Table of Contents

SEC Adopts Amendments to Enhance Private Fund Reporting

SEC Charges Registered Investment Adviser for Failing to Disclose Influencer’s Role in Connection with ETF Launch

SEC Charges Two Investment Advisers with Making False and Misleading Statements About Their Use of Artificial Intelligence

SEC Charges Advisory Firm for Disclosure Failures Ahead of Acquisition Bid

SEC Adopts Reforms Relating to Investment Advisers Operating Exclusively Through the Internet

SEC Proposes Rule to Update Definition of Qualifying Venture Capital Funds

SEC ADOPTS AMENDMENTS TO ENHANCE PRIVATE FUND REPORTING

On February 8, the Securities Exchange Commission (the “SEC” or the “Commission”) and the Commodities Futures Trading Commission (the “CFTC”) jointly adopted amendments to Form PF, used by certain investment advisers to private funds, including investment advisers that are registered with the CFTC as commodity pool operators (“CPOs”) or commodity trading advisers, to report confidential information regarding the private funds they advise. According to the final rule’s adopting release, the amendments “are designed to enhance the Financial Stability Oversight Council’s ability to monitor systemic risk as well as bolster the SEC’s regulatory oversight of private fund advisers and investor protection efforts.”

The amendments to Form PF (the “Form Amendments”) require separate reporting for each component of master-feeder arrangements and parallel fund structures (other than feeder funds that invest all of its assets in a master fund, U.S. Treasury bills, and/or cash and cash equivalents). Advisers will also be required to include the value of investments in other private funds when determining whether: (i) the adviser is required to file Form PF; (ii) the adviser meets the thresholds for reporting as a large hedge fund adviser, large liquidity fund adviser, or large private equity fund adviser; (iii) a hedge fund is a qualifying hedge fund, as opposed to permitting an adviser to either include or exclude the value of other investments for determining the adviser’s reporting threshold. In a change from the SEC’s initial proposal, which contemplated permitting advisers to report fully owned trading vehicles on an aggregated or disaggregated basis and requiring advisers to report partially owned trading vehicles on a disaggregated basis, the final rule includes that advisers will be required to identify trading vehicles in Section 1b of Form PF and report on an aggregated basis for the reporting fund and all trading vehicles. In addition, the final rule adds an instruction for advisers to specify whether the reporting fund holds assets, incurs leverage, or conducts trading or other activities through a trading vehicle.

Additionally, the Form Amendments amend Sections 1a and 1b of Form PF (applicable to all filers) to require filers to provide “additional identifying information” about the adviser and its related persons and their private fund assets under management. Filers will also be required to provide additional identifying information about the private funds they manage and certain other information about such funds, including the fund’s assets, financing, investor concentration, and performance.

The Form Amendments also amend Section 1c of Form PF (applicable to private fund advisers to hedge funds). Advisers will be required to report the fund’s use of “digital assets as an investment strategy.” With respect to Sections 2a and 2b of the Form, the Form Amendments remove aggregate reporting questions for large hedge fund advisers and require large hedge fund advisers to report information about the reporting fund’s investment exposure, open and large position reporting, borrowing and counterparty exposure, and market factor effects.

The effective date and compliance date for the Form Amendments is March 12, 2025.

SEC CHARGES REGISTERED INVESTMENT ADVISER FOR FAILING TO DISCLOSE INFLUENCER’S ROLE IN CONNECTION WITH ETF LAUNCH

On February 16, the SEC announced that a registered investment adviser (the “IA”) had agreed to pay a $1.75 million civil penalty to settle charges that the IA failed to disclose a social media influencer’s role in the launch of a new exchange-traded fund (“ETF”). The IA launched a social media sentiment ETF designed to track an index “based on ‘positive insights’ from social media, news articles, blog posts and other data.” According to the SEC’s order (the “Order”), the index provider informed the IA that it planned to retain a well-known social media influencer (the “Influencer”) to promote the index in connection with the launch of the Fund. The Order also included that the index provider requested, and the IA agreed, to an index license fee structure that would provide the index provider with a larger percentage of the fee when the ETF’s assets under management reached certain thresholds.

As further described in the Order, the initial discussions between the IA and the index provider with respect to the index license fee resulted in a preliminary agreement in October 2020 that the IA would pay the index provider an index license fee equal to 20% of the management fee the IA received from the ETF, though no agreement was executed at that time. Subsequently, the index provider determined to partner with the Influencer, who would receive a portion of the licensing fees paid to the index provider. In light of this partnership, the index provider proposed new economic terms for the index licensing agreement to incentivize the influencer to raise awareness of the ETF.

Specifically, the Order states that under the new economic terms of the proposed licensing agreement, the index provider would receive, “at least 20% of the net management fee [the IA] accrued (after netting out four basis points attributed to expenses) and as much as 60% of the management fee if the new ETF had in excess of $1.25 billion in assets under management within eighteen months of launching the fund.” In mid-November 2020, representatives of the IA and index provider informally agreed to these terms, though the index licensing agreement was not executed until February 2021.

The ETF’s board of trustees (the “ETF Board”) met in early December 2020, at which time the ETF Board considered the advisory contract with the IA. In connection with such approval, the IA provided a memorandum that discussed certain of the economic terms of the licensing agreement. According to the Order, this memorandum disclosed that the licensing fee would equal 20% of the net management fee, but did not disclose the sliding scale whereby the index provider’s compensation would increase if the ETF reached certain asset thresholds. The materials presented to the ETF Board also did not disclose the influencer’s involvement or discuss the controversies surrounding the influencer.

In connection with a board of director’s consideration of an advisory contract, Section 15(c) requires advisers to furnish such information as may reasonably be necessary for the directors to evaluate the terms of the contract. Funds are required to include disclosure in their shareholder reports concerning, among other items, (i) the extent to which economies of scale would be realized as the fund grows, (ii) whether economies of scale are for the benefit of shareholders, and (iii) the costs of services to be provided and profits to be realized by the adviser and its affiliates from its relationship with the fund. According to the Order, the ETF Board did not have ability to consider the economic impact of the sliding scale arrangement as part of its evaluation of the IA’s profitability and the extent to which economies of scale would be realized if the ETF grew. Additionally, the Order included that the IA did not have adequate written policies and procedures for furnishing the Board with accurate information reasonably necessary for the board to evaluate the terms of the advisory contract as well as the material information related to a proposed fund launch.

As a result of the above, the Order stated that the IA violated: (i) Section 15(c) of the Investment Company Act; (ii) Section 206(2) of the Investment Advisers Act of 1940 (the “Advisers Act”), which prohibits an investment adviser directly or indirectly, from engaging in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client; and (iii) Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which required registered investment advisers to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder.

SEC CHARGES TWO INVESTMENT ADVISERS WITH MAKING FALSE AND MISLEADING STATEMENTS ABOUT THEIR USE OF ARTIFICIAL INTELLIGENCE

On March 18, the SEC announced settled charges against two investment advisers (“Adviser 1” and “Adviser 2”) for making false and misleading statements about their purported use of artificial intelligence (“AI”). As the first set of SEC settlements related to AI claims, the settlements highlight the SEC’s focus on investment adviser’s unsubstantiated claims about using AI – “AI washing” – compared to ESG “greenwashing.”

