The Compliance and Regulatory Consulting practice outlines the SEC’s and the SEC’s Office of Compliance Inspections and Examinations’ (OCIE) recent updates, announcements, proposed amendments, observations and examination priorities from the fourth quarter of 2020.
SEC Renames Office of Compliance Inspections and Examinations
On December 17, 2020, 25 years after the creation of the OCIE, the Commission has decided to rename the OCIE to the Division of Examinations (the Division). The newly named Division of Examinations will continue to perform is all of its core examination functions and leverage its offices and program areas to support.
Read more here.
SEC Updates Regulatory Framework for Fund of Funds Arrangements
On October 7, 2020, the SEC voted to adopt a new rule and related amendments to implement a comprehensive regulatory framework for fund of funds arrangements.
“Main Street investors have increasingly used mutual funds, exchange-traded funds (ETFs) and other types of funds to access our markets and invest for their future,” said SEC Chairman Jay Clayton. “To achieve asset allocation, diversification and other objectives, many funds have also invested in other funds. Today’s action will enhance and modernize the regulatory framework for these arrangements.”
The SEC voted to adopt Rule 12d1-4 under the Investment Company Act of 1940, as amended (the 1940 Act). Rule 12d4-1 will allow a registered investment company or a business development company to acquire shares of any other registered investment company or business development company in excess of the limits set forth in Section 12(d)(1) of the Investment Company Act of 1940. The SEC also amended ICA Rule 12d1-1 to allow funds to continue to invest in money market funds out of the same group of investment companies.
The Staff estimates that approximately 40% of all registered funds hold an investment in at least one other fund.
Read more here.
SEC Updates Auditor Independence Rules
The SEC announced on October 16, 2020 that it adopted final amendments to certain auditor independence requirements in Rule 2-01 of Regulation S-X. The adopted amendments modernize the rules and more effectively focus the analysis on relationships and services that may pose threats to an auditor’s objectivity and impartiality.
The amendments will:
- Amend the definitions of “affiliate of the audit client” and “investment company complex;”
- Amend the definition of “audit and professional engagement period;”
- Amend Rule 2-01(c)(3) to replace the reference to “substantial stockholders;”
- Amend Rule 2-01(e) to introduce a transition framework to address inadvertent independence violations that only arise as a result of a merger or acquisition transaction; and
- Make certain other miscellaneous updates.
Read more here.
SEC Adopts Modernized Regulatory Framework for Derivatives Use by Registered Funds and Business Development Companies
On October 28, 2020, the SEC voted to enhance the regulatory framework for derivatives use by registered investment companies. The amendments will provide a modernized, comprehensive approach to the regulation of these funds’ derivatives use that addresses investor protection concerns and reflects developments over the past decades.
The new rule will permit funds to enter into transactions that involve potential future payment obligations, including obligations under derivatives such as forwards, futures, swaps and written options, if they comply with certain conditions implemented to protect investors. These conditions include adopting a derivatives risk management program and complying with a limit on the amount of leverage-related risk that the fund may obtain based on value-at-risk, or VaR.
Finally, the new rule requirements also apply to leveraged or inverse ETFs. The Commission has directed the Staff to review the effectiveness of existing regulatory requirements in protecting investors, particularly those with self-directed accounts, who invest in complex investment products (including leveraged or inverse products).
Read more here.
SEC Harmonizes and Improves “Patchwork” Exempt Offering Framework
The SEC voted on November 2, 2020 to amend its rules in order to “harmonize, simplify, and improve” the multilayer and overly complex exempt offering framework to promote capital formation and expand investment opportunities while preserving or improving important investor protections.
The amendments:
- More clearly establish the ability of issuers to move from one exemption to another in one broadly applicable rule;
- Increase the offering limits for Regulation A, Regulation Crowdfunding and Rule 504 offerings and revise certain individual investment limits;
- Set clear and consistent rules governing certain offering communications, including permitting certain “test-the-waters” and “demo day” activities; and
- Harmonize certain disclosure and eligibility requirements and bad actor disqualification provisions.
Read more here.
Risk Alert: Observations from Examinations of RIAs—Supervision, Compliance and Multiple Branch Offices
On November 9, 2020, the SEC’s Division of Examinations published a risk alert containing observations made from nearly 40 examinations of registered investment advisers’ main offices combined with one or more examinations of each adviser’s branch offices.
