Each quarter the UMB Fund Services registered fund accounting, administration and tax teams consolidate the most impactful regulatory and tax developments in the fund industry.

To guide your strategic and operational planning, our registered funds servicing team recommends you review and consider these developments from the prior quarter.

Securities Exchange Commission (SEC) Proposes New Reporting Regime for Short Sales

On February 25, 2022, the SEC proposed Rule 13f-21 and Form SHO under the Securities Exchange Act of 1934, that would require all “institutional investment managers” to file monthly reports disclosing certain short selling activity.

Why it matters:

Form SHO would be confidentially filed with the SEC and would include detailed information about certain trading activities. The SEC would aggregate the reported information by security and publicly disclose only that aggregated information (without identifying any investors) monthly.

The relevant thresholds are:

  • For equity securities of issuers that are SEC-reporting companies, either:
    a gross short position with a U.S. dollar value of $10 million or more at the close of any settlement date during the calendar month; or a monthly average gross short position (determined by looking to the gross short position as of the close of each settlement date during the calendar month) equal to 2.5% or more of the shares outstanding.
  • For equity securities of other issuers, a gross short position with a U.S. dollar value of $500,000 or more at the close of any settlement date during the calendar month.

Short positions established through derivatives would not be counted towards those thresholds; and short positions in ETFs would not need to include securities held by the ETF in its portfolio when calculating if the threshold has been met.

Investors would be required to file reports with the SEC 14 calendar days after the end of each month.

IRS Publishes Final Regulations on LIBOR Transition

The Internal Revenue Service published final regulations on LIBOR transition.

Why it matters:

The final regulations provide guidance on the tax consequences of the transition away from the use of certain interbank offered rates in debt instruments, derivative contracts, and other contracts.

The final regulations are necessary to address the possibility that a modification of the terms of a contract to replace such an interbank offered rate with a new reference rate could result in the realization of income, deduction, gain, or loss for federal income tax purposes or have other tax consequences.

It is important for mutual funds that invest in debt instruments that use certain interbank offered rates such as the LIBOR rate to understand that modifications of the terms of the contract to replace such rate could result in having certain tax consequences.

Sanctions Implemented in Response to the Russia/Ukraine Conflict

Executive Order 14065 and OFAC Directive 3 under E.O. 14024 implement new sanctions in response to Russia’s invasion of Ukraine.

Why it matters:

On February 21, 2022, President Biden signed Executive Order 14065, “Blocking Property With Respect To Specified Harmful Foreign Activities of the Government of the Russian Federation” and on February 24, 2022, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) issued Directive 3 under E.O. 14024 “Prohibitions Related to New Debt and Equity of Certain Russia-related Entities” in response to Russia’s invasion of Ukraine.

Executive Order 14065 prohibits new investment in the region, and OFAC Directive 3 under E.O. 14024 sets forth blocking sanctions against major Russian private and public banks, as well as sanctions against Russian entities and individuals. Funds must ensure that they comply with the sanctions by suspending purchases of impacted securities.

OFAC has made several additions to the sanctioned entities since the original directive was issued. Additional information is available on OFAC’s Ukraine-/Russia-related Sanctions page, and UMB is closely monitoring the sanctions as this situation evolves.

ICI Tax Equalization Survey

The Investment Company Institute recently surveyed its tax committee members to get a better understanding on member firm’s equalization approach, policies, and calculation methods.

Why it matters:

Using equalization, or more specifically equalization debits, refers to the allocation of a portion of a fund’s earnings and profits to shareholder redemptions and treating the allocated portions of earning and profits as deemed distributed, thereby reducing the remaining earnings and profits that remains to be distributed to shareholders as dividends.

Having an understanding of the overall mutual fund industry approaches, policies, and practices, can help provide funds with a perspective when dealing or working with their own approaches and applications of equalization. UMB clients with questions regarding the survey results may consult with their relationship manager and UMB’s fund tax team for more information.

SEC Proposes Cyber Risk Management Rules for RIAs and Funds

On February 9, 2022, the SEC published proposed new rules that would require investment advisers, registered investment companies and business development companies to “adopt and implement written cybersecurity policies and procedures designed to address cybersecurity risks that could harm advisory clients and fund investors.”

Why it matters:

The proposal would include the adoption of new Rule 38a-2 under the Investment Company Act of 1940 requiring registered investment companies to implement cybersecurity risk programs, and new Rule 206(4)-9 under the Investment Advisers Act of 1940 requiring advisers to registered funds to implement policies and procedures reasonably designed to address cybersecurity risk.

Key elements of an investment company’s cybersecurity risk program would include:

  • Periodic risk assessments
  • User security and access
  • Information protection
  • Threat and vulnerability management
  • Cybersecurity incident response and recovery
  • Annual reviews and written reports
  • Fund board oversight
  • Recordkeeping obligations
  • Reporting of significant cybersecurity incidents to the SEC

In addition, the proposal would establish a new “Form ADV-C” on which advisers would provide information regarding significant cybersecurity incidents.

SEC Proposes Rule Amendments to Modernize Beneficial Ownership Reporting

On February 10, 2022, the SEC proposed rule amendments governing beneficial ownership reporting under Sections 13(d) and 13(g) of the Securities Exchange Act of 1934.

Why it matters:

The proposed amendments would:

  • Accelerate filing deadlines for Schedule 13D and 13G filings
  • Expand the application of Regulation 13D-G to certain derivative securities
  • Clarify when two or more persons have formed a “group” subject to beneficial ownership reporting
  • Provide exemptions to allow certain persons to communicate/consult with one another, jointly engage issuers, and execute certain transactions without being subject to regulation as a “group”
  • Require that Schedules 13D and 13G be filed using structured, machine-readable data.