The SEC charged Adviser 1 with violations of Sections 206(2) and 206(4) of the Advisers Act and Rules 206(4)-1 and 206(4)-7 (the “Antifraud Provisions,” the “Marketing Rule,” and “Compliance Rule”, respectively) thereunder in connection with regulatory filings, advertisements, and social media relating to its purported use of artificial intelligence and machine learning. Per the SEC’s order, Adviser 1 represented that it used artificial intelligence and machine learning to analyze its retail clients’ spending and social media data to inform its investment advice when, in fact, no such data was being used in its investment process. For example, in Adviser 1’s Form ADV brochures from August 2019 through 2021, Adviser 1 claimed that its advice was “powered by the insights it makes when individuals . . . connect their social media, banking, and other accounts . . . or respond to Adviser 1’s questionnaires” which make its investment decisions “more robust and accurate[.]” Moreover, starting in November 2020, Adviser 1’s website claimed that Adviser 1 “turns your data into an unfair investing advantage” and that Adviser 1 “put[s] collective data to work to make our artificial intelligence smarter so it can predict which companies and trends are about to make it big and invest in them before everyone else.” According to the SEC, these statements were false and misleading because Adviser 1 had not developed the capabilities they represented. The Division of Examinations (“EXAMS”) identified Adviser 1’s AI-related statements as problematic during an examination in October 2021, for which Adviser 1 admitted to EXAMS that it had not used any of its client’s data and had not created an algorithm to use client data. Adviser 1 then took certain corrective actions to correct false and misleading statements regarding the use of client data, such as revising its Form ADV Part 2A, hiring an additional compliance manager for its compliance team, and retaining two outside compliance consulting firms to assist with a corrective review of the firm’s marketing and regulatory disclosure documents. Still, Adviser 1 continued to make certain false and misleading advertising statements regarding using client data in various formats through August 2023. For example, investors who joined Adviser 1 in 2021 and 2022 were sent an email communication stating that their data was “helping [Adviser 1] train [its] algorithm for pursuing even better returns” and that Adviser 1 “will pool your data with everyone else’s to power our algorithm.” Similarly, the aforementioned website claims made in November 2020 remained through August 2023. Without admitting or denying the SEC’s findings, Adviser 1 agreed to pay a civil penalty of $225,000.

The SEC charged Adviser 2 with violations of Sections 206(2) and 206(4) of the Advisers Act and Rules 206(4)-1 and 206(4)-7, thereunder in connection with Adviser 2’s false and misleading claims about its purported use of AI on its website and social media sites, as well as in emails to current and prospective clients. According to the SEC, Adviser 2 could not substantiate its claim as the “first regulated AI financial advisor” and falsely claimed on its public website that its technology incorporated “[e]xpert AI-driven forecasts,” when in fact it did not. Adviser 2 was also cited by the SEC for other non-AI related violations of the Marketing Rule (e.g., false claims on Adviser 2’s website and in a press release that it had more than $6 billion of assets on its platform when Adviser 2 did not have or report any regulatory assets under management on its Form ADV; use of hypothetical performance and testimonials on Adviser 2’s website and YouTube without meeting any of the use conditions under the Marketing Rule) as well as other instances of misconduct in violation of the Antifraud Provisions (e.g., an improper liability disclaimer language, commonly referred to as a “hedge clause”). Without admitting or denying the SEC’s findings, Adviser 2 agreed to pay a civil penalty of $175,000.

SEC CHARGES ADVISORY FIRM FOR DISCLOSURE FAILURES AHEAD OF ACQUISITION BID

On March 1, 2024, the SEC announced settled charges against a New York-based investment adviser (the “Adviser”) for its failure to make timely ownership disclosures in the months up to its acquisition bid for a public company (the “Company”), as required under rules governing beneficial ownership reporting under Sections 13(d) and 13(g) of the Securities Exchange Act of 1934. By way of brief background, these rules require investors that beneficially own more than 5% of a public company’s equity securities to publicly disclose their beneficial ownership and other related information in either a Schedule 13D or Schedule 13G. Schedule 13G is available to “passive” investors who acquired shares without intending to change or influence the control of the issuer, as long as their ownership remains below 20%. Once passive intent no longer exists, the investor can no longer file on the shortform Schedule 13G as a passive investor and must file on the longer form Schedule 13D.

According to the SEC, an affiliated hedge fund advised by the Adviser began purchasing Company common stock in August 2021 and first exceeded the 5% beneficial ownership threshold on December 8, 2021. As of December 31, 2021, the Adviser beneficially owned 5.6% of the outstanding common stock of Company. the Adviser disclosed its 5.6% beneficial ownership position on an initial Schedule 13G that it filed with the SEC on February 14, 2022 (the “Company Schedule 13G”).

Under Item 10 of Schedule 13G, a filer relying upon Rule 13d-1(b) or 13d-1(c) must sign a certification specifically attesting to the lack of a “control” purpose or effect. Again, pursuant to Rule 13d-1(e), any person who has filed a Schedule 13G pursuant to Rule 13d-1(b) or 13d-1(c) becomes immediately subject to Rule 13d-1(a) and must file a Schedule 13D if the investor once a passive intent no longer exists and the filer holds the securities with a disqualifying “control” purpose or effect. The term “control” is defined in Rule 12b-2 of the Exchange Act to mean “possession . . . of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.” Nevertheless, the determination of whether securities are held with the purpose or effect to change or influence control is fact specific analysis.

From January 1, 2022 through April 18, 2022, the Adviser purchased an additional 2,050,000 shares of Company common stock, giving it total beneficial ownership of 5,050,000 shares, or approximately 9.9% of the outstanding shares. the Adviser also entered into cash-settled swap agreements between April 27 and May 12, 2022, which provided the Adviser with economic exposure comparable to approximately an additional 450,000 shares or 0.9% of outstanding Company common stock.

On April 26, 2022, the Adviser first considered making its own acquisition bid for Company, with financing to be provided by a private equity firm. On the same day the Adviser began to draft an offer letter to Company with a placeholder offer price of $85 per shares. According to the SEC, these activities shifted the Adviser from passive to control status by no later than that date (April 26, 2022), as the Adviser held its Company common stock with the intent to change or influence “control” of the issuer. Accordingly, because its Company Schedule 13G certification was no longer accurate, the Adviser was therefore required to convert its Company Schedule 13G to a Schedule 13D within ten (10) days, i.e., no later than May 6, 2022.

Instead, on April 27, 2022, the Adviser contacted outside counsel to advise on its Schedule 13D and provided counsel with a draft of the offer letter. On May 12, 2022, the Adviser met with Company management for the first time to discuss whether management would be receptive to an acquisition bid. The Adviser did not file the required Schedule 13D until May 13, 2022, the same day that it submitted to Company management, and publicly announced, its proposal to acquire all Company shares not already held by the Adviser, at $86 per share, approximately a 20% premium to the prior day’s closing trading price on the New York Stock Exchange.

The SEC found that the Adviser’s seven-day delay in filing Schedule 13D violated Section 13(d)(1) of the Exchange Act and Rule 13d-1 thereunder. Without admitting or denying the SEC’s findings, the Adviser agreed to pay a $950,000 civil money penalty to settle the matter.

SEC ADOPTS REFORMS RELATING TO INVESTMENT ADVISERS OPERATING EXCLUSIVELY THROUGH THE INTERNET

On March 27, the SEC adopted amendments to Rule 203A-2(e) under the Advisers Act that exempt certain investment advisers that provide advisory services through the internet (“Internet Advisers”) from the prohibition on SEC registration (the “Internet Adviser Exemption”), as well as related amendments to Form ADV.

Under Section 203A of the Advisers Act, investment advisers are generally prohibited from registering with the SEC unless they reach assets under management threshold, advise an investment company registered under the Investment Company Act of 1940, or qualify for an exemption under SEC rules or another statute. However, Internet Advisers are exempt from the Section 203A prohibition under the Internet Adviser Exemption if they meet certain conditions. As initially adopted in 2002, an adviser could rely on the Internet Adviser Exemption if, among other obligations, it provided investment advice to all of its clients exclusively through an “interactive website,” with a de minimis exception which permitted Internet Advisers to have a limited number (i.e., fewer than 15) of non-internet clients in the preceding 12-month period. According to the SEC’s adopting release, the amendments to the Internet Adviser Exemption are designed to modernize Rule 203A-2(e) to reflect the broader evolution in technology and the marketplace since its adoption in 2002 and to better align current practices in the investment adviser industry with the narrow exemption for certain investment advisers that did not fall neatly within the framework established by Congress.

The SEC’s 2024 amendments change the conditions of the Internet Adviser Exemption in two key ways. First, the amendments rename and redefine Rule 203A-2(e)’s existing defined term “interactive website” as “operational interactive website.” Existing Rule 203A-2(e) defines an “interactive website” as a website in which computer software-based models or applications provide investment advice to clients based on personal information each client supplies through the website. As amended, an “operational interactive website” is defined as a website or mobile application through which the investment adviser provides “digital investment advisory services” on an ongoing basis to more than one client (except during temporary technological outages of a de minimis duration). The amendments also define “digital investment advisory service” as investment advice to clients generated by the operational interactive website’s software-based models, algorithms, or applications based on personal information each client supplies through the operational interactive website. Second, the amendments eliminate the de minimis exception of 15 non-internet clients. Accordingly, under amended Rule 203A-2(e), an Internet Adviser must provide advice to all its clients exclusively through an operational interactive website. As noted in the adopting release, when the SEC initially adopted the fewer than 15 client de minimis exception, the Commission stated that it was similar to the since repealed “private adviser exemption,” which, subject to certain additional conditions, exempted from the requirement to register with the Commission any adviser that during the course of the preceding 12 months, had fewer than 15 clients.

Lastly, the Internet Adviser Exemption amendments amend Form ADV to require an Internet Adviser relying on the Internet Adviser Exemption as a basis for registration to represent on Schedule D of its Form ADV that, among other things, it has an operational interactive website.

The amendments to the Internet Adviser Exemption will become effective July 8, 2024 (90 days after publication in the Federal Register). An Internet Adviser relying on the exemption must comply with the amended rules, including the requirement to amend its Form ADV to include the required representations, by March 31, 2025. An Internet Adviser that is no longer eligible for the exemption and otherwise ineligible for SEC registration must register in one or more states and withdraw its SEC registration by filing a Form ADV-W by June 29, 2025.

SEC PROPOSES RULE TO UPDATE DEFINITION OF QUALIFYING VENTURE CAPITAL FUNDS

On February 14, the SEC proposed a rule that would, if adopted, adjust for inflation the threshold for a fund to qualify as a “qualifying venture capital fund” for the purposes of the Investment Company Act. Qualifying venture capital funds are excluded from the definition of an “investment company” under the Investment Company Act. A “qualifying venture capital fund” is defined under the Investment Company Act as “a venture capital fund that has not more than $10 million in aggregate capital contributions and uncalled committed capital.” Pursuant to the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018, the SEC is required to adjust the threshold for inflation once every five years. The proposed rule would raise the threshold to $12 million aggregate capital contributions and uncalled committed capital, based on the Personal Consumption Expenditures Chain-Type Price Index (PCE Index). The proposed rule also would establish a process for future inflation adjustments every five years.

The period to submit comments on the proposed rule closed on March 22, 2024.

Table of Contents:

Securities and Exchange Commission Division of Examinations Announces 2024 Priorities

SEC Adopts Rule to Increase Transparency into Short Selling and Amendment to CAT NMS Plan for Purposes of Short Sale Data Collection

Treasury Revisits Past Rulemaking to Bring Investment Advisers Under AML Oversight

Securities Lending Transparency Rules

SEC Releases Form ADV FAQs

SECURITIES AND EXCHANGE COMMISSION DIVISION OF EXAMINATIONS ANNOUNCES 2024 PRIORITIES

On October 16, 2023, the Securities and Exchange Commission’s (the “SEC” or the “Commission”) Division of Examinations (the “Division”) released its 2024 examination priorities (the “Priorities”)^.
As noted in the Priorities, the Division will prioritize areas that “pose emerging risks to investors or the markets, as well as examinations of core and perennial risk areas.” This analysis focuses on the Division’s examination priorities with respect to investment advisers, registered investment companies, and broker-dealers, but the Priorities also include discussions of the Division’s priorities with respect to self-regulatory organizations, clearing agencies, and certain other market participants.

Examinations of Investment Advisers

Noting the Division’s priority to examine for advisers’ adherence to their duties of care and loyalty, the Division indicated that it would continue to focus on:

• investment advice provided to clients regarding products, investment strategies and account types, particularly: (i) complex products, such as derivatives and leveraged exchange-traded funds (ETFs); (ii) high cost and illiquid products, such as variable annuities and non-traded real estate investment trusts (REITs); and (iii) unconventional strategies, including those that purport to address rising interest rates;
• processes for determining that advice is provided in clients’ best interests, including processes for: (i) initial and ongoing suitability determinations; (ii) best execution; (iii) evaluating costs and risks; and (iv) identifying and addressing conflicts of interest. With respect to conflicts of interest, the Priorities note that examinations will review how advisers address conflicts, including mitigating or eliminating conflicts and allocating investments to accounts where investors have more than one account;
• Economic incentives that an adviser and its financial professionals may have to make recommendations, such as the source and structure of compensation, revenue or other benefits. The Priorities indicated that examinations will focus on economic incentives and conflicts associated with advisers that are also registered as broker-dealers, use affiliates to perform services for clients and have financial professionals servicing both brokerage customers and advisory clients to identify (i) advice to purchase or hold certain investments or invest through certain accounts when there are other lower cost options available and (ii) investment advice with respect to proprietary products and affiliated service providers that result in additional or higher fees; and
• Disclosures to investors and whether such disclosures include all material facts relating to conflicts associated with investment advice sufficient to allow clients to provide informed consent to the conflict.

Additionally, the Priorities discuss the examination focus on adviser compliance policies and procedures, noting that such examinations will include:

• Marketing practice assessments for whether advisers, including advisers to private funds, have (i) adopted and implemented reasonably designed written policies and procedures to prevent violations of the Advisers Act and its rules including the recent Marketing Rule reforms; (ii) appropriately disclosed marketing-related information on Form ADV; and (iii) maintained substantiation of their processes and other required books and records. Additionally, the Priorities include that marketing practice reviews will also assess whether advertisements include untrue statements of a material fact, are materially misleading, or are otherwise deceptive and, comply with the requirements for performance, third-party ratings, and testimonials and endorsements;
• Compensation arrangement assessments focusing on (i) fiduciary obligations of advisers to their clients, including registered investment companies, particularly with respect to the advisers’ receipt of compensation for services or other material payments made by clients and others; (ii) alternative ways that advisers try to maximize revenue, such as revenue earned on clients’ bank deposit sweep programs; and (iii) fee breakpoint calculation processes, particularly when fee billing systems are not automated;
• Valuation assessments regarding advisers’ recommendations to clients to invest in illiquid or difficult to value assets;
• Safeguarding assessments for advisers’ controls to protect clients’ material non-public information, particularly when multiple advisers share office locations, have significant turnover of investment adviser representatives, or use expert networks; and
• Disclosure assessments to review the accuracy and completeness of regulatory filings, including Form CRS, with a focus on inadequate or misleading disclosures and registration eligibility.

Examinations of Investment Advisers to Private Funds

As noted in the Priorities, the Division will continue to focus on private fund advisers and prioritize specific topics, including:

• Portfolio management risks where there is exposure to market volatility and higher interest rates, which may include private funds experiencing poor performance, significant withdrawals, and valuation issues, as well as private funds with leverage and illiquid assets;
• Adherence to contractual requirements for limited partnership advisory committees (or similar structures), including adhering to notification and consent requirements;
• Accuracy with respect to the calculation and allocation of fund fees and expenses, including valuation of illiquid assets, calculations of management fees after the close of the commitment period, adequacy of disclosures, and potential offsets to such fees and expenses; and
• Due diligence practices for consistency with policies, procedures, and disclosures, particularly:
  • Conflicts, controls, and disclosures regarding private funds managed side-by-side with registered investment companies and use of affiliated service providers;
  • Compliance with Advisers Act requirements regarding custody, including accurate Form ADV reporting, timely completion of private fund audits by a qualified auditor and the distribution of private fund audited financial statements; and
  • Policies and procedures for reporting on Form PF, including with respect to certain reporting events.

Registered Investment Companies

Citing their importance to retail investors and retail investors saving for retirement, the Priorities note that the Division continues to prioritize examinations of registered investment companies, including mutual funds and ETFs. The Priorities include that examinations of investment companies may include the following examination focus areas:

• Fees and expenses and reviewing whether registered investment companies have adopted effective written compliance policies and procedures concerning the oversight of advisory fees and implemented any associated fee waivers and reimbursements. The Priorities note that a particular focus will be on (i) charging different advisory fees to different share classes of the same fund; (ii) identical strategies offered by the same sponsor through different distribution channels but have differing fee structures; (iii) high advisory fees relative to peer funds; and (iv) high registered investment company fees and expenses, particularly those of registered investment companies with weaker performance relative to their peers.
• Derivatives risk management assessments to review whether registered investment companies and business development companies have adopted and implemented written policies and procedures reasonably designed to prevent violations of the SEC’s fund derivatives rule (Rule 18f-4 under the Investment Company Act). Review of compliance with the derivatives rule may include review of the adoption and implementation of a derivatives risk management program, board oversight, and whether disclosures concerning the registered investment companies’ or business development companies’ use of derivatives are incomplete, inaccurate or potentially misleading.

Broker Dealers

With respect to broker-dealers and Regulation Best Interest, the Priorities include that in reviewing whether broker-dealer recommendations are in customers’ best interest, the following will be areas of particular importance (i) recommendations with regard to products, investment strategies, and account types; (ii) disclosures made to investors regarding conflicts of interest; (iii) conflict mitigation practices; (iv) processes for reviewing reasonably available alternatives; and (v) factors considered in light of the investor’s investment profile, including investment goals and account characteristics.

The Priorities also include that the Division’s examinations will review the content of the broker-dealers’ relationship summary on Form CRS, compliance with the Net Capital Rule and Customer Protections Rule and related internal processes, procedures and controls, and broker-dealer trading practices.

SEC ADOPTS RULE TO INCREASE TRANSPARENCY INTO SHORT SELLING AND AMENDMENT TO CAT NMS PLAN FOR PURPOSES OF SHORT SALE DATA COLLECTION

On October 13, the Commission adopted new Rule 13f-2 and related Form SHO under the Securities Exchange Act of 1934 (the “Exchange Act”) to require certain institutional investment managers (“Managers”) to report, on a monthly basis on Form SHO, certain short position data and short activity data for certain equity securities required by Rule 13f-2. Additionally, the Commission adopted an amendment to the national market system plan (“NMS Plan”) governing the consolidated audit trail (“CAT”) to require the reporting of reliance on the bona fide market making exception in the Commission’s short sale rules.

Rule 13f-2 will require a Manager to file a Form SHO report via the Commission’s EDGAR system within fourteen (14) calendar days after the end of each calendar month with regard to:

• With respect to any equity security that is of a class of securities registered pursuant to Section 12 of the Exchange Act or for which the issuer of that class of securities is required to file reports pursuant to Section 15(d) of the Exchange Act (a “Reporting Company Issuer”) over which the Manager and all accounts over which the Manager (or any person under the Manager’s control) has investment discretion with respect to a monthly average gross short position that meets or exceeds either (i) a monthly average of daily gross short positions at the close of regular trading hours in the equity security with a U.S. dollar value of $10 million or more, or (ii) a monthly average of daily gross short positions at the close of regular trading hours as a percentage of shares outstanding in the equity security of 2.5% or more; and
• With respect to any equity security that is of a class of securities of an issuer that is not a Reporting Company Issuer over which the Manager and all accounts over which the Manager (or any person under the Manager’s control) has investment discretion with respect to a gross short position that meets or exceeds a gross short position in the equity security with a U.S. dollar value of $500,000 or more at the close of regular trading hours on any settlement date during the calendar month.

For each reported equity security, a Manager will be required to report on Form SHO certain information, including:

• The Manager’s end-of-month gross short position in the equity security at the close of regular trading hours on the last settlement date of the calendar month; and
• For each individual settlement date during the calendar month, the Manager’s “net” activity in the reported equity security, which includes activity in derivatives, such as options.

The Commission will then publish, through EDGAR, and on a slightly delayed basis (expected to be within one (1) month after the end of the reporting calendar month), certain aggregated short sale related information regarding each equity security reported by Managers on Form SHO, including, for example:

• As an aggregated number of shares across all reporting Managers, the Managers’ gross short position in the reported equity security at the close of regular trading hours on the last settlement date of the calendar month, as well as the corresponding dollar value of that reported gross short position; and
• For each settlement date during the calendar month, the net activity in the reported equity security, as aggregated across all reporting Managers.

The amendment to the CAT NMS Plan will require CAT reporting firms to report to the CAT, for the original receipt or origination of an order to sell an equity security, whether the order is a short sale effected by a market maker in connection with bona fide market making activities in the equity security for which the bona fide market making exception in Rule 203(b)(2)(iii) of Regulation SHO is claimed.

Rule 13f-2, Form SHO, and the amendment to the CAT NMS Plan became effective January 2, 2024. The compliance date for Rule 13f-2 and Form SHO is twelve (12) months after the effective date, with public aggregated reporting to follow three (3) months later. The compliance date for the amendment to the CAT NMS Plan is July 1, 2025.

TREASURY REVISITS PAST RULEMAKING TO BRING INVESTMENT ADVISERS UNDER AML OVERSIGHT

On December 11, the U.S. Department of the Treasury (“Treasury”) announced in a Fact Sheet its renewed focus on the perceived money laundering risks associated with investment advisers.

The Fact Sheet covered a broad range of topics, focusing on the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) increased efforts to address the illicit finance and national security threats posed by corruption across various industries and sectors, including asset management. Per the Fact Sheet, investment advisers are not subject to consistent or comprehensive anti-money laundering (“AML”) and countering the financing of terrorism (“CFT”) obligations in the United States. Accordingly, the Treasury is re-examining and updating its September 1, 2015, Notice of Proposed Rule Making (the “2015 Proposal”). Generally, private funds are subject to the AML requirements of the USA PATRIOT Act and similar regulations in other jurisdictions.

The 2015 Proposal proposed to include investment advisers in the definition of “financial institution” in the regulations implementing the Bank Secrecy Act (the “BSA”), which, among other things, would require advisers to comply with suspicious activity reporting requirements, including filing Currency Transaction Reports (“CTRs”) and keeping records relating to the transmittal of funds. The 2015 Proposed Rule stalled following a 2017 moratorium on in-process rules.

Since that time, in January 2021, Congress enacted the Anti-Money Laundering Act of 2020 (the “AMLA”), which made sweeping reforms to the Bank Secrecy Act. Part of the AMLA is the Corporate Transparency Act (the “CTA”). Additionally, in September 2022, under the CTA, FinCEN issued a beneficial ownership reporting rule (the “BOI Rule”), which establishes a beneficial ownership information reporting requirement for certain “reporting companies.” The BOI, which became effective January 1, 2024, is intended to help prevent and combat money laundering, terrorist financing, tax fraud, and other illicit activity. Although there are exemptions to the definition of a “reporting company” under the BOI Rule, the BOI Rule is expected to impact private funds and their advisers and sponsors significantly.

In light of Tresuary’s renewed focus, investment advisers may want to pay particular attention to their compliance programs and consider implementing or enhancing existing procedures to attempt to ensure they are prepared for enacted and potential AML laws and regulations.

SECURITIES LENDING TRANSPARENCY RULES

On October 13, 2023, the Commission voted to adopt new Rule 10c-1a under the Exchange Act, which is intended to increase the transparency and efficiency of the securities lending market. Generally speaking, Rule 10c-1a will require “covered persons” who agree to a “covered securities loan” to provide specified Rule 10c-1a information comprised of certain “data elements” to a registered national securities association (“RNSA”) by the end of the day on which the loan is effected or modified. Rule 10c-1a will also require a RNSA to make publicly available most of the Rule 10c-1a information it receives, by the morning of the next business day, except for the loan amount, which must be made public after 20 business days. The RNSA must keep the “confidential data elements” it receives confidential, in accordance with applicable law and the rule’s requirements regarding data retention and availability. Currently, the Financial Industry Regulatory Authority (“FINRA”) is the only RNSA. Rule 10c-1a became effective on January 2, 2024. Covered persons will have to start reporting information to FINRA by the compliance date, January 2, 2026, which is 24 months after the effective date. However, FINRA will not publicly report information regarding Rule 10c-1a until 90 calendar days after the compliance date.

Covered Persons

Rule 10c-1a requires “covered persons” to report to FINRA by the end of the day. Rule 10c-1a defines the term “covered person” to mean (i) any person that agrees to a covered securities loan on behalf of a lender (an “intermediary”) other than a clearing agency when providing only the functions of a central counterparty or central securities depository; (ii) any person that agrees to a covered securities loan as a lender when an intermediary is not used, unless the borrower is a broker or dealer borrowing fully paid or excess margin securities; or (iii) a broker or dealer when borrowing fully paid or excess margin securities. Rule 10c-1a does not provide any sort of de minimis exemption from the definition of covered person.

Covered Securities Loans

Rule 10c-1a requires the reporting of all “covered securities loans” agreed to by any covered person. A covered securities loan is defined as “a transaction in which any person on behalf of itself or one or more other persons, lends a reportable security to another person.” In turn, a “reportable security” is defined in Rule 10c-1a(j)(3) as any security or class of an issuer’s securities for which information is reported or required to be reported to the consolidated audit trail (“CAT”) as required by Rule 613 and the CAT National Market System Plan, FINRA’s Trade Reporting and Compliance Engine (“TRACE”), the Municipal Securities Rulemaking Board Real-Time Transaction Reporting System, or any reporting system that replaces one of these systems.

Rule 10c-1a Data Elements

Rule 10c-1a prescribes three types of data elements that must be reported. The first set of data elements are public facing and concerns the material terms of the covered securities loan, requiring covered persons to provide in their initial report information regarding the:

• Legal name of the issuer of the securities to be borrowed;
• Ticker symbol of those securities;
• Time and date of the covered securities loan;
• Name of the platform or venue, if one is used;
• Amount of reportable securities loaned;
• Rates, fees, charges, and rebates for the loan;
• Type of collateral provided for the covered securities loan and the percentage of the collateral to the value of the reportable securities loaned;
• Termination date of the covered securities loan; and
• Borrower type, e.g., broker, dealer, bank, customer, bank, clearing agency, custodian.

The second set of data elements concerns information related to modifications of a covered securities loan if the modification impacts any previously reported “data element” submitted to FINRA. In this instance, covered persons are required to provide:

• the date and time of the modification;
• the specific modification and the specific data element being modified; and
• the unique identifier assigned to the original covered securities loan.

The third set of data elements concerns confidential information about the loan not intended to ever become publicly available (though FINRA may share such data with the SEC and such “other persons as the Commission may designate by order upon a demonstrated regulatory need”), and requires covered persons to include in their report:

• The legal names of the parties to the loan, including the person’s CRD or IARD No., MPID and LEI, and whether such person is the lender, the borrower or the intermediary;
• When the lender is a broker-dealer, whether the security loaned to its customer is loaned from the broker-dealer’s inventory; and
• Whether the loan will be used to close out a fail to deliver pursuant to Rule 204 of Regulation SHO or whether the loan is being used to close out a fail to deliver outside of Regulation SHO.

Timing of Reporting

Covered persons must report the required data elements by the end of the day on which the covered securities loan is effected or modified; the reporting obligation does not depend on when the securities loan is actually settled. Importantly, Rule 10c-1a uses the term “day” rather than “business day” when discussing the reporting requirements applicable to covered persons and reporting agents under sections (c) and (d) of the rule, which indicates that loans entered into on non-business days may still be subject to end of day reporting.

FINRA Publication of Data

The final rule requires FINRA to make publicly available the data elements (except for the loan amount), the unique identifier assigned to the loan by FINRA, and the LEI, ISIN, CUSIP, FIGI, or other security identifier(s) that FINRA determines is appropriate to identify the relevant reportable security, as well as information pertaining to the aggregate transaction activity and distribution of loan rates for each reportable security and those security identifier(s), not later than the morning of the business day after the covered securities loan is effected. On the 20th business day after the covered securities loan is effected, FINRA will publicize the loan amount. Likewise, the modification of any data element will be made public by FINRA on the day after the modification and any modification to the loan amount will be disclosed on the 20th business day after the covered securities loan is modified.

SEC RELEASES FORM ADV FAQS

On October 26, the SEC’s Division of Investment Management staff updated the “Frequently Asked Questions on Form ADV and IARD” (the “FAQs”) for investment advisers that submit Form ADV to the SEC pursuant to the Investment Advisers Act of 1940, as amended (the “Advisers Act”), either as “exempt reporting advisers” (“ERAs”) or registrants (“RIAs”). By way of background, Form ADV is the uniform form used by investment advisers to register with both the SEC and state securities authorities. ERAs must also file a Form ADV, although the specific requirements and deadlines may vary. The form consists of three parts. Parts 1 and 2 are used by the SEC and the states. Part 3 is used by the SEC and some states.

The FAQs provide additional guidance from the staff concerning specific questions concerning Form ADV and the Investment Adviser Registration Depository (“IARD”) system, which filers submit Form ADV and amendments thereto. The FAQs include both technical updates to previously existing FAQs as well as new FAQs on a variety of topics.

A summary of some of the more significant new and amended the FAQs are set forth below.

New FAQ on Audits for Newly Created Private Funds

Item 7.B.(1) requires RIAs to complete a separate Section 7.B.(1) of Schedule D for each private fund it advises. Section 7.B.(2) of Schedule D requires RIAs to report information about each private fund, including information about the fund’s service providers, such as its auditor, prime broker, custodian, administrators, and marketers. In a new FAQ on question 23(a) of Schedule D, Section 7.B.(1) related to auditors, the staff stated that an adviser to a newly created private fund should not report that a private fund’s financial statements are subject to an annual audit if an auditing firm has not been engaged to conduct an audit for the applicable fiscal year.

Modified FAQ on Delivery of Private Fund Audits

Question 23(g) of Schedule D, Section 7.B.(1) asks whether the private fund’s audited financial statements for the most recently completed fiscal year were distributed to the private fund’s investors. For RIAs relying on the “audit approach” for their compliance with the Custody Rule (Rule 206(4)-2), audited financial statements must be delivered to investors within 120 days of the pool’s fiscal year-end and within 180 days of the fiscal year end of a fund-of-funds. Due to the timing of the annual update (within 90 days after the end of your fiscal year), some RIAs to private funds may have neither received the audit reports nor distributed them at the time of filing the Form ADV annual update. As a result, these RIAs may not have distributed the audit reports by the Form ADV filing deadline.

In a modified FAQ, the staff clarified that if the applicable deadline for distributing the private fund’s audited financial statement has not yet passed, an adviser may answer “Yes” if it has engaged an auditor, and the audited financial statements will be distributed as required. Otherwise, an adviser should answer “No” if the applicable deadline for distribution has passed and audited financial statements were not delivered to clients for the most recently completed fiscal year.

New FAQ on Material Changes to ADV Part 2A

The instructions to Item 2 of Part 2A require prompt disclosure of any material changes to Part 2 that an RIA may make a part of its annual update for Form ADV. A new FAQ clarifies the staff’s expectations that providing a list of material changes is not a sufficient discussion; instead, an adviser must identify and discuss material changes.

New FAQ on Typos and Mistakes in an Annual Updating Amendment

In a new series of FAQs on Filing an annual Updating Amendment, the staff addressed the mistaken submission of an “other-than-annual amendment” instead of an Annual Updating Amendment and the occurrence of typos in an adviser’s annual amendment filing. The staff noted that it cannot change the date (or any information filed) on Form ADV filing. Accordingly, filing an other-than-annual amendment is not a substitute for filing an annual updating amendment. In both scenarios, an adviser must file another Form ADV annual updating amendment with the correct year. The adviser may wish to consider entering a note in the Miscellaneous section of Schedule D explaining the reason for filing an amended annual updating amendment.

Miko Brown serves as Associate General Counsel at Airbnb, Inc., where she leads the Community Trust Team. Prior to joining Airbnb, Miko was a partner in the Trial Department at Davis Graham and defended high-profile companies in catastrophic personal injury lawsuits nationwide, including moving vehicle accidents, product liability matters, and mass torts. She has extensive experience in civil rights and employment matters and has successfully defended breach of contract and intellectual infringement cases. In 2013, Miko launched the Women in Leadership Lecture Series (WILLS), which continues to be held at Davis Graham to this day.

What does a typical day look like for you at Airbnb?

Putting out fires and damage control. Because I lead the trust and safety legal team, I jump from one crisis to the next – shootings, stabbings, drug trafficking, discrimination, etc. – I’ve seen it all!

What was it like to transition from law firm partner to in-house counsel during the pandemic?

It was very challenging. Having to learn a new role at a new organization over Zoom isn’t ideal. But the biggest challenge was building trusting relationships with people I had never met in person. I didn’t realize how important face-to-face meetings were until they were no longer an option.

What do you value most about your time at Davis Graham?

The friends I made at the firm. I’ve never worked with so many smart, supportive, and genuinely kind people.

Who are some of the people at Davis Graham that had the greatest influence on you and why?

Shannon Stevenson, Kristin Lentz, Chad Williams, and Kenzo Kawanabe. When I think of the term “leader,” these are four individuals who immediately spring to mind. They lead with humility and empathy, which is rare and what drew me to Davis Graham.

In all of your time at Davis Graham and beyond, you have been a champion of women and diverse lawyers. Recently, you launched Project Ganesha. Tell us how Project Ganesha is furthering this mission.

Project Ganesha is named after the Hindu god, Ganesha, known as the remover of obstacles. The aim of Project Ganesha is to increase the number of women and diverse law firm leaders and rainmakers with a heavy emphasis on mental and physical health. To accomplish this goal, I created easy-to-implement training and playbooks for Partners and Associates that provide simple tools for reducing attrition, boosting well-being, and improving Associates’ substantive and business development skills. All Project Ganesha proceeds will go towards funding grants for women and diverse law students and Law School…Yes We Can! Fellows who are interested in pursuing careers in private practice. You can check out the Project Ganesha website at www.projectganesha.org.

What can we expect from Project Ganesha in the future?

I’m hoping that the practices taught by Project Ganesha become the new law firm standard and we see a marked increase in the number of women and diverse Associates who become successful law firm Partners.

What is your best advice for associates on a partnership track?

Read and follow the Project Ganesha Associate Playbook!

Table of Contents:

SEC Adopts Final Private Fund Adviser Rules

SEC Adopts Final Amendments to the Investment Company Names Rule

SEC Adopts Money Market Fund Reforms

SEC ADOPTS FINAL PRIVATE FUND ADVISER RULES

On August 23, 2023, the Securities and Exchange Commission (the “SEC” or the “Commission”) voted to adopt a final set of new rules and amendments under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) (collectively the “Private Fund Adviser Rules” or the “Rules”) that expand the regulatory compliance requirements for both registered, and to some extent, private fund advisers. The Private Fund Adviser Rules consist of five regulations and prohibitions:

• Restricted Activities Rule,
• Preferential Treatment Rule,
• Quarterly Statement Rule,
• Private Fund Audit Rule, and
• Adviser-Led Secondaries Rule.

The Rules also include amendments to the Advisers Act’s Books and Records Rule that will require SEC-registered advisers to retain records to facilitate the SEC’s ability to assess such adviser’s compliance with the Final Rules, including the delivery of quarterly statements and annual audited financials to private fund investors, as well as certain records related to the Restricted Activities Rule and the Preferential Treatment Rule.

Notably, the Private Fund Adviser Rules do not apply to investment advisers to securitized asset funds. Along that same vein, the Rules apply specifically to “private funds.” Section 202(a)(29) of the Advisers Act defines the term “private fund” as an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, as amended (the “Investment Company Act”), but for section 3(c)(1) or 3(c)(7) of that Act. Real estate funds relying on Section 3(c)(5)(C), as well as others, are outside the technical scope of the Rules.

As explained in the Adopting Release, the Private Fund Adviser Rules were designed specifically to address consequences relating to transparency, conflicts of interest, and governance mechanisms for client disclosure, consent, as well as oversight matters that are common in an adviser’s relationship with private funds and their investors.

In addition to these new Rules, the SEC also adopted amendments to the existing Compliance Rule for all registered investment advisers, whether or not advising private funds.

By way of background, the SEC proposed the initial form of the Private Fund Adviser Rules (collectively, the “Proposed Rules”) on February 9, 2022. The Proposed Rules drew significant industry debate with more than 300 public comments submitted by various industry participants, groups, and stakeholders over two rounds of comment period. In their initial form, the Proposed Rules departed in many ways from the Adviser Act’s disclosure-based regulatory regime for conflicts of interest, prescribing and prohibiting specific actions by advisers instead of focusing on the quality of advisers’ disclosures or negotiations between advisers and private fund investors. Similarly, the Proposed Rules did not include a “grandfathering” provision to reduce the burden of amending existing agreements or changing certain practices in older private funds to comply with the Proposed Rules. The SEC ultimately chose not to adopt Proposed Rules relating to prohibitions on charging fees for unperformed services (e.g., accelerated monitoring fees) and limiting adviser liability and related indemnification/exculpation in a private fund’s governing documents. Likewise, the SEC chose to include grandfathering provisions, as the Final Rules provide “legacy status” and disapply certain portions of the Restricted Activities Rule and Preferential Treatment Rule with respect to preexisting contractual arrangements. Although the final Private Fund Adviser Rules are less extensive than the Proposed Rules, they still introduce new obligations and limitations expected to change business practices significantly and lead to additional administrative responsibilities and expenses. The new Rules also remain shrouded in controversy: on September 1, 2023, a lawsuit was filed jointly by six trade associations with the Fifth Circuit Court of Appeals in New Orleans, challenging the validity and enforceability of the Private Fund Adviser Rules. While the lawsuit does not automatically stop the transition periods of the Rules or delay their compliance date, a stay of the Rules may be requested or granted, either by court order as part of the proceedings or as otherwise determined by the SEC.

Generally, advisers covered by the Final Rules will have either a 12-month or an 18-month compliance transition window following the November 13 effective date, depending on their status as “Larger” or “Smaller” Private Fund Advisers. The Adopting Release defines Larger Private Fund Advisers with $1.5 billion or more in private fund assets under management. Smaller Private Fund Advisers are advisers with private fund assets under management of less than $1.5 billion in private funds assets. For the Adviser-Led Secondaries Rule, the Preferential Treatment Rule, and the Restricted Activities Rule, the compliance date for Larger Private Fund Advisers is September 14, 2024, and for Smaller Private Fund Advisers, March 14, 2025. For the Private Fund Audit and Quarterly Statement Rule, the compliance date for all SEC-registered private fund advisers, regardless of size, will be March 14, 2025.

The compliance date for the Compliance Rule amendments regarding a Written Annual Review is November 13, 2023.

Restricted Activities Rule (Rule 211(h)(2)-1)

The Restricted Activities Rule generally prohibits all advisers to private funds — regardless of whether they are registered with the SEC — from engaging in certain “restricted” practices unless the prescribed disclosure-based or disclosure and consent-based requirements are followed. Departing from the SEC’s flat probation on certain adviser activities and expense practices as Proposed, the adopted Rules include exceptions for each “restricted” activity. For example, Unlike the Proposed Rules, the Final Rules do not explicitly prohibit advisers from charging portfolio investment monitoring fees, servicing fees, consulting fees, or other similar fees in respect of any services the investment adviser does not or does not reasonably expect to, provide to the portfolio investment.

The Restricted Activities Rule will restrict private fund advisers from the following activities:

• Regulatory, Compliance, and Examination Expenses Restriction: Private fund advisers are restricted from reducing charging or allocating fees regulatory or compliance fees and expenses of the adviser or its related persons unless the adviser distributes a written notice of any such fees or expenses, and the dollar amount thereof, to the investors of such private fund client within 45 days after the end of the fiscal quarter in which the charge occurs.
• Post-Tax Clawback Restriction: Private fund advisers are restricted from reducing the amount of an adviser-carried interest clawback by actual, potential, or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders unless it sends a written notice to the investors of the private fund that sets forth the aggregate dollar amounts of its clawback before and after any such tax reduction for actual, potential, or hypothetical taxes within 45 days after the end of the fiscal quarter in which the adviser in which the clawback occurs.
• Non-Pro-Rata Allocation of Fees and Expenses Restriction: Private fund advisers may not directly or indirectly charge or allocate fees or expenses related to a portfolio investment (or potential portfolio investment) on a non-pro rata basis when multiple private funds and other clients advised by the adviser or its related persons have invested (or propose to invest) in the same portfolio investment unless the adviser meets two requirements: (i) the non-pro rata charge or allocation is fair and equitable under the circumstances and (ii) before charging or allocating such fees or expenses to a private fund client, the investment adviser distributes to each investor of the private fund a written notice of the non-pro rata charge or allocation and a description of how it is fair and equitable under the circumstances.
• Investigation Expenses Restriction: Private fund advisers may not charge private fund clients for fees and expenses associated with an investigation of the adviser or its related persons by any governmental or regulatory authority, even if the conduct would otherwise be indemnifiable under the applicable private fund governing documents unless the adviser requests and obtains consent of a majority in interest of investors that are not related persons of the adviser. Under the Rule, regardless of disclosure and consent, an Adviser may not chargeback fees or expenses related to an investigation that results in sanction(s) for violating the Advisers Act. The SEC noted that investor consent to bearing such fees and expenses is likewise impermissible, as the SEC would view any waiver as invalid under section 215(a) of the Advisers Act.
• Borrowing Restriction: Private fund advisers may not borrow money, securities, or other fund assets or receive an extension of credit from the fund unless the adviser (i) provides written notice to each investor of the material terms of such transactions and (ii) obtains advance consent from at least a majority in interest of investors that are not related persons of the adviser.

As explained in the Adopting Release, the consent-based exceptions require informed consent from the fund’s investors; approval from fund governance bodies, such as LPACs, advisory boards, or boards of directors, are deemed insufficient to satisfy the consent requirements. Moreover, consent must be obtained from a majority-in-interest of investors who are not “related persons” of the adviser (as defined in Form ADV).

The SEC has extended “legacy status” to a portion of the Restricted Activities Rule that requires informed investor consent for the adviser to borrow from a private fund or to charge certain investigation fees and expenses. Specifically, for any private funds commencing operation prior to the applicable compliance date (“existing private funds”), the restrictions do not apply so long as the existing private fund’s contractual agreements were in place prior to the compliance date and would require the parties to amend the agreement in order to comply. The “commencement of operations” includes any bona fide activity directed towards operating a private fund, including investment, fundraising, or operational activity. Examples of such bona fide activity include issuing capital calls, setting up a subscription facility for the fund, holding an initial closing, conducting due diligence on potential fund investments or making an investment on behalf of the fund.

Preferential Treatment Rule (Rule 211(h)(2)-3)

The Preferential Treatment Rule prohibits all advisers to private funds — regardless of whether they are registered with the SEC — from providing preferential redemption rights to a subset of investors or providing portfolio holdings or investment exposure information to a subset of investors, with certain limited exceptions.

Specifically, advisers will be prohibited from granting preferential redemption rights that would have a material, negative effect on the other investors in the fund or similar pool or assets unless (1) such redemptions are required by law or (2) the adviser has offered the same redemption ability to existing/future investors without qualification.

Advisers are also prohibited from granting preferential rights related to portfolio holdings or fund exposure information if the adviser reasonably expects or should expect that the disclosure would have a material, negative effect on other investors in the fund or similar pool of assets unless the adviser offers such information to all other existing investors at substantially the same time. The Rule applies to all types of investor communications: formal, informal, written, visual, and oral.

Whether any particular preferential treatment is expected to have a “material, negative effect” on other investors in the private fund is a facts and circumstances analysis.

The Final Rule defines a “similar pool of assets” as a pooled investment vehicle (other than an investment company registered under the Investment Company Act of 1940 or a company that elects to be regulated as such) with similar investment policies, objectives, or strategies to those of the private fund managed by the adviser or its related persons. The SEC noted that the term will capture parallel funds, funds-of-one, and co-investment vehicles. However, separately managed accounts are excluded from the definition.

In addition, the Preferential Treatment Rule prohibits all private fund advisers from directly or indirectly providing any “other preferential treatment” to an investor unless (1) the adviser provides advance disclosure to prospective investor’s investment of material economic terms granted preferentially to other investors and (2) the adviser or its related persons has provided to other investors in the same private fund notice of all preferential terms “as soon as reasonably practicable” after the end of the fundraising period (for illiquid funds) or the investor’s investment (for liquid funds) and at least annually after that (if new preferential terms are granted since the last notice).

“Material economic terms” are terms that a prospective investor “would find most important and significantly impact its bargaining position.” The SEC gave the example of co-investment rights as a term that would generally qualify as a material, economic concession to the extent they include materially different fee and expense terms from those of the main fund (e.g., no fees or no obligation to bear broken deal expenses).

The SEC has extended limited legacy status to the Preferential Treatment Rule only with respect to the prohibition of preferential treatment relating to redemption and information rights. Critically, “legacy status” will apply only to existing private fund’s contractual agreements entered into before the compliance date if the Preferential Treatment Rule would otherwise require the parties to amend such an agreement.

