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The Friday List: Effects of the Government Shutdown on the Investment Management Industry


Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic. 

As the partial federal government shutdown continues, the investment management industry is beginning to feel the effects of reduced SEC operations.   The people most affected are those furloughed SEC employees who lose compensation every day the shutdown continues.  However, the entire industry has been affected.  Below is our list of the top 10 effects of the partial federal government shutdown. 

Effects of the Government Shutdown

  1. New product approvals.  New products including registration statements must await approval until the furloughed workers return.
  2. Exams.  The OCIE staff has delayed ongoing exams until the shutdown ends.  It is unclear whether the shutdown will reduce the total number of exams. 
  3. Enforcement litigation.  While the SEC continues to conduct market surveillance, ongoing litigation that is not time-sensitive will be delayed.
  4. Regulatory information.  The SEC is not posting regulatory information or interpretations on its website during the shutdown
  5. Exemptive applications/No Action Letters.  Requested exemptive applications and no-action letters seeking relief from the black letter rules cannot go forward without SEC staff.
  6. New rules.  The SEC is not reviewing potential new rule initiatives or comments to current proposals. 
  7. Travel.  Many of our clients and colleagues have delayed travel to discuss new initiatives or to attend meetings. 
  8. Service providers.  With asset managers unable to launch new products, service providers such as lawyers and fund administrators must wait for their clients to go forward. 
  9. Conferences.  It is unclear whether SEC officials will attend this winter’s industry conferences where they traditionally provide some guidance.  Even if they do attend, any guidance will necessarily depend on how long the shutdown continues. 
  10. Industry outreach.  The SEC will likely delay industry outreach to management, compliance professionals and boards.

SEC Filed 32% More Enforcement Cases Against Advisers and Funds in Fiscal 2018

 The SEC Enforcement Division filed 32% more standalone enforcement cases against investment advisers and investment companies in fiscal 2018 (through September 30), as compared to 2017.  Cases against investment advisers and investment companies (the second largest category) and broker-dealers (fourth largest) represented 35% of all standalone actions filed.  Overall, the SEC Enforcement Division brought 490 standalone cases in fiscal 2018, a 10% increase over 2017.  Excluding the municipal disclosure initiative, the Enforcement Division filed more cases than it did in 2016 and 2015, the last two years under the prior administration.  The Enforcement Division obtained $3.9 Billion in penalties and disgorgement, which is consistent with amounts obtained during the prior several years.  The Enforcement Division outlined five core principles, including a focus on individual accountability because “holding culpable individuals responsible for wrongdoing is essential to achieving our goals of general and specific deterrence and protecting investors by removing bad actors from our markets.”

 The Enforcement Division continues to pursue its active litigation agenda, especially against the investment industry.  Apparently, the Jay Clayton SEC is not much different from the Mary Jo White SEC when it comes to enforcement cases against adviser, funds, and broker-dealers. 

The Friday List: 10 Topics the Division of Investment Management Should Reconsider

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

Last month, SEC Chairman Jay Clayton said that SEC no-action letters and other staff statements “are nonbinding and create no enforceable legal rights or obligations.”  He instructed the SEC staffs to “review whether prior staff statements and staff documents should be modified, rescinded or supplemented in light of market or other developments.”  More recently the Director of the Division of Investment Management, Dalia Blass, said that her division is reviewing and assessing prior staff statements.  Both Mr. Clayton and Ms. Blass invited engagement and input from the public.  With that invitation, we offer ten topics that the Division of Investment Management should reconsider as it assesses its staff positions:

 

10 Topics the Division of Investment Management Should Reconsider

  1. Custody:  The custody rule and the reams of staff FAQs have only confused the industry and ensured massive inadvertent noncompliance.  If the staff only tackles one problem, this is it.
  2. Valuation:  Please offer clear guidance on the fair valuation of securities that are not publicly traded.  The current regime is too subjective, relying on accounting interpretations and shifting market information.
  3. Proxy Voting:  Firms spend significant resources complying with the proxy voting recordkeeping and supervision requirements.  Do these rules really protect clients and shareholders?
  4. Private Funds:  Restricting private funds to 100 holders or qualified purchasers is overly restrictive.  The staff should also reconsider the definition of “accredited investor.”
  5. Leverage:  With the advent of derivatives and other forms of innovative investment products, the staff should modernize its positions on permitted leverage.
  6. Advertising:  The staff has not materially changed the adviser advertising rules in 30 years.  The new media world requires some new rules.
  7. Code of Ethics:  A significant percentage of compliance time and resources is spent on personal securities transaction compliance.  The staff should consider other less onerous schemes to prevent and punish unlawful personal trading.
  8. Affiliate Transactions:  Scholars have written entire treatises on the definition of “affiliate transaction” under the Investment Company Act.  It may be the most confusing definition in the securities laws.
  9. Disclosure:  Few retail investors read prospectuses or Form ADV.  One way to make clearer and more readable documents is too exempt issuers from securities law liability.
  10. Wrap Programs: The SEC has brought dozens of actions against wrap programs.  We would recommend that the staff adopt some definitive rules that the industry could follow.

