Each quarter, UMB’s 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 fund servicing team recommends you review and consider these developments from the prior quarter.

SEC Division of Examinations Issues Multiple Risk Alerts

 Registered Fund Examination Findings

On October 26, 2021, the Securities and Exchange Commission’s (SEC) Division of Examinations (the “Division”) issued a Risk Alert providing its observations during examinations of mutual funds and exchange-traded funds assessing industry practices and regulatory compliance in certain areas that impact retail investors (the “Initiative”). The Initiative was previously announced in 2018 and included in the Division’s exam priorities in 2019 with the related examinations covering more than 50 fund complexes and 100 advisers.

Why it matters:

The Initiative specifically targeted (i) the effectiveness of compliance policies and procedures of funds and advisers, (ii) fund disclosures to investors, and (iii) fund governance practices.  Observations noted related to the following topics:

Observations noted relate to the following topics:

  • Compliance Program
    • Oversight of Investments and Portfolios
    • Oversight of Valuation
    • Oversight of Trading Practices
    • Oversight of Conflicts of Interest
    • Oversight of Fund Fees and Expenses
    • Oversight of Advertisements and Sales Literature
  • Omitted, Incomplete or Inaccurate Disclosures to Investors
  • Oversight of Compliance Programs, Disclosure Practices and Vendors

Electronic Investment Advice

In November 2021, the SEC’s Division of Examinations issued a risk alert regarding their findings from their recent electronic investment advice initiative.

Why it matters:

The initiative focused on obtaining a better understanding of the operations of, and services provided by, firms undertaking to provide:

  • Robo-advisory services to employee-sponsored retirement plans and/or retail investors
  • Advisory or sub-advisory services to a digital investment platform
  • And/or digital investment platform access to third-party advisers, broker-dealers and banks through the sale or licensing of such platform.

The Division also reviewed how these firms took steps to satisfy their fiduciary duties to clients.  The risk alert states that “[n]early all of the examined advisers received a deficiency letter”. The most common findings reported related to: “compliance programs; portfolio management; and marketing and performance advertising” and that advisers were not acting in accordance with, the Internet [A]dviser exemption and … Rule 3a-4.”

Investment advisers providing electronic investment advice will find further discussion and commentary on the Division’s concerns that may be helpful in reviewing their own provision of electronic investment advice.

Investment Advisor Fee Calculations

Stressing the importance of fair and accurate disclosure regarding the calculation of investment advisory fees, in November 2021, the SEC’s Division of Examinations issued a risk alert to highlight issues observed during their recently completed national initiative focused on advisory fees, particularly those charged to retail clients.

Why it matters:

As part of their initiative, the Division reviewed the various ways advisers charter for those services and the adequacy and accuracy of fee disclosures. Approximately 130 examinations were completed as part of this initiative. The Division’s observed deficiencies often resulted in financial damage to clients through overbilling due to incorrect calculations. As a related matter, the SEC also noted deficiencies in disclosures stemming from the calculation errors.

Investment advisers should consider the types of deficiencies noted in the risk alert and review their practices to identify and correct any similar issues.

OIRA Issues Fall 2021 Unified Agenda of Regulatory and Deregulatory Actions.

On December 13, 2021, the Biden Administration’s Office of Information and Regulatory Affairs (OIRA) released its Fall 2021 Unified Agenda of Regulatory and Deregulatory Actions (the “Agenda”) which includes regulatory actions to be taken by the SEC and Commodity Futures Trading Commission (CFTC) by October 2022.

Why it matters:

The Agenda includes SEC Chair Gensler’s agenda of five rule proposals, 18 proposals and one final rule expected by April 2022, and the CFTC Acting Chair Behnam’s seven proposals expected by September 2022.  The SEC’s proposals include, among others, climate change disclosure, short sale disclosure reforms, the role of third party service providers, corporate board diversity, ESG rules for investment companies and advisors, cybersecurity risk governance, fund liquidity dilution and management, amendment to fund name rules, updates to private fund adviser rules, Reg D and Form D improvements, and streamlined shareholder reporting. The CFTC’s proposals include governance requirements for derivatives clearing organizations (DCOs), filing, reporting and public information requirements for DCOs, and protection of digital asset customer collateral.

FinCEN Issues Updated Ransomware Advisory

On November 8, 2021, the Financial Crimes Enforcement Network (FinCEN), issued an advisory updating and replacing its October 1, 2020 Advisory on Ransomware and the Use of the Financial System to Facilitate Ransom Payments. The updated advisory was issued in response to the recent increase in ransomware attacks, including attacks on critical infrastructure, such as the May 2021 attack on Colonial Pipeline.

