Proposed Investment Adviser Cybersecurity Requirements
On February 9, 2022, the Securities and Exchange Commission (the “SEC” or the “Commission”) proposed cybersecurity risk management rules for investment advisers and registered funds to buttress their preparedness for, and resilience in the face of, cybersecurity attacks. The proposed rules (Investment Advisers Act of 1940 rule 206(4)-(9) and Investment Company Act of 1940 rule 38a-2) require policies and procedures reasonably designed to address cybersecurity risks, reporting to the SEC on a new form of significant incidents affecting the adviser or its registered or private funds, additional disclosures in the adviser’s client brochure (or ADV Part 2) and fund registration statements (for two fiscal years), and maintenance of related records.
The full text of the proposal can be found at: https://www.sec.gov/rules/proposed/2022/33-11028.pdf.
Proposed Expansion of Private Fund Requirements and Reporting
The SEC also proposed on February 9, 2022 new requirements for private fund advisers under the Commission’s jurisdiction. First, such advisers would have to provide investors with quarterly performance, fee and expense reports. Second, annual fund audits would be required (with reporting to the SEC in special circumstances). Third, adviser-led exchange offerings for existing fund interests into other adviser-sponsored investment vehicles would require third party fairness opinions (with disclosure of the third party’s prior relationships with the adviser and related persons). Finally, certain practices would be prohibited: charging fees for unperformed services (e.g., post-fund closure), charging for the expense of investigations or examinations of the adviser, demanding indemnification (or reimbursement) from the fund for certain activities, reducing clawbacks for tax obligations, charging portfolio investment expenses not proportionately, borrowing from private fund clients, providing preferential redemptions or portfolio holding information to certain investors, or offering other preferential treatment unless disclosed. (In addition, the compliance rules affecting all advisers, not just private fund advisers, would insist that annual compliance reviews be documented in writing.)
The full text of the proposal can be found at: https://www.sec.gov/rules/proposed/2022/ia-5955.pdf.
Earlier, on January 26, 2022, citing efforts to enhance the ability of the Financial Stability Oversight Council’s (“FSOC”) to assess systemic risks, the SEC proposed amendments to the reporting obligations of private fund advisers on Form PF. The changes would provide data to enable the SEC to analyze and assess risks to investors and the markets and to what the Commission calls reporting gaps. Large hedge fund advisers would have to file reports within a business day of extraordinary losses, counterparty defaults, margin calls and cash reductions, changes in prime brokers, significant withdrawals and redemptions and certain operational changes. Large private equity advisers (to be defined down to $1.5 billion in assets from $2 billion) would have to report within a business day on adviser-led secondary transactions, clawbacks, general partner removals and termination of funds or investment periods. Additional information would also be called for by Form PF by reporting private equity advisers concerning leverage and financings by funds and portfolio companies, investments in multiple levels of portfolio company capital structure, and their restructurings and recapitalizations. Private liquidity funds would be required to provide information similar to what money market funds do.
The full text of the proposal can be found at: https://www.sec.gov/rules/proposed/2022/ia-5950.pdf.
SEC Moves Toward T+1 Settlement
The Commission announced on February 9, 2022 its initiative to move the clearing and settlement cycle to a single business day after trade date. The SEC cited market volatility around COVID-19 in March 2020 and “meme” stocks in January 2021 as focusing attention on trade settlement risks. Under its proposals, investment advisers would be required to record each affirmation and allocation sent to, and each confirmation received from a broker or dealer to enable the SEC to track settlement times. The proposal anticipates that full compliance would not be required until March 31, 2024.
The full text of the proposal can be found at: https://www.sec.gov/rules/proposed/2022/34-94196.pdf.
New Director of Investment Management Division Appointed
William A. Birdthistle, professor at Chicago-Kent College of Law, was chosen to lead the SEC’s Investment Management Division on December 21, 2021. He had written a book published in 2019 entitled “Empire of the Fund” that focused on mutual fund scandals and criticized the level of active fund fees.
Management Fee Overcharge Settlement for Private Equity Adviser
The SEC reported on December 21, 2021 that it had fined a private equity fund advisor $4.5 million for failing to offset management fees by certain portfolio company payments upon a partial disposition as provided in the relevant fund offering (and governing) documents. The SEC registered adviser remediated the violations by returning $5.4 million to affected clients, in addition to the penalty imposed.
The full text of the settlement can be found at: https://www.sec.gov/litigation/admin/2021/ia-5930.pdf.
Recordkeeping Settlement for Reps Communicating Through Apps
JP Morgan entered into a settlement with the SEC on December 17, 2021 for failing to preserve employee communications about securities business matters made on personal devices, using text messages, WhatsApp, and personal email accounts. In responding to Commission investigations and subpoenas, JP Morgan neglected to apply word searches and fulfill other requests by reviewing relevant communications made on such devices or using such applications. It admitted to violations of the Securities Exchange Act of 1934 (the “1934 Act”) §17(a), rules thereunder and failures to supervise, accepting a censure, a cease and desist order and a penalty of $125 million.
