The SEC has voted to delay the classification requirement of the open-end fund liquidity risk management rule until June 1, 2019 for large funds (over $1 Billion) and December 1, 2019 for smaller funds. The other requirements of the rule – implementing a risk management program, limiting illiquid investments to 15% of the portfolio – will still go into effect on December 1, 2018 for large funds and June 1, 2019 for smaller funds. The SEC also released a series of FAQs that provide additional guidance about how to effect the classification requirements.
OUR TAKE: The bad news is that the Clayton SEC will not rescind the liquidity risk management rule. The good news is that the SEC will provide more time and flexibility to implement its more complicated requirements.
The staff of the SEC’s Division of Investment Management has released FAQs for the new Liquidity Risk Management Rule for open-end funds and ETFs (Rule 22e-4). Most significantly, the staff will allow funds to delegate liquidity program responsibilities to a sub-adviser either in whole or in part “subject to appropriate oversight” including relevant policies and procedures. The staff also clarifies that the same investment may carry different liquidity classifications by different advisers or funds, provided the liquidity program properly supports the classification. The FAQs address several technical issues for in-kind ETFs.
OUR TAKE: Many industry participants acknowledged the broad policy goals of the liquidity rule but questioned the rule’s practical implementation. The FAQs help that process by addressing some of the outstanding questions.
The SEC has commenced civil enforcement proceedings against a hedge fund sponsor and its principals for failing to notify investors of its liquidity crisis and using improper transactions to pay redeeming investors. The Department of Justice has brought parallel criminal charges. According to the SEC, the respondents reported positive returns that averaged 17% per annum from 2003-2015. Additionally, the respondents assured investors that they would pay all redemptions within 90 days. The SEC alleges the firm inflated valuation of investments including 2 oil production companies, looted certain portfolio companies to pay redemptions, unlawfully transferred assets, and lied to auditors. As redemptions accelerated and the liquidity crisis grew, the SEC asserts that the respondents misled current and prospective investors about the funds’ valuation, liquidity and prospects. Ultimately, the funds ceased redemptions by placing most assets in an illiquid side pocket.
OUR TAKE: Compliance officers and due diligence professionals should review this complaint as a primer on private fund management misconduct. Red flags included consistent high performance, subjective valuations, conflicted transactions, and misrepresentations to auditors.
The SEC has adopted a new rule requiring open-end registered funds to establish liquidity risk management programs. New Rule 22e-4 will require registered funds to implement a program that assesses liquidity risk, classify securities into one of four liquidity categories, set a liquidity minimum, and report violations of overall portfolio illiquidity limits. The liquidity risk program also requires Board oversight including the designation of a fund officer to administer the program. The SEC also adopted new monthly portfolio disclosure rules for registered funds as well as a rule allowing funds to use swing pricing. Fund complexes with more than $1 Billion in net assets must comply with the liquidity risk management rule by December 1, 2018.
OUR TAKE: The new rules will require a great deal of additional work for the folks in operations, legal and compliance. The Oper-Pros will need to figure out how to pull and classify the data. The lawyers will have to create additional disclosures. And, the Compli-Pros will likely be the appointed officers to administer the programs.