SEC Issues an Investor Bulletin on ESG Funds

 In February 2021, the Securities & Exchange Commission (SEC) Office of Investor Education and Advocacy issued an investor bulletin to provide investors with important information and considerations for investments in ESG funds, such as mutual funds and ETFs.

Why it matters:

The bulletin addressed a variety of topics, including:

Understanding ESG Funds

  • ESG funds are not all the same and the factors that make a fund an ESG fund may be subjective.
  • Each fund will vary the extent to which the fund weighs the importance of ESG factors with potential other investment strategy factors.
  • Further, each fund may place varied importance on the elements of ESG – environmental, social, and governance – within its overall strategy.

Important Considerations for Investing in ESG Funds

  • As with any fund, investors are encouraged to read all a fund’s available information to understand the role ESG plays in that fund.
  • Review how an ESG fund’s fees, expenses and performance compares to other funds.

DOL Issues Statement on Recent ESG and Proxy Voting Rules

The Department of Labor (DOL) issued a statement in March 2021 announcing that it would not enforce its two recently finalized rules on ESG and Proxy Voting to allow for further DOL review.

Why it matters:

The DOL finalized two rules, “Financial Factors in Selecting Plan Investments” and “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.” Both rules, as written, contain potentially significant implications for fiduciaries who include any ESG factors in the financial evaluation process. Subsequent to the finalization of these rules, the presidential administration changed. On January 20, 2021, President Joe Biden directed all federal agencies to review and consider any recently adopted climate-related regulations. As a result of the President’s directive, the DOL issued a temporary non-enforcement order of the two rules to allow for further analysis of each rule.

Congress enacts Anti-Money Laundering Act of 2020

 In January 2021, the U.S. Congress enacted the Anti-Money Laundering Act of 2020 (AML Act) as part of the National Defense Authorization Act for Fiscal Year 2021.

Why it matters:

The AML Act makes several changes to U.S. AML laws and regulations, notably changing the AML requirements for certain private funds. Affected funds must implement these changes no later than January 1, 2022.

The AML Act of 2020:

  • Enhances beneficial ownership requirements;
  • Expands authorities for enforcement, subpoenas and whistleblower protection;
  • Expands coordination and transparency efforts

Additionally, the AML Act allows for increased penalties for certain violations, removes the cap on whistleblower awards and adds new whistleblower protections, and facilitates information sharing among government agencies and financial institutions.

Executive Order 13959 – Threats from Securities Investments that Finance CCMCs

In November 2020, former President Trump signed Executive Order 13959 Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies.

Why it matters:

The Executive Order prohibits trading by U.S. persons in the securities (and derivatives thereof) of Chinese entities identified as supporting the People’s Liberation Army of China (the “CCMC Covered Companies”). The Office of Foreign Assets Control (OFAC) has made available a current listing of the entities identified as CCMC Covered Companies.

The U.S. Department of Treasury issued a FAQ and the Securities and Exchange Commission released a risk alert regarding the Executive Order.

SEC Releases 2021 Examination Priorities

 In March 2021, the SEC’s Division of Examinations (EXAMS), formerly the Office of Compliance Inspections and Examinations, released its 2021 examination priorities.

Why it matters:

EXAMS’ 2021 examination priorities are as follows:

  • Protection of Retail Investors, Including Seniors and Individuals Saving for Retirement
  • Information Security and Operational Resiliency
  • Financial Technology and Innovation, Including Digital Assets
  • Anti-Money Laundering
  • The London Inter-Bank Offered Rates (LIBOR) Transition
  • Additional Focus Areas Involving Registered Investment Advisors and Investment Companies
  • Additional Focus Areas Involving Broker-Dealers and Municipal Advisors
  • Market Infrastructure
  • Focus on FINRA and MSRB

In addition to EXAMS’ 2021 priorities, the release includes observations regarding the impact of the Covid-19 pandemic on the financial services industry, the implementation of Regulation Best Interest, the importance of compliance programs and compliance staff, and trends in risk, technology and the industry.

