Each quarter the UMB Fund Services registered fund accounting, administration and tax teams consolidate the most impactful regulatory and tax developments in the registered 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 and Exchange Commission (SEC) clarifies when exemptive relief will be granted on expedited review
In 2021, the SEC implemented a rule that expedites certain types of applications “that are substantially identical to recent relief.”
Recently the SEC has clarified that it will only expedite exemptive relief for applicants that file for products that are identical in structure to ones that are already on the market. Specifically:
- The relief requested must come from the same law or rule, and the terms and conditions of the exemption must be identical,
- Facts must only differ in ways that are not material to the relief requested, the guidance notes. Example: name of the company requesting relief is not material
One type of exemption that has not seen expedited review is applications for co-investment relief. The SEC has noted that expedited exemptive relief should “consider carefully” whether they are substantially identical to existing products prior to seeking expedited review.
Firms will have the highest likelihood of receiving the expedited relief if they ensure that their applications’ terms and conditions are identical to prior applications, as well as the wording, except “for factual differences that are not material to the requested relief”.
Why it matters
Exemptive relief can take time, which needs to be considered by advisors who plan on starting a new fund or making changes to an existing fund.
The SEC adopts rules to prevent security-based swaps fraud and misconduct
On June 7, 2023, the SEC adopted Rule 9j-1 and Rule 15fh-4(c) under the 1934 Act to address fraud, manipulation, and deception in transactions of security-based swaps and prevent the fraudulent influence of CCOs.
Why it matters
SEC indicated that Rule 9j-1 “is designed to prevent fraud, manipulation, and deception in connection with effecting any transaction in, or attempting to effect any transaction in, or purchasing or selling, or inducing or attempting to induce the purchase or sale of, any security-based swap.” The rule applies to both attempted and completed misconduct.
Rule 15fh-4(c) makes it unlawful for any officer, director, supervised person or employee of a SBS Entity (security-based swap dealer or major security-based swap participant) to directly or indirectly influence the SBS Entity’s CCO in performing their duties.
The final rules are effective August 29, 2023 and can be found here‡.
In May 2022, the Fifth Circuit held that removal protections for SEC ALJs violated the president’s constitutional authority to remove executive branch officers, calling ALJs’ statutory removal protection into question across the federal bureaucracy.
Why it matters
Federal agencies frequently engage in adjudication to resolve the application of a statute or regulation to a particular case. For adjudications presided over by most non-SEC ALJs, the ALJs enjoy certain independence (i.e. protection from removal) from their employing agency. Once appointed, such ALJs are removable only for good cause as determined by an independent agency.
However, the Jarkesy Court reasoned that the U.S. president is accountable to the electorate for the actions of the executive branch, but that accountability is undermined when the president loses the ability to control the actions of executive branch officers through the authority to remove such officers. Therefore, the above-mentioned independence/protection from removal of SEC ALJs is limited by Article II of the Constitution, arguably increasing the likelihood that ALJ decisions will reflect a pro-agency bias.
SEC adopts share repurchase disclosure rules
On May 3, 2023, the SEC released final rules requiring enhanced disclosure relating to issuers’ repurchases of their securities and executives’ trading thereof (the Repurchase Rules ‡), which became effective on July 31, 2023 and requires issuers to disclose greater detail related to share repurchases in their periodic reports, including:
- Daily share repurchase data
- Checkbox disclosure if any officers or directors purchased or sold shares that are the subject of a repurchase plan within four business days before or after the announcement of the plan (or an increase thereof)
- Enhanced narrative disclosure about the issuer’s objectives and rationales for its plan, the process and criteria used to determine the amount of any repurchases, and sales of shares by its officers and directors during a repurchase program
- The adoption, modification, or termination of any Rule 10b5-1 trading plans.
Why it matters
The SEC’s primary goal in promulgating the Repurchase Rules is to provide investors with a broader set of data to assess the purposes and effects of repurchases. Issuers preparing for the Repurchase Rules to come into effect should:
- Review their existing policies and procedures governing repurchases and insider transactions
- Draft language describing the objectives and rationales for their repurchase programs in advance of the effective date
- Carefully document their processes for implementing share repurchases
SEC charges advisor and trustees with liquidity rule violations
On May 5, 2023, the SEC charged a fund’s advisor (Pinnacle Advisers) and independent trustees with aiding and abetting rule violations ‡ (specifically, Rules 22e-4(b)(1) and 30b1-10 under the Investment Company Act).
Why it matters
Funds, advisors, and trustees should be familiar with the liquidity rule, which prohibits mutual funds from investing more than 15% of their net assets in illiquid investments.
Pinnacle’s fund is alleged to have held 21-26% of its net assets in illiquid investments, classifying the fund’s largest illiquid investment as a “less liquid” investment. This was done despite share restrictions, transfer limitations, the absence of a market for the shares, and being against the advice of fund counsel and auditors.
The SEC (i) alleges that Pinnacle did not present the fund’s board with a plan to reduce the illiquid investment to 15% or make required related filings with the SEC; (ii) accuses the trustees of misleading it regarding the basis for the fund’s liquidity classifications; and (iii) seeks permanent injunctions and civil money penalties.
SEC risk alert: Safeguarding consumer records and information at branch offices
On April 26, 2023, the SEC issued a risk alert‡ to highlight the importance of establishing written policies and procedures for safeguarding customer records and information at branch offices.
Why it matters
Individuals in branch offices often have access to information technology systems that contain customer records and information. Firms should consider their entire organization when implementing written policies and procedures for the safeguarding of customer records and information to ensure compliance with Regulation S-P.
Issues of concern include:
- Ensuring branches conduct proper due diligence and oversight of vendors
- Weak email configuration can result in account takeover or business email compromise, and default email configuration must capture all account activity to ensure adequate incident response
- Applying policies and procedures to identify where customer records and information were stored electronically to branch offices
- Extending password complexity and multi-factor authentication for remote access to firm systems requirements to branch offices
- Applying written policies and procedures for inventory management, patch management, and vulnerability management to branch offices.
Click here to review the Spring 2023 – Regulatory lookback: Registered funds regulatory and tax insights.
Learn more about UMB 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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