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SEC Commissioner Questions Informal Staff Guidance

SEC Commissioner Hester Peirce recently criticized unpublished staff guidance that operates as de facto legal precedent without going through a process that ensures transparency and accountability.  Referring to the securities regulatory framework as a “compliance minefield” where the wrong move can be a “matter of professional life or death,” Ms. Peirce questioned the propriety of informal staff positions about specific products or types of businesses.  She characterized sub rosa staff guidance as secret law that binds firms without legislative authority, effective oversight, or consistency. 

We agree that unpublished staff guidance can result in industry favoritism and (perceived) unfairness.  The next question is how the SEC addresses Ms. Peirce’s very legitimate concerns. 

IA Watch Compliance Conference: The CCS Summary

Three CCS professionals – Jocelyn Dalkin, Jason Ewasko and Bridget Garcia – recently attended the IA Watch’s 21st Annual IA Compliance: The Full 360° View East conference in Washington.  If you were unable to attend, you should review their summary of the most significant sessions including Dan Kahl’s summary of Enforcement Priorities, a top panel’s views on SEC rulemaking, and more specialized sessions on cybersecurity and custody.  If you want more information, feel free to contact Jo, Jason or Bridget

SEC Proposes Overhaul of BDC and Closed-End Fund Rules

The SEC has proposed an overhaul of the registration and offering rules for business development companies and closed-end funds.  The proposal provides for a shelf registration for funds with a public float of at least $75 Million and a more flexible offering and communications scheme for Well-Known Seasoned Issuers with a public float over $700 Million.  The proposal would allow interval funds to pay registration fees based on the issuance of shares rather than paying an estimate at registration.  The proposed new rules would change disclosure rules to follow operating companies, utilizing Form 8-K for significant events and management discussion of fund performance in annual reports.  A 60-day comment period will begin upon publication. 

These changes are long overdue.  The current rules shoehorn BDC and closed-end funds into the mutual fund regulatory regime, resulting in some unintended regulatory consequences.  While we’re sure that industry pros will debate the specifics of the proposal, it’s hard to argue that the SEC shouldn’t revamp the rules. 

SEC’s Blass Announces Plans to Modernize Adviser Marketing Rules

The SEC’s Investment Management Division Director, Dalia Blass, anticipates that the Division will soon recommend changes to the adviser marketing and solicitation rules.  In her annual speech to the Investment Company Institute membership, Ms. Blass also announced initiatives for a summary shareholder report, updates to the valuation guidance, modernization of the offering rules for business development companies and closed-end funds, and changes to the rules for funds’ use of derivatives.  Additionally, Ms. Blass wants the Division to finalize the proposed ETF and fund-of-funds rules.  She has also asked the staff to begin an outreach to small and mid-sized fund sponsors about regulatory barriers.  She announced that the Division is considering the formation of an asset management advisory committee to solicit diverse viewpoints on critical issues.

We applaud the reinvigorated Investment Management Division for tackling some of the thornier problems that have faced the industry for many years.  For instance, the marketing rules haven’t changed for decades despite revolutionary change in the financial services industry. 

Self-Reporting ICO Forced to Offer Rescission to All Investors

The sponsor of an initial coin offering agreed to offer full rescission of proceeds raised in order to settle SEC charges that the firm engaged in an unregistered securities offering.  The sponsor raised $12.7 Million by issuing digital tokens in exchange for Ether as part of its efforts to raise funds to further develop its internet security product.  The tokens would serve as currency for a peer-to-peer network that would allow participants to access additional bandwidth in the event of a cyber-attack.  As part of its marketing, principals suggested that the value of the tokens should rise as the network expanded.  The SEC maintains that this “reasonable expectation of a future profit” satisfied the Howey test and that, therefore, the tokens were “securities” and the offering constituted an unregistered securities offering.  The SEC did not impose a civil penalty because the firm self-reported. 

We don’t think that the SEC has a slam-dunk case that ICOs are securities offerings.  In fact, some courts have opined that the SEC must specifically prove that each ICO is in fact a securities offering.  Until the courts offer some specific guidance, ICO sponsors should observe the securities laws to avoid a crippling enforcement action. 

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.