These exams assessed the compliance and supervisory practices for advisory personnel working within the advisers’ branch offices and evaluated how supervised persons located in branch offices provided investment advice to advisory clients. The intent of this alert is to encourage advisers to consider the unique risks and challenges of employing a business model that includes numerous branch offices and business operations and to adopt policies and procedures to address those risks and challenges.
The observations noted by the SEC were as follows:
- Compliance programs
- Oversight and supervision of supervised persons
- Advertising
- Code of ethics violations
- Portfolio management
Read Duff & Phelps’ summary of the alert here.
Read the SEC’s announcement here.
SEC Adopts Rules to Facilitate Electronic Submission of Documents
The SEC voted on November 17, 2020 to adopt rules and rule amendments to Rule 302(b) of Regulation S-T to allow the signatory to an electronic filing to have the option to sign either manually or electronically, while following certain requirements specified in the EDGAR Filer Manual.
Additionally, the SEC adopted rule amendments to require electronic filing and service of documents in administrative proceedings and to require the redaction of sensitive personal information before filing. These amendments are in effect as of December 17, 2020; however, compliance will not be required until April 12, 2021.
Read more here.
Risk Alert: Investment Adviser Compliance Programs
The SEC issued a Risk Alert on November 19, 2020 to outline violations found during recent examinations around the effectiveness and implementation of investment advisers’ compliance programs.
Compliance Rule Deficiencies and Weaknesses Identified by the SEC:
- Inadequate Compliance Resources
- Chief compliance officers (CCOs) who wear multiple hats within an organization, with other professional responsibilities, did not have adequate time to devote to their compliance responsibilities.
- Compliance was not adequately staffed, equipped with technology and inadequately trained. The SEC determined that because of this, advisers were not able to implement an effective compliance program.
- Advisers had grown in size and complexity, but did not add additional compliance staff, resources and technology to support.
- Insufficient Authority of CCOs
- Advisers restricted their CCOs from accessing critical information.
- CCOs and senior management had limited interaction, leaving CCOs with limited knowledge about the firm’s leadership, strategy, transactions and business operations.
- CCOs were not consulted by senior management and employees on matters that had potential compliance implications.
- Annual Review Deficiencies
- Evidence of annual review – Advisers could not produce adequate documentation that affirmed an annual compliance review had been conducted.
- Identifications of risks – Advisers could not identify key risk areas applicable to their business.
- Review of significant aspects of adviser’s business – Advisers did not review significant areas of their business.
- Implementing Actions Required by Written Policies and Procedures
- Advisers did not implement actions required by their written policies and procedures.
- Maintaining Accurate and Complete Information in Policies and Procedures
- Advisers had inadequate policies and procedures that contained outdated or inaccurate information about the adviser, including “off-the-shelf” policies.
- Maintaining or Establishing Reasonably Designed Written Policies and Procedures
- Advisers did not establish, implement or tailor policies and procedures that were designed to prevent violations of the Advisers Act.
Read more here.
SEC Adopts Modernized Marketing Rule for Investment Advisers
On December 22, 2020, the SEC announced that it has finalized reforms under the Investment Advisers Act to modernize rules that govern investment adviser advertisements and payments to solicitors.
The amendments create a single rule that replaces the current advertising and cash solicitation rules, Rule 206(4)-1 and Rule 206(4)-3, respectively. The amendments update the definition of advertisement (two-pronged), to reflect the below:
- Any direct or indirect communication an investment adviser makes that: (i) offers the investment adviser’s investment advisory services with regard to securities to prospective clients or private fund investors, or (ii) offers new investment advisory services with regard to securities to current clien
- Includes any endorsement or testimonial for which an adviser provides cash and non-cash compensation directly or indirectly (e.g., directed brokerage, awards or other prizes and reduced advisory fees).
The amendments explicitly prohibit certain advertising practices. However, such prohibitions are generally consistent with SEC guidance.
- If anything, such guidance is now specifically referenced and compiled within the single rule, rather than through various risk alerts, action letters, etc.
Testimonials and endorsements are prohibited, unless the following items are addressed:
- Disclosure;
- Oversight and written agreement; and
- Disqualification.
The amendments will be effective as of February 22, 2020. The SEC has adopted a compliance date that is 18 months after the effective date to give advisers a transition period to comply with the amendments.
Read more here.
