The SEC has adopted a new rule allowing third party broker-dealers to publish mutual fund research reports, so long as the reports include standardized performance information. The new rule (139b) provides that a research report prepared by a broker-dealer unaffiliated with the mutual fund manager or sponsor will not result in an unregistered offering, and the research report will not constitute a prospectus. The rule requires several conditions including: (i) the subject fund must have met all reporting requirements during the prior 12 months, (ii) the fund must have a net asset value of at least $75 Million, and (iii) any performance information must comply with Rule 482, which requires performance information to be presented in a standardized format. The SEC initially proposed the rule in May.
The only controversy here is whether performance information should need to comply with Rule 482. To keep performance information consistent probably makes life simpler for investors, broker-dealers, and the staff at the SEC and FINRA. Regardless, we still believe that the SEC should take a fresh look at Rule 482 given the proliferation of investment products beyond open end funds investing in publicly-traded securities.
An investment bank was fined and censured for failing to enforce information barriers between its research department and an affiliated hedge fund managed by the bank’s CEO. The investment bank maintained policies and procedures related to the misuse of material nonpublic information, including a restricted list applicable to the bank’s employees. However, the restricted list did not stop the hedge fund from making 126 trades in restricted list securities over a 6-month period. In response to deficiencies raised during an SEC examination that occurred before the unlawful trading, the hedge fund adopted policies and procedures that applied the restricted list, required physical barriers, instituted email monitoring, and restricted information flow. The SEC alleges that the hedge fund failed to enforce those policies.
OUR TAKE: Compliance means more than a drafting unused policies and procedures. It means actually enforcing those policies to prevent unlawful conduct. This firm likely incurred the enforcement action because it told the SEC that it had fixed the problem by adopting policies and procedures but then ignored implementation.
A KPMG study reports that the overwhelming majority (94%) of hedge fund managers recognize the importance of investing in technology to compete and that compliance is a top reason (90%) to invest in technology. The report explains: “Given that — in 2013 — we estimated that compliance was costing the industry upwards of US$3 billion per year (and that number has likely risen much higher since), it is not surprising that compliance ranked as a top objective among our respondents.” The report also explains the importance of technology in the back office where improved data management allows firms “to meet the increased regulatory and investor reporting demands being placed on them.”
OUR TAKE: Technology that organizes and presents data has become a critical element to meet ever-increasing regulatory requirements especially in areas such as personal trading, email review, and investor reporting. Technology alone, however, is not a regulatory silver bullet. Firms must still retain top compliance talent who can assess, interpret, and react to the data and then advise senior management on how to proceed.