The SEC’s Director of Corporation Finance, William Hinman, recently opined that cryptocurrencies themselves are not securities subject to SEC oversight, although undertakings operated by a central control group and targeted to passive third parties would constitute a securities offering. Absent a “central enterprise” such that the digital asset is sold only to be used to purchase a good or service available through the network on which it was created, Mr. Hinman would not apply the securities laws. Factors that transform an enterprise into an offering of securities include (i) a central group that promotes the offering and benefits and expends assets/effort to increase the value; (ii) the raising of funds in excess of what is necessary to establish a functional network; (iii) purchasers that seek a return in excess of the current market value; and (iv) a sales effort directed to the general public rather than users. Mr. Hinman announced that the Division would be willing to offer promoters more formal interpretive or no-action guidance to ensure legal comfort.
OUR TAKE: Mr. Hinman offers practical guidance and some clarity on how to apply decades-old precedent to modern cryptocurrency networks and offerings. We expect more guidance in the coming months from the other SEC divisions.
Link to speech
The Commodity Futures Trading Commission (CFTC) and the North American Securities Administrators Association (NASAA), the organization of state securities regulators, have signed an information sharing agreement intended to facilitate state regulators to investigate and enforce the Commodity Exchange Act. The Agreement also allows the CFTC to share information about state securities laws violations. The NASAA President described the unique role of state securities regulators because “they can bring enforcement actions for both securities law and commodities law violations” which is “particularly relevant given the recent epidemic of schemes involving cryptocurrencies and other modern types of commodities.
OUR TAKE: The MOU deputizes the state regulators to enforce the commodities laws, which helps the budget-strapped CFTC. It also continues the trend of more active state securities authorities.
Memorandum of Understanding
The SEC adopted a new rule that allows mutual funds and ETFs to dispense with having to deliver paper shareholder reports to investors. New rule 30e-3 allows funds to post shareholder reports to a website so long as the funds provide paper notice of the reports’ availability and shareholders have the right to receive a hard copy upon request. The rule does not go into effect until 2021. The SEC also seeks comment about how to improve fund disclosure as well as the overall framework for processing fees charged by intermediaries for forwarding shareholder reports.
OUR TAKE: If you didn’t work in the fund industry, you might think it inconceivable that fund firms have been required to mail hard copies of voluminous shareholder reports. Finally, the SEC has stood down the paper lobby to adopt this long overdue modernization. Our only question is why wait until 2021?
Link to SEC Press Release
Jocelyn Dalkin of Cipperman Compliance Services recently attended the Private Fund Compliance Forum in New York. Sponsored by Private Equity International, the forum brings together legal and compliance professionals from the biggest firms to discuss investment management regulatory issues. Keynote speaker David Sorkin (KKR) advised compli-pros to continuously monitor regulatory and business changes to adapt compliance programs in real-time. A panel of compliance experts from several large PE firms discussed how to allocate compliance responsibilities both internally and externally. Other panels considered SEC exams, regulatory priorities, and how to address conflicts of interest. Feel free to contact Jocelyn if you want more information.
Link to Summary
The SEC fined a fund-of-funds manager $500,000 for failing to disclose that it received revenue sharing compensation from two affiliates that managed funds that the respondent recommended. According to the SEC, the fund-of-funds manager negotiated side letters initially intended to benefit clients but which directly benefited the respondent through payments routed through the firms’ common parent domiciled in France. The respondent failed to properly record the payments in its financials. The SEC accuses the fund-of-funds manager with violating the specific terms of client agreements and failing to implement an adequate compliance program.
OUR TAKE: Inter-company payments among affiliates raise the same regulatory conflict of interest concerns as payments received from non-affiliates. Compli-pros should follow the money to all of an adviser’s revenue sources in order to assess possible conflicts. Also, non-U.S. entities, perhaps less sensitive to the Adviser’s Act’s requirements, should hire qualified lawyers or compli-pros to avoid tripping over the regulatory wires.
Link to SEC Order
The SEC fined an investment adviser $8 Million for failing to disclose compensation received from vendors it recommended to clients. The respondent and its investment adviser representatives routinely counselled clients with UK pension benefits to transfer those assets to offshore vehicles operated by third party custodians and trustees. The SEC alleges that the adviser did not disclose that the third parties paid a portion of their fees back to the adviser and its IARs based on the business recommended. The SEC faults the firm for inadequate disclosure and a compliance program that failed to address this inherent conflict of interest.
OUR TAKE: The best solution for avoiding compensation conflicts is to include all compensation in the disclosed management fee and avoid any payola from third parties. Receiving payments from third parties raises such a significant conflict of interest that the SEC may not be satisfied with mere disclosure, no matter how fulsome.
Link to SEC Order
The SEC censured and fined 13 private fund managers for failing to file Form PF over multi-year periods. Form PF, required to be filed annually since 2012, requests information about a fund manager’s assets under management, fund strategies, performance, leverage, and derivatives. An SEC Enforcement official advised: “We encourage investment advisers to take a fresh look at whether they are meeting their reporting obligations and adjust their compliance programs accordingly.”
OUR TAKE: While some may wonder whether this is a return to broken windows enforcement, these cases involved a complete failure to make the Form PF filings over several years, not mere quibbling over definitions and categories. If you don’t know what filings you have to make, it’s time to hire a compliance officer or a compliance consulting firm.
Link to SEC Press Release
Cassandra Borchers, a partner at Thompson Hine, and Todd Cipperman recently sat down to discuss the 10 most significant regulatory trends for the investment management industry. In their podcast, Todd and Cassandra discuss an investment adviser’s fiduciary responsibilities, including Regulation Best Interest and wrap programs, senior executive liability, service provider accountability, compliance programs, whistleblowers, and cybersecurity. Their conversation is based on Cipperman’s upcoming book that delves deeper into these Top 10 investment management regulatory trends. Thompson Hine LLP, a full-service business law firm with approximately 400 lawyers in 7 offices, has received numerous awards for innovation, service and expertise. Cipperman Compliance Services leads the investment management industry in providing outsourced compliance services.
The former Chief Financial Officer of a now-defunct hedge fund was fined and barred from the industry for authorizing improper inter-fund transfers and other financial improprieties. The SEC alleged that the CFO authorized the ongoing transfers of funds from an affiliated offshore fund to facilitate the activities of a cash-strapped on-shore funds. The CFO continued the practice even after two subordinate accountants resigned after complaining that the practice did not comport with the funds’ governing documents or applicable accounting standards. The SEC accused the CFO with aiding and abetting his firm’s activities that defrauded investment advisory clients.
OUR TAKE: The SEC will seek to hold individual officers accountable for the illegal actions of the firms they manage. The SEC’s Enforcement Division has cited personal accountability as a core enforcement principle.