Why it matters:

The updated advisory focuses on:

  • The Role of Financial Intermediaries in Facilitating Ransom Payments
  • Trends and Typologies of Ransomware and Associated Payments
  • Recent Examples of Ransomware Attacks
  • Financial Red Flag Indicators of Ransomware and Associated Payments

The advisory also reminds U.S. financial institutions of their suspicious activity reporting requirements regarding ransomware incidents.

The SEC’s Office of Investor Education and Advocacy issues an Investor Bulletin regarding fund liquidations.

On December 17, 2021, the SEC’s Office of Investor Education and Advocacy issued an investor bulletin regarding fund liquidations.

Why it matters:

The investor bulletin provides shareholders with information regarding fund liquidations seeking to help investors understand what happens when a fund closes and distributes its assets.

The bulletin explains:

  • What is a fund liquidation
  • Who makes the decision to liquidate a fund
  • Shareholder notifications surrounding fund liquidations, including proxies
  • Actions shareholders may need to take to facilitate the liquidation.

SEC’s Electronic Filing Proposals

In November 2021, the SEC issued two proposals regarding filing practices. One would mandate the electronic filing of certain forms that currently must be filed on paper, as well as update certain other forms and processes. The other would require electronic filing through EDGAR of documents that currently may be filed in paper or electronically. The Investment Company Institute (ICI) recently filed a comment letter on the proposals.

The proposals would:

  • Require electronic filing of Form 13F Confidential Treatment Requests and applications under the Investment Advisers Act
  • Modernize the structure of Form 13F data reporting
  • Mandate the electronic submission of documents for submitting applications for orders under the Investment Advisers Act and the Investment Company Act.

The proposed changes would take affect six months after adoption of final rules.

SEC Proposes Rule on Reporting of Security Loans

The SEC proposed a new rule (10c-1) requiring that securities lending transactions and related information regarding the securities that are loaned be reported to a Registered National Securities Association (RNSA). The proposed rule would also require that the RNSA make available to the public certain information concerning each transaction and aggregate information on securities on loan and available to loan.

Why it matters:

The proposal contemplates a single-sided reporting regime in which securities lending agents or broker-dealers that serve as “reporting agents,” for purposes of proposed rule 10c-1, would have the primary obligation to report. Beneficial owners that do not employ a lending agent or enter into a written agreement with a reporting agent would be responsible for complying with the requirements of the proposed rule themselves.

Proposed rule 10c-1 would require the reporting of the material terms of a securities loan to FINRA within 15 minutes of a loan “being effected” or modified.

If adopted, this new rule would have the potential to increase costs and/or reduce returns from security lending. The rule may also increase the reporting requirements for funds that do not use a third-party agent.

SEC Proposes Money Market Reform

On December 15, 2021, the SEC proposed a new round of rule amendments intended to “improve the resilience and transparency of money market funds.” The proposed amendments would:

  • Remove the liquidity fee and redemption gate provisions from Rule 2a-7 under the Investment Company Act of 1940
  • Prohibit money market funds from operating a negative interest rate via a reverse distribution mechanism, routine reverse stock split, or other device that would periodically reduce the number of a fund’s outstanding shares to maintain a stable share price.
  • Propose changes to Form N-CR and N-MFP
  • Require institutional prime and institutional tax-exempt money market funds to implement swing pricing policies and procedures
  • Require all money market funds to increase their daily liquid asset and weekly liquid asset minimum requirements from 10% and 30% to 25% and 50%, respectively.

Why it matters:

Swing pricing would be a significant change and operationally complex to implement. Removal of fees and gates returns money market funds to the period prior to 2014 when fees and gates were first added.

As proposed, the changes would create the following timeline impacts:

  • Swing pricing changes would take affect 12 months after effective date
  • Removal of liquidity fee and redemption gates would be immediately effective upon adoption of final rules
  • Liquidity and reporting requirements would take affect six months after effective date

Private Equity Advisor Settles Charges for Failing to Properly Disclose Fees and Expenses

In December 2021, the SEC announced it reached a settlement with Global Infrastructure Management, LLC (“Global”) resulting from charges that Global failed to properly offset management fees and misled investors about funds’ fees and expenses.

Why it matters:

The SEC looked to disclosures in Global’s fund offering documents that indicated Global would offset certain advisory and other fees paid by portfolio companies against fund-level management fees.