SEC Charges Investment Advisor with Significant Valuation Fraud

In February 2022, the SEC charged James Velissaris, formerly of Infinity Q Capital, with violating antifraud and other federal securities laws’ provisions by engaging in a fraudulent scheme to overvalue two funds’ assets by over $1 billion to collect over $26 million in fees.

Why it matters:

The SEC complaint details a complicated web of fraud that Velissaris conducted to effectuate the overvaluation in both a private fund and mutual fund managed by the firm. They noted that Velissaris provided investors with “fraudulent documents, altered performance results, and manipulated valuations.”

The SEC also asserts that upon its investigation into Velissaris’s practices, he “sought to actively deceive” the SEC staff by creating fake, backdated valuation committee minutes and altering valuation policy documents. The Department of Justice and the CFTC also announced charges against Velissaris.

SEC Proposes New Rules to Enhance SPAC IPO and Shell Company Transaction Disclosures

On March 30, 2022, the SEC released rule proposals aimed to increase investor protection by increasing disclosure requirements relating to Special Purpose Acquisition Companies (SPAC’s), IPOs, and business combination transactions.

Why it matters:

The SEC noted a dramatic rise in the use of SPACs and shell companies and the related increase in risk to investors. To address these risks, the SEC proposed amended rules to ensure that SPAC’s IPOs and other transactions are treated the same as traditional IPOs. Proposed disclosure includes the identity of SPAC sponsors, conflicts of interest, sources of dilution and business combination transactions between SPACs and private operating companies. The rule also provides a framework for which SPACs would be exempt from registering under the Investment Company Act of 1940.

Currently, public comments remain open through May 31, 2022.

SEC’s Shadow Trading Theory Endorsed by District Court

In January 2022, a district court endorsed a novel theory that would consider “shadow-trading” to be a prohibited form of insider trading.

Why it matters:

Shadow-trading involves the use by an insider of confidential information regarding the business of one issuer to trade in the securities of another issuer, such as a peer company in the same relatively small industry, whose stock price is alleged to be correlated with that of the issuer. Typically, private fund managers, and their firms, would be restricted in these situations from trading in the securities of the issuer or issuers that were the subject of the material non-public information.

Although the SEC has yet to ultimately prove guilt in the ongoing shadow-trading case and the decision may not be binding precedent in other cases, it should be expected that the SEC will bring forth other insider trading cases citing this theory. Firms should consider the theories and facts presented in the SEC v Panuwat case to determine whether compliance policies and practices could be revised to reduce potential risk.

SEC’s Division of Examinations Issues Risk Alert Regarding Private Fund Adviser Deficiencies

In January 2022, the Division issued its risk alert to highlight additional observations in four key areas to assist private fund advisers in reviewing and enhancing their compliance policies and procedures.

Why it matters:

The risk alert assists private fund advisers by highlighting and discussing their fiduciary duties to clients. It also notes specific examples of practices (A) where advisers failed to act consistently with disclosures; (B) of using misleading disclosures regarding performance and marketing; (C) of due diligence failures relating to investments or service providers; and (D) using potentially misleading “hedge clauses.”

Private fund advisers are urged to review the examples and discuss with their compliance teams whether changes in policies and practices are warranted to avoid similar types of compliance failures.

SEC Proposes Rules on Private Fund Disclosure

In January 2022, the SEC proposed amended new rules to increase reporting obligations for private funds and their advisors.

Why it matters:

The SEC currently requires private funds and private fund advisers to disclose information via Form ADV and Form PF. In its January 2022 proposal, the SEC described practices it has identified in its examinations of private fund advisers that negatively impact investors. The SEC presented the following proposed rules or rule amendments:

  • Proposed rule to require investment advisers to prepare and distribute to investors a quarterly statement containing information on fund fees, expenses and performance
  • Proposed rule to require SEC-registered private fund advisers to obtain an annual financial statement audit for each of its private funds
  • Proposed rule to enhance disclosure and documentation of adviser-led secondary transactions
  • Proposed rule to prohibit certain sales practices and compensation schemes.

SEC Aims to Enhance and Standardize Climate-Related Disclosures

In March 2022, the SEC released proposed rules to enhance and standardize climate-related disclosures in annual reports and other periodic findings.

Why it matters:

In response to perceived concern by investors, the SEC issued proposed rules that would create a framework for issuers to disclose information regarding environmental risks that are designed to benefit both investors and issuers. This rule proposal is lengthy and complex.

Most observers believe that, if adopted in a form similar to that proposed, it could impose significant disclosure burdens and expense, particularly for issuers that do not have the processes in place to gather, consolidate and disclose the required information. Issuers may want to keep a close eye on developments and making preliminary plans for compliance as these proposed rules proceed towards the possibility of being finalized.

SEC’s Division of Enforcement Issues 2022 Examination Priorities

The Division of Enforcement has issued its 2022 examination priorities which can assist funds, investment advisers, broker-dealers and other industry professionals review their policies and procedures to determine where improvements could be made.

Why it matters:

In 2021, the Division completed 3,040 examinations which was about the same as pre-pandemic levels. As part of these examinations, more than 2,100 deficiency letters were issued. The topics listed in the examination priorities document highlight those practices, products and services that the SEC believes present potentially heightened risks to investors and the capital markets.

Industry professionals should take the time to review and understand the risks identified by the Division and review their own practices in these areas to determine if modifications are warranted.

Click here for a review of the Fall 2021 registered funds tax and regulatory roundup.

Learn more about UMB Fund Services and how we can support your firm’s registered and alternative investment fund administration needs, or contact us to be connected with a fund services team member.


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