SEC Official Says that a Cryptocurrency is Not a Security, Absent a Sponsored Offering

 

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.

 

SEC Chairman Re-Commits to Examinations and Enforcement

In recent testimony about the SEC’s proposed 2018 budget, Chairman Jay Clayton emphasized enforcement and examination activities.  Mr. Clayton noted that 50% of requested budget resources will go to enforcement and examinations.  He said that the SEC is on track to deliver a 20% increase in adviser examinations and plans a further 5% increase.  He noted that the staff will put a special focus on cybersecurity efforts.  Mr. Clayton also committed to continue the SEC’s “vigorous enforcement efforts to investigate and bring civil charges” including critical areas such as “investment professional misconduct.”

OUR TAKE:  It appears that the Clayton SEC will continue the examinations and enforcement focus of the Mary Jo White SEC.  The more things change, the more they stay the same.

 

SEC Staff Publishes 2017 Exam Priorities

priorities II

The staff of the SEC’s Office of Compliance Inspections and Examinations has released the 2017 Examination Priorities, which focus on retail investment products, retirement advice, FINRA supervision, and private funds.  The staff’s retail initiatives will include a focus on robo-advisers (compliance programs, suitability, data protection); wrap programs (suitability, trading away), ETFs (exemptive relief compliance, creation/redemption processes), and newly-registered advisers.  As part of its emphasis on retirement products, the SEC will scrutinize variable insurance and target date funds and assess how pension plan advisers satisfy their fiduciary obligations.  The staff will continue to target private fund advisers and cybersecurity.  As part of its obligation to assess market-wide risks, OCIE will enhance oversight of FINRA, including assessing the quality of broker-dealer exams.  OCIE’s Director advised registrants to “evaluate their own compliance programs in these important areas and make necessary changes and enhancements.”

OUR TAKE: Many of these areas – wrap, ETFs, variable insurance, target date funds, cybersecurity – continue longstanding initiatives.  Others – robos, private advisers, FINRA – are more recent regulatory objectives.  Compliance officers should use this exam priorities letter as a tool to upgrade their own compliance programs.

https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2017.pdf

SEC Staff Provides Guidance for Adviser M&A and Reorg Transactions

acquistion-fish

The staff of the SEC’s Investment Management Division has provided guidance clarifying that, absent a change in control, an internal reorganization of an investment adviser does not require a new registration.  The staff opines that an unregistered entity that acquires the assets of an affiliate RIA need only file a succession by amendment, so long as the same parent company continues to control both entities.  The staff offered similar guidance with respect changes in jurisdiction and form of organization.  However, a change in control would require the filing of a succession by application.   In either event, the registrant must file within 30 days of the subject event.

OUR TAKE: With expected consolidation coming in the asset management sector, the staff offers practical regulatory guidance that will facilitate transactions.

https://www.sec.gov/investment/im-guidance-2016-05.pdf

 

SEC Risk Alert Warns About Whistleblower Policies and Practices

whisteblower-intimidation

The SEC’s Office of Compliance Inspections and Examinations has issued a Risk Alert notifying advisers and broker-dealers that examination staff will examine whether agreements and other documents limit whistleblowers in violation of the Dodd-Frank Act.  The staff will examine compliance manuals, codes of ethics, and employment and severance agreements to determine whether any provisions directly or indirectly impede an employee or former employee from communicating potential securities laws violations to the SEC.  For example, the staff will assess whether confidentiality agreements include exceptions for SEC reporting or provisions requiring an employee to represent that s/he has not assisted with an investigation.  The Risk Alert recommends immediate remedial measures including revising documents and notifying both current and former employees about their unrestricted right to report to the SEC.   The SEC has brought several cases during the last year alleging that a registrant’s practices violated Dodd-Frank’s whistleblower provisions.

OUR TAKE: Our most recent C-suite survey reported that 91% of respondents have not changed their compliance programs due to whistleblower concerns.  Compli-pros should add policies and procedures that ensure that whistleblowers are in no way impeded by company documents.  Then, firms should test the policies by reviewing agreements and interviewing current and former employees.

 

SEC Adopts Liquidity Risk Management Program Rule

liquidity

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.

https://www.sec.gov/news/pressrelease/2016-215.html