SEC Issues Statement and Seeks Comment on the Custody of Digital Assets by Special Purpose Broker-Dealers

 In December 2020, the SEC issued a statement and request for comment regarding the custody of digital asset securities by broker-dealers (the “Statement”). Through the Statement, the SEC seeks to encourage innovation regarding the application of Rule 15c3-3 under the Securities Exchange Act (the “Rule”) to digital asset securities.

Why it matters:

In the Statement, the SEC details circumstances under which broker-dealers may operate for a period of five years, subject to certain conditions, without being subject to enforcement action on the basis that the broker-dealer deems itself to have obtained and maintained physical possession or control of customer fully paid and excess margin digital asset securities as required by paragraph (b)(1) of the Rule. Conditions that must be met by broker-dealers include, limiting its business to digital asset securities, implementation of procedures reasonably designed to mitigate risks of operating a digital asset securities business, and providing customers with certain disclosures regarding the risks of transacting in digital asset securities.

SEC Outlines Crypto Examinations Playbook

 In February 2021, the SEC’s Division of Examinations (EXAMS) published a Risk Alert which outlines its framework for vetting digital asset investments and the use of distributed ledger or blockchain technology.

Why it matters:

The Risk Alert provides EXAMS’ observations assembled through examinations of investment advisers, broker-dealers, and transfer agents with regard to digital asset securities that may serve as a guide to such firms in developing and enhancing their compliance programs. EXAMS encourages market participants to review their own practices and seek improvements to supervisory, oversight and compliance programs, and to engage with the SEC through its Strategic Hub for Innovation and Technology as questions arise.

ICI Profile of Mutual Fund Shareholders Annual Survey

 The Investment Company Institute (ICI) conducts an annual survey to track U.S. households’ ownership of mutual funds and to gather information on their demographic and financial characteristics. The most recent survey was conducted from May to June 2020.

ICI released a report summarizing findings of the survey.

Why it matters:

In 2020, ICI reports the “typical” mutual fund–owning head of household:

  • was middle-aged, employed, educated, married or living with a partner;
  • shared investment decision making with his or her spouse or partner;
  • had $105,000 in household income and $300,000 in household financial assets;
  • owned investments other than mutual funds, including individual stocks, and had more than half of the household’s financial assets (excluding the primary residence) invested in mutual funds;
  • had $126,700 invested in four mutual funds, including at least one equity fund;
  • owned mutual funds inside an employer-sponsored retirement plan, such as a 401(k) plan, 403(b) plan, 457 plan, SEP IRA, SAR-SEP IRA, or SIMPLE IRA;
  • owned mutual funds outside employer-sponsored retirement plans, primarily purchased through investment professionals (e.g., registered investment advisers, full-service brokers, independent financial planners, bank or savings institution representatives, insurance agents, or accountants);
  • owned a traditional or Roth IRA; and
  • was confident that mutual funds could help him or her reach financial goals.

Update on New Valuation Rule 2a-5

 The Staff of the SEC’s Division of Investment Management prepared a series of FAQs regarding the implementation of the new Rule 2a-5 under the Investment Company Act (the “Rule”). The Staff expects to update FAQs over time in response to additional questions. In addition, the SEC prepared a Small Entity Compliance Guide to assist in the good faith determination of fair value. The Rule went into effect on March 8, 2021 and has a compliance date of September 8, 2022.

Why it matters:

  • States that all registered investment companies and business development companies, regardless of the type or classifications are covered by the Rule
  • Summarizes the requirements of the Rule that include:
    • Periodically assessing any material risks associated with the determination of the fair value of the fund’s investments and managing those identified valuation risks.
    • Establishing and applying fair value methodologies. This involves the selection and application of appropriate fair value methodologies along with periodically reviewing their appropriateness and accuracy of the methodologies selected and making any necessary changes or adjustments. This element also involves monitoring for circumstances that may necessitate the use of fair value.
    • Testing fair value methodologies for appropriateness and accuracy. This requirement includes the identification of the testing methods to be used and the minimum frequency with which such testing methods are used but does not require particular testing methods or a specific minimum frequency for the testing.