Not only did the SEC find that Global failed to offset the fees, they noted that Global failed to implement policies and procedures to identify and cure inconsistencies among fund documents and fund practices. Global was fined $4.5 million. This highlights the importance of ensuring accuracy in disclosures to investors.

JP Morgan Fined $200 Million for Failing to Monitor Employees’ Text Messages

A joint regulatory sweep by the SEC and CFTC resulted in charges that JP Morgan failed to monitor employees’ work-related communications made on their personal devices.

Why it matters:

Regulators found that JP Morgan employees were able to escape regulatory and internal oversight of their work-related communications by discussing those matters via text messaging, messaging apps and personal email accounts on their personal devices rather than via the firm’s approved methods of business communication.

The firm was charged with both failing to establish policies and procedures to ensure that employees’ communications occurred via authorized mediums as well as failing to meet document retention obligations for the communications that occurred on personal devices.

Firms will want to ensure they properly train employees on approved methods of communication as well as properly retain all work-related communications.

Treasury and IRS Releases Final Foreign Tax Credit Regulations

The U.S. Department of the Treasury (the “Treasury”) and Internal Revenue Service (IRS) released final regulations published in early January 2022 that relate to the foreign tax credit, including:

  • The disallowance of a credit or deduction for foreign income taxes with respect to dividend eligible for a dividends-received deduction
  • The allocation and apportionment of interest expense, foreign income tax expense, and certain deduction of life insurance companies
  • The definition of a foreign income tax and a tax in lieu of an income tax
  • The definition of foreign branch category income
  • The time at which foreign taxes accrue and can be claimed as a credit.

The final regulations also contain clarifying rules related to foreign-derived intangible income (FDII). The final regulations affect taxpayers that claim credits or deduction for foreign income taxes, or that claim a deduction for FDII.

Why it matters:

Mutual funds that have more than 50% of their total assets invested in stocks or securities of foreign corporations may elect to pass through to shareholders foreign taxes paid by the mutual fund. Regulations issued by Treasury and IRS provide interpretation and guidance to rules determined under the tax code.

Investment Company Institute 2021 State Tax Survey

The Investment Company Institute (ICI) has updated their annually released State Tax Survey and it is available to ICI members on the ICI’s website.

The surveys include:

  • Survey 1: State Income Taxation of Dividends Paid by a RIC Derived in Whole (or in Part) from Interest on Federal Obligations,
  • Survey 2: State Taxation of State and Local Obligations,
  • Survey 3: State Taxation of Long-Term Capital Gain Distributions Made by RICs to Individual Shareholders,
  • Survey 4: State Taxation of Contributions to and Distributions from Certain Retirement Plans; and
  • Survey 5: State Taxation of Qualified Tuition Programs (Section 529 Plans).

Why it matters:

UMB Fund Services, Inc. registered funds references the ICI’s State Tax Survey as it prepares shareholder calendar tax information.

SEC Proposes Rules to Enhance Disclosures Regarding Proxy Voting

In September 2021, the SEC proposed amendments to Form N-PX  that would alter fund reporting duties and standardize how voting information is reported.

Why it matters:

If adopted, funds and investment advisers would be required to revise existing procedures, possibly significantly, to gather and report the required information. The proposed changes would require, amongst other things, disclosure of information using the same language and in the same order as in an issuer’s proxy statement and to categorize the subject matter of the votes using pre-determined categories. Insofar as Form N-PX is generally prepared and submitted to the SEC with the assistance of a fund’s administrator, funds and advisers will also need to coordinate their efforts with their service providers.

SEC Proposes Rule Amendments Regarding Rule 10b5-1 Plans and Insider Trading

In December 2021, the SEC announced proposed rules designed to further refine existing rules regarding insider trading.

Why it matters:

The SEC’s proposal would add new conditions to the availability of the affirmative defense under Exchange Act Rule 10b5-1(c)(1) designed to address concerns about abuse of the rule to opportunistically trade securities on the basis of material nonpublic information. The SEC is also proposing new disclosure requirements regarding the insider trading policies of issuers, and the adoption and termination (including modification) of Rule 10b5‑1 and certain other trading arrangements by directors, officers, and issuers.

On a related note, the SEC proposed amendments to the disclosure requirements for executive and director compensation regarding the timing of equity compensation awards made in close proximity in time to the issuer’s disclosure of material nonpublic information. The SEC closed by proposing amendments to Forms 4 and 5 to require corporate insiders subject to the reporting requirements of Exchange Act Section 16 to identify transactions made pursuant to a Rule 10b5-1(c)(1) trading arrangement, and to disclose all gifts of securities on Form 4.

Click here for a review of the summer 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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