An exempt reporting adviser is still subject to several provisions of the Advisers Act, including its fiduciary and anti-fraud rules. We recommend that ERAs implement a legitimate compliance program to avoid a firm-ending regulatory action like this one.
The SEC fined a now-defunct fund manager for ignoring its compliance obligations. The SEC charges that the firm never delivered audited fund financials within 120 days as required by the custody rule (206(4)-2). Although the firm did hire an auditor, the firm never received an opinion that the financials were prepared in accordance with GAAP. Instead, the audit firm issued reports stating that it was unable to express such an opinion. In addition, the SEC charges the firm with violating the compliance rule (206(4)-7) because the principal, who also served as the Chief Compliance Officer, failed to adopt and implement policies and procedures and disregarded his obligation to conduct annual compliance reviews.
When you register as an investment adviser, you subject yourself to the full panoply of substantive regulation imposed by the Investment Advisers Act. To comply and continue as a going concern, you need to hire a competent Chief Compliance Officer to help you meet the regulatory requirements. Otherwise, you may end up either in your next career or in jail.
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.
A federal judge has ruled that an initial coin offering may not constitute an offering of securities. In rejecting the SEC’s request for a preliminary injunction against an ICO, Judge Gonzalo Curiel of the Southern District of California, opined that the SEC failed to present sufficient facts to satisfy the Howey test requiring an investment of money in a common enterprise with an expectation of profit produced by the efforts of others. Faced with conflicting interpretations of how the ICO operated, the Court denied the preliminary injunction because of genuine disputes about material facts.
The significance of this decision is that a court is requiring the SEC to factually prove the three prongs of the Howey test rather than simply accept the SEC’s position that digital tokens are securities. If the SEC fails to prove its case and digital tokens are not securities, the SEC will not have the legal authority to regulate ICOs.
Joe Scavetti of Cipperman Compliance Services recently attended the Investment Adviser Association Compliance Conference in Washington. The conference brings together senior regulatory officials and compliance professionals to address cutting-edge regulatory issues. Linked below is a more detailed summary of the meeting prepared by Joe, who would be happy to discuss with you in more detail. SEC Commissioner Hester Peirce, the conference headliner, spoke at length about the SEC’s regulatory agenda including the prospect of an SEC conduct rule. SEC officials Peter Driscoll, Director of OCIE, and Stephanie Avakian, Co-Director of Division of Enforcement, also participated, offering their views on examination and enforcement priorities. Over the course of 2 days, several panels addressed issues such as mutual funds, cybersecurity, vendor management, advertising, Form ADV, custody, and SEC exams.
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.
Valuation: The SEC asks whether funds could obtain sufficient information to properly value fund assets pursuant to current accounting rules especially given the “nascent state and current trading volume” in the futures markets.
Liquidity: Could funds reduce crypto-assets to cash so as to meet daily redemption requests? How would funds classify assets under the SEC’s new liquidity rule (22e-4)?
Custody: The SEC questions how a fund custodian could validate the existence and ownership of cryptocurrency assets, and how funds would address physical security where applicable.
ETF Creation: Will the creation unit process operate in a way that ensures that funds and authorized participants limit arbitrage opportunities that harm investors?
Volatility: The limited history and volume of the cryptocurrency markets could negatively impact fund operations and affect investors.
Lack of regulation: Neither cryptocurrency markets nor providers/issuers are subject to prudential regulation.
Market manipulation: The SEC cites Chairman Clayton’s concerns over market manipulation and potential fraud.
Cybersecurity: Could a potential hack threaten ownership interests and valuation? What safeguards are in place?
Disclosure: How would fund sponsors ensure sufficient risk disclosure and transparency in fund prospectuses and other shareholder communications?
Suitability: How will broker-dealers and advisers ensure their suitability and fiduciary obligations when recommending crypto-funds to retail investors?