SEC Issues No-Action Relief Regarding Custody of Loan Interests

 In January 2021, the SEC issued a no-action providing flexibility regarding the cumbersome rule requirements related to the custody of loan interests under the Investment Company Act.

Why it matters:

Generally, Section 17(f) and Rule 17f-2 under the Investment Company Act (the “Rule”) govern the conditions and procedures under which registered funds may maintain custody of their own investments. Specifically, the Rule requires that documents evidencing a fund’s investments “shall be deposited in the safekeeping of, or in a vault or other depository maintained by, a bank or other company whose functions and physical facilities are supervised by Federal or State authority.”

The Rule also imposes restrictions on which persons may have access to a fund’s investments and requires that each person withdrawing or depositing a fund’s investments sign a notation confirming the transaction. The SEC’s Division of Investment Management Staff determined that it would not recommend enforcement action if a fund were to maintain custody of its own interests in corporate loans if the following conditions are met instead of meeting the above requirements:

  • Only a limited number of personnel to provide instructions to the fund’s custodian and the administrative agents for the loans;
  • Passwords or other security procedures are required to ensure only properly authorized personnel can submit those instructions;
  • The fund reconciles settled loan interests with the records of the applicable administrative agents on a regular basis;
  • Loan interests are titled or recorded at the administrative agents in the name of the fund;
  • There is no affiliation between the fund/investment adviser and the administrative agent(s); and
  • The fund adopts policies and procedures reasonably designed to prevent violations of provisions of the conditions set forth above.

SEC Staff Issues Statement on Cross Trading

 In March 2021, the SEC’s Division of Investment Management Staff (the “Staff”) issued a statement addressing certain aspects of investment company cross trading and requesting information related to how the SEC could enhance the regulatory regime regarding cross trading.

Why it matters:

In its statement, the Staff commented on “ways to enhance the regulatory regime” in light of the SEC’s recent adoption of Rule 2a-5, the ”Valuation Rule.” In conjunction with the recently adopted Valuation Rule, the SEC provided a definition of the term “readily available market quotations” that is narrower than that previously used in the industry. This narrower definition has served to restrict the ability of registered funds to effect cross transactions in compliance with the Investment Company Act because such transactions are permissible only as to securities for which there are readily available market quotations. Accordingly, the Staff asked for comment as to whether any changes to Rule may be appropriate. Among the things the Staff requested information about were:

  • the circumstances in which funds currently engage in cross trading and the extent of readily available market quotations;
  • the advantages and disadvantages of the threshold requirement that a security have a “readily available market quotation”;
  • the controls and procedures advisers have in place to govern cross trading; and
  • the extent to which cross-trades affect market efficiency if not publicly reported.

Defining Special Purpose Acquisition Companies

Special purpose acquisition companies (SPACs) are a type of a blank check company that raises cash through an initial public offering, typically priced at $10 a share, after which the shell company has a specified timeframe (generally two years) to use the raised funds to acquire or merge with a private company, thereby making that company a public company. The time it takes for the SPAC to merge with a private company may be completed in as little as three or four months, which can be substantially shorter than an initial public offering timeframe. Sometimes the SPAC garners additional funds to complete the transaction and may raise additional capital through a private investment in public equity which generally will close in conjunction with the merger. If the SPAC does not complete the merger within the timeframe, the SPAC liquidates, and the proceeds are returned to the shareholders.

 Why it matters:

Asset managers may invest in SPACs within a fund structure or an asset manager may set up a SPAC structure. To learn more, visit the SEC’s glossary and related content on SPACs.

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