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.

Department of Labor (DOL) issues final rule for ESG investing in ERISA-covered plans

The DOL issued a final rule on November 22, 2022 that governs ERISA-covered plans investment selections‡ relative to environmental, social and governance (ESG) considerations.

Why it matters:

Generally, the DOL mandates the paramount focus of ERISA plan managers is to manage risk and overall returns. Therefore, consideration of ESG factors in the investment selection for ERISA-covered plans has been potentially at odds with those principles.

The much-anticipated DOL final rule on ESG investing was the result of multiple iterations of proposed rules and public feedback. While the final rule largely resembles its predecessor proposals, and still maintains that the fiduciary duties of prudence and loyalty require focus on risk and returns, it lessens the burden on ERISA-covered plans that wish to pursue ESG-related investments.

Specifically, the rule acknowledges that consideration of ESG factors may play a significant factor in the duty of prudence. The final rule also addresses proxy voting as it relates to ERISA plan managers’ fiduciary duties and underlying shareholder responsibilities.

Securities Exchange Commission (SEC) proposes “regulation best execution” for broker-dealers

In December 2022, the SEC proposed new rules that would create a regulatory framework for best execution amongst key industry players.

Why it matters:

Although other regulators, such as FINRA, have enacted best-execution regulations, the proposed Regulation Best Execution‡ would mark the first rule on best execution from the SEC. The proposal would require broker-dealers to establish policies and procedures to ensure compliance with the best execution standard. As with similar SEC regulatory framework, the policies and procedures would need to address a variety of relevant factors and undergo a documented annual review protocol. Public comments are welcomed on the proposal.

SEC adopts amendments to Form N-PX proxy voting disclosures

On November 2, 2022, the SEC adopted a final rule and form amendments (the Final Rule) requiring additional disclosure on Form N-PX about the proxy votes of registered funds. The effective date of the Final Rule is July 1, 2024, so N-PX filers will be required to file their first reports under the Final Rule by August 31, 2024.

Why it matters:

The Final Rule‡ requires those filing on form N-PX to:

  • Identify proxy voting matters using the same language as disclosed on the issuer’s form of proxy and presented in the same order as the matters appear in the form of proxy card required to be filed with the SEC.
  • Categorize matters voted on using 14 prescribed topical categories.
  • Disclose the number of shares voted and the number of shares loaned and not recalled for voting.
  • File Form N-PX in a custom XML-based structured data language created specifically for reports on Form N-PX.

The Final Rule also adopted new Rule 14Ad-1 under the Securities Exchange Act of 1934 requiring institutional investment managers to report on Form N-PX their voting on approval of executive compensation, so-called “say-on-pay” votes, a requirement mandated by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.

SEC announces enforcement results for fiscal year 2022

On November 15, 2022, the SEC announced that it filed 760 total enforcement actions in fiscal year 2022, noting that this represented a 9% increase over fiscal year 2021. Civil penalties, disgorgements, and pre-judgment interest relating to the enforcement action is totaled at more than $6.4 billion, a record, eclipsing the approximately $3.9 billion amount from fiscal year 2021. Civil penalties alone nearly tripled compared with the prior year (from $1.46 billion to $4.19 billion).

Why it matters:

The enforcement statistics for 2022‡ illustrate that the SEC continues to pursue its mission of filing an increasing number of enforcement actions. Enforcement actions in 2022 continued to focus on the SEC’s traditional enforcement priorities, such as regulated firms, financial fraud and issuer disclosures. However, emerging areas such as environmental, social and governance (ESG), crypto asset securities and private funds drew increased attention.

The SEC’s Division of Examinations issues Risk Alert regarding observations from identity theft prevention examinations

On December 5, 2022, the SEC’s Division of Examinations (EXAMS) issued a Risk Alert‡ noting observations from recent examinations of broker-dealers and advisers in regard to compliance with Regulation S-ID. Listed in the Risk Alert‡ are various areas where EXAMS noted deficiencies in identity theft prevention programs, including identification of covered accounts, establishment of the program, required elements of the program, and administration of the program.

Why it matters:

The Risk Alert‡ describes frequent deficiencies in identity theft prevention programs that EXAMS has observed during recent examinations. These observations can assist investment advisers in the review of their identity theft prevention policies and procedures. EXAMS is encouraging advisers to review their policies and procedures to ensure they are compliant with regulations.

SEC adopts amendments to electronic recordkeeping for BD 17a-4

On October 12, 2022, the SEC adopted the proposed amendment‡ allowing for broker-dealers to use an alternative method of storage and preservation of books and records and move away from the Write One Read Many (WORM) compliant systems that have been in use for the last 25 years.