The full text of the settlement can be found at: https://www.sec.gov/litigation/admin/2021/34-93807.pdf.
Anti-Fraud Rule for Securities-Based Swaps Is Proposed
On December 15, 2021, the SEC proposed an anti-fraud rule (9j-1) under the 1934 Act in connection with securities-based swaps that fall under the Commission’s jurisdiction. It cited academic discussion since 2010 of manufactured credit events or other opportunistic strategies in the credit default swap (“CDS”) market, and the parallel CFTC anti-fraud rule. One goal is to make explicit that liability extends to manipulation, fraud and deceptive practices affecting not just purchases and sales, but cash flows, payments, deliveries, and other ongoing obligations under security-based swaps, such as efforts to avoid, trigger, delay, accelerate, decrease, and/or increase payouts on CDS. The proposal would affect securities-based swap dealers and major security-based swap participants.
The Commission also proposed a rule (15Fh-4(c)) to prohibit an individual associated with such a swap dealer or participant to coerce, manipulate, mislead, or fraudulently influence the entity’s chief compliance officer, directly or indirectly.
The full text of the proposal can be found at: https://www.sec.gov/rules/proposed/2021/34-93784.pdf.
Money Market Fund Rules Proposed to be Amended (Again)
Also on December 15, 2021, the SEC proposed to roll back some of the 2014 money market fund reforms that had been tested, and found wanting, in the March 2020 COVID-19 induced liquidity crunch. Requirements to consider liquidity fees and redemption gates at specified liquidity levels had affected manager and investor behavior in ways that seemed to spur rather than prevent “runs” on “prime” money funds (i.e., those that purchase commercial paper and bank certificates of deposit).
Prime funds represent currently around 17.5% of money market fund assets; institutional prime funds, most susceptible to runs, only 13% ($650 billion). In March 2020, for several weeks, commercial paper markets had become frozen, with dealers unwilling to bid. Redemptions caused $80 billion of sales by prime funds, about two-thirds of which went to a federal reserve liquidity facility.
The SEC proposes to increase the proportion of prime fund assets that must be held in securities convertible to cash within a day and U.S. Treasury securities (“daily liquid assets”) to 25%, and those to be held in daily liquid assets together with securities convertible to cash within a week plus federal agency securities maturing within 60 days (“weekly liquid assets”), to 50%. New acquisitions must top up those levels and notifications must be made to the directors and to the Commission when daily or weekly liquid assets fall to half the specified levels.
In addition, the SEC proposes to balance the elimination of fees and gates by requiring prime funds to establish policies and procedures for “swing pricing.” Swing pricing had previously been permitted for non-money market mutual funds since 2016, but it does not appear that any fund has actually tried it. It consists of reducing net asset value by the estimated costs of effecting sales of assets to meet significant redemptions when redemptions meet specified thresholds. Certain members of the industry have objected to the proposal.
The full text of the proposal can be found at: https://www.sec.gov/rules/proposed/2021/ic-34441.pdf.
SEC Proposes Securities Lending Disclosure Regime
On November 18, 2021, the SEC proposed new rule (10c-1) under the 1934 Act to require that persons who lend securities, for themselves or others, be required to report to a registered national securities association the material terms of those transactions, as well as information regarding the securities on loan or available to loan. The association would, in turn, make public about aggregated and specified transactions. The purpose of the proposal is to increase the transparency of the $1.5 trillion securities lending market, perceived by the Commission to be “opaque.”
The SEC intends that the proposed rule would provide market participants with access to pricing and other information, so as to improve price and reduce information asymmetries between borrowers and lenders. The SEC also plans to use the data for regulatory functions, such as surveillance – of securities markets – and monitoring – of individual member’s activity – for better awareness of developing risks. The Commission hopes to learn more about strategies that broker-dealers use to source securities that are lent to their customers, such as custodians and specialist third party agents, and to enable customers to gain useful knowledge about market conditions.
The full text of the proposal can be found at: https://www.sec.gov/rules/proposed/2021/34-93613.pdf.
Some SEC Proxy Advice Regulation Proposed to be Rescinded
On November 17, 2021, the SEC proposed to rescind two conditions added in 2020 to proxy voting agents’ ability to qualify for exemption from proxy solicitor information and filing requirements. The conditions were that (i) registrants be provided advice affecting them “in a timely manner” and (ii) clients be made aware of registrants’ responses.
The Commission is responding to arguments that the conditions impair the independence and timeliness, and increase compliance costs, of proxy voting advice. The proposal also clarifies that professional judgments and subjective determinations do not subject a proxy voting adviser to liability for misleading statements or omissions of fact, deleting a controversial note added to Rule 14a-9 in 2020.
The full text of the proposal can be found at: https://www.sec.gov/rules/proposed/2021/34-93595.pdf.
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