Accordingly, existing funds must disclose “other” preferential treatment previously granted but not yet disclosed. This means the preferential terms of side letters agreements and other confidential arrangements providing preferential treatment entered into prior to the compliance will need to be disclosed (1) to prospective investors investing in the fund after the compliance date and (2) to all investors (i) with respect to liquid funds, as soon as reasonably practicable following the new investor’s investment in the private fund and (ii) with respect to illiquid funds, as soon as reasonably practicable following the final closing date.

Quarterly Statement Rule (Rule 211(h)(1)-2)

Under the Quarterly Statement Rule, SEC-registered private fund advisers (or their administrators) will be required to prepare and distribute quarterly statements for each private fund that contain certain fund-level fee and expense disclosures, investment-level compensation disclosures, and specific performance disclosures, the content of which, depends on whether the private fund is a liquid fund or an illiquid fund, as determined by the adviser. For standard private funds, the quarterly statements are due within 45 days after the end of the first three fiscal quarters of each fiscal year and 90 days after the end of each fiscal year (with an extended timeline for fund of funds to 75 and 120 days, respectively). Investors may not waive the Quarterly Statement rule.

Specifically, the fee and expense-related quarterly statement must include a “fund table” with fund-level reporting across (i) all compensation, fees, and other amounts allocated or paid to the adviser or any of its related persons by the private fund, (ii) all fees and expenses (including separate line items for organizational, accounting, legal, administration, audit, tax, due diligence and travel), (iii) any offsets or rebates carried forward to reduce future management fee payments. Moreover, the investment level compensation quarterly statement must also include a “portfolio Investment table” with investment-level reporting across all “portfolio investment compensation” allocated or paid by each “covered portfolio investment” (including origination, management, consulting, monitoring, servicing, transaction, administrative, advisory, closing, disposition, directors, trustees or similar fees or payments by the covered portfolio investment to the investment adviser or any of its related persons). In the Adopting Release, the SEC noted no exclusions for de minimus expenses, general grouping of more negligible expenses into broad categories, or labeling expenses as miscellaneous; instead, advisers must list and label each expense category.

The performance-related quarterly statements must provide fund-level performance data specified intervals (the past 10 fiscal years or since inception) depending on the type of private fund (illiquid or liquid) through the latest quarter-end computed with and without the impact of any “fund-level subscription facilities,” that includes (1) Gross IRR and Gross MOIC, (2) Net IRR and Net MOIC, (3) Gross IRR and Gross MOIC for the realized and unrealized portions of the fund’s portfolio (shown separately) and (4) statement of contributions and distributions. “Fund-level subscription facilities” are defined as any subscription facilities, subscription line financing, capital call facilities, capital commitment facilities, bridge lines, or other indebtedness incurred by the private fund that is secured by the unfunded capital commitments of the private fund’s investors. The definition of an illiquid fund is based primarily on the lack of withdrawal and redemption capability. An “illiquid fund” is defined as a private fund that (1) is not required to redeem interests upon an investor’s request and (2i) has limited opportunities, if any, for investors to withdraw before termination of the fund. A “liquid fund” is defined as a private fund that is not an illiquid fund.

The Quarterly Statement Rule also requires that reports include prominent disclosure as to the manner of calculation, including cross-references to the applicable sections of a private fund’s operative documents. While advisers do not need to provide all supporting calculations as part of a quarterly statement, the SEC noted that advisers generally should make them available upon request from an investor.

Private Fund Audit Rule (Rule 206(4)-10)

The Private Fund Audit Rule requires SEC-registered private fund advisers to obtain an annual financial statement audit of each covered private fund they advise that complies with the current “Custody Rule” (rule 206(4)-2). The private fund audit must be: (1) performed by an independent public accountant registered with and subject to PCAOB oversight; (2) meet the definition of audit in rule 1-02(d) of Regulation S-X; (3) be prepared in accordance with U.S. GAAP as required under the custody rule; and (4) delivered to investors (i) annually, within 120 days of the private funds fiscal year-end and (ii) promptly upon liquidation. Because the Private Fund Audit Rule effectively mandates that private advisers rely on the “audit exception” under the Custody Rule, the Rule eliminates the surprise audit option for private funds under the Custody Rule. As such, private fund advisers currently relying on the “surprise examination” option under the Custody Rule for private funds will need to be audited annually per the audit requirements of the Custody Rule.

The Private Fund Audit Rule also imposes a separate standard for funds and advisers that are not in a control relationship. An adviser needs only to take reasonable steps to cause the private fund to undergo an audit if the adviser is not in a control relationship.

Adviser-Led Secondaries Rule (Rule 211(h)(2)-2)

The Adviser-Led Secondaries Rule requires that SEC-registered private fund advisers conducting “adviser-led secondary transactions” must, before the due date of the election, (i) obtain and distribute to investors a fairness opinion or a valuation opinion from an independent opinion provider and (ii) prepare and distribute to investors a summary of any material business relationships among the adviser and the independent opinion provider for the two years prior to the issuance of the opinion.

The SEC defined “adviser-led secondary transaction” as any transaction initiated by the investment adviser or any of its related persons that offers private fund investors the choice between (1) selling all or a portion of their interests in the private fund and (2) converting or exchanging all or a portion of their interests in the private fund for interests in another vehicle advised by the adviser or any of its related persons. The SEC noted that whether the adviser or its related person initiates a secondary transaction requires a facts and circumstances analysis.

Compliance Rule Amendments (Rule 206(4)-7)

Although preparing written annual reviews is a widely adopted “best practice” among advisers, the Advisers Act’s Compliance Rule did not explicitly require it. However, the Final Rules will now mandate that all SEC-registered advisers, including those who do not advise private funds, document the annual review of their compliance policies and procedures in writing. As noted in the Adopting Release, the review should consider any compliance issues that have arisen during the previous year, any changes in the business activities of the adviser or its affiliates, and any changes in the Advisers Act or applicable regulations that may require revisions to policies and procedures.

SEC ADOPTS FINAL AMENDMENTS TO THE INVESTMENT COMPANY NAMES RULE

On September 20, 2023, the Commissioners of the SEC voted to adopt final amendments and changes to Rule 35d‑1 (the “Names Rule”) under the Investment Company Act.

By way of background, the Names Rule generally requires a registered investment company or business development company (“BDC,” and together with registered investment companies, “Registered Funds”) with a name that suggests it has a focus on particular types of investments, industries or geographic regions, or whose distributions are tax-exempt, to adopt a policy to invest at least 80% of the value of its assets in investments that are consistent with its name (an “80% investment policy”).

The amendments broaden the scope of funds that are subject to the 80% investment policy requirement required by Rule 35d-1 to include fund names with terms suggesting that the fund focuses on investments that have or investments whose issuers have particular characteristics, including a name with terms such as “growth,” “value,” or terms that reference a thematic investment focus such as indicating that the fund’s investment decisions incorporate one or more ESG factors. The amendments require Registered Funds subject to the 80% investment policy requirement to disclose in their prospectuses the definitions of the terms used in their names, including the criteria the funds use to select the investments the term describes.

Beyond the expansion of the scope of the 80% investment policy, the amendments revised Rule 35d-1 to provide for in the event of a fund’s departure from its 80% investment policy as a result of a drift or other-than-normal circumstances, the fund will now have 90 days to get back into compliance with the 80% investment policy requirement.

The amendments also clarified that registered funds must use the notional amount of a derivatives instrument (with certain adjustments) rather than its market value to determine compliance with the 80% investment policy.

Moreover, registered funds subject to the 80% investment policy requirement will be required to disclose on their quarterly Form N-PORT the definitions of terms used in their names, the value of their 80% baskets, and each investment