Why it matters:

Under the amendment, broker-dealers will need to ensure that electronic records are maintained using a system that complies with the original WORM requirements or utilizes an audit-trail requirement described in the amended rule.

The greatest benefits of this rule change will likely be seen by smaller broker-dealers or new entrants to the industry where the potential cost savings from new technologies can be more easily recognized.

SEC sends a clear message on digital communications and recordkeeping violations in a year of record penalties

The SEC announced charges in September 2022‡ against 15 broker-dealers and one affiliated investment adviser for widespread and longstanding failures by the firms and their employees to maintain and preserve electronic communications. The firms acknowledged the violations and agreed to pay combined penalties totaling more than $1.1 billion with the largest 8 firms on the hook for $125 million each. This was the result of employees conducting business via personal text messaging and other unsupervised “off-channel” platforms such as WhatsApp.

Why it matters:

2022 was a significant year for the SEC, racking up a record total $4.2 billion in civil penalties. The fact that more than $1 billion of that amount represents cumulative penalties paid in connection with recordkeeping violations underscores how critical it is for firms to effectively implement digital communication policies and successfully enforce those procedures.

The message is loud and clear: unauthorized, unwatched, or willfully ignored digital communications will not be tolerated and behavior at the top must change. If a comprehensive review of your firm’s electronic communication practices has been a perpetual to do item, it seems prudent to move it up as a priority in 2023.

Investment Company Institute 2022 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‡.

Why it matters:

UMB Fund Services references the ICI’s state tax survey as it prepares shareholder calendar tax information.

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).

2022 year-end reporting layouts and target delivery deadlines

The ICI released their 2022 calendar year reporting layouts‡ and target delivery dates. The Primary Layout has been designed to track the IRS Form 1099-DIV. The Secondary Layout provides a means for regulated investment companies (RICs) to use to report various additional tax related items. The NRA Layout provides a means for reporting information reported on IRS Form 1042-S.

Why it matters:

The 2022 Primary Layout has been updated because the “FATCA filing requirement” checkbox on Form 1099-DIV has been assigned a box number 11. Subsequently, Form 1099-DIV box numbers 11 through 15 have been renumbered 12 through 16, respectively. The 2022 Primary Layout, Column 30, has been updated to now read as “Box 12 Exempt Interest Dividends”. The 2022 Primary Instructions references have been modified to reflect the changes.

The target dates for delivering 2022 calendar year tax information to brokers and banks will be as follows: Primary Layout – Tuesday, January 17, 2023; Secondary Layout – Tuesday, January 24, 2023; and NRA Layout – Tuesday, January 31, 2023. Funds are encouraged to provide their year-end tax information to brokers and banks as soon as it is available.

The Primary, Secondary and NRA layouts are used by regulated investment companies (RICs) to report their 2022 calendar year tax information to brokers and banks using standardized formats and target delivery dates.

SEC finalizes clawback rules

On October 26, 2022 the SEC adopted final rules requiring publicly traded companies to implement and disclose policies for the recovery of incentive-based compensation awarded to past and present executive officers based on misstated financial statements which later resulted in a restatement.

Why it matters:

In addition to publicly traded companies, these clawback rules‡ apply to other listed issuers apply to registered investment companies excluding some that have not paid incentive-based compensation to its executive officers during the past three years.

Business development companies will be subject to the clawback rules. These clawback rules became effective on January 27, 2023 and related changes to applicable listing standards must be effective no later than November 28, 2023.

FairValue measurement of equity securities subject to contractual sale restrictions

The Financial Accounting Standards Board (FASB) set a standard on whether the effects of the restriction should be considered in measuring the security fair value.

Why it matters:

The standard clarifies that:

  • A contractual sale restriction on an equity security (e.g., an underwriter lockup agreement) is not part of the unit of account of the security and, therefore, is not considered when measuring fair value of the equity security because the contractual sale restriction is a characteristic of the holder rather than a characteristic of the asset.
  • Applying a discount to reflect the contractual sale restriction is not permitted.
  • Recognizing the restriction as a separate unit of account is also not permitted.

The standard requires the following disclosures for equity securities subject to contractual sale restrictions:

  • The fair value of equity securities subject to contractual sale restrictions
  • The nature and remaining duration of the restriction(s)
  • The circumstances that could cause a lapse in the restriction(s)

SEC adopts new tailored shareholder reports

The SEC adopted a new rule regarding tailored shareholder financial reports for open-end and exchange traded funds (ETFs).

Why it matters:

The rule is effective for financial statements issued for the period ending May 31, 2024. UMB encourages managers of these products to review details of the new rules‡.

Click here to review the Fall 2022 – 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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