macro Strategy ETF (FIG) exceeded Rule 18f-4’s 200% relative value-at-risk (VaR) limit during two periods: April 26 – May 2 and May 6 – 16, 2024. During the first episode, FIG’s relative VaR reached approximately 291%. The SEC found that Simplify failed to satisfy several conditions necessary for the fund to rely on Rule 18f-4, causing FIG to violate Section 18(f)(1) of the Investment Company Act. The SEC also found that Simplify caused violations of Rule 30b1-10 because the required Forms N-RN were not filed on time. The order also addressed prohibited joint transactions with affiliates, deficient shareholder notices and related compliance program failures. Accordingly, the $400,000 penalty should not be attributed solely to the VaR and reporting failures.
Key Compliance Lessons
- Daily monitoring must connect to a clear escalation process. A fund’s daily VaR calculation is only the starting point. Firms need defined responsibilities for identifying an exceedance, escalating it to the derivatives risk manager and determining when the rule’s reporting requirements have been triggered.
- Board reporting obligations are time-sensitive and distinct. When a fund remains above its VaR limit for five business days, the derivatives risk manager must provide the board with a written report addressing the circumstances and explaining how and by when the fund is expected to return to compliance. Within 30 calendar days, the derivatives risk manager must report how the fund returned to compliance and any program changes made or update the board if the exceedance continues. In this matter, the board was not notified of the two episodes until Aug. 8, 2024.
- Form N-RN filing responsibilities require operational readiness. The applicable filing is due within one business day after a fund has exceeded its VaR limit for five business days. The Forms N-RN for the two episodes were not filed until Aug. 9, 2024.
- Remediation should be timely and well documented. An extended exceedance should prompt a documented analysis of its causes and a determination of whether the derivatives risk management program needs to change. The SEC found that Simplify did not promptly update the program to address the circumstances that contributed to the exceedances.
What Firms Should Review
Fund advisers, derivatives risk managers and boards overseeing registered investment companies or business development companies subject to Rule 18f-4 should consider whether their procedures:- Confirm that VaR is calculated each business day and that results are retained.
- Assign clear ownership and escalation responsibilities when a VaR threshold is exceeded.
- Document the process and deadlines for the initial and follow-up written reports to the board.
- Assign responsibility for Form N-RN filings and test the one-business-day filing process.
- Require a documented analysis of each extended exceedance and determine whether the derivatives risk management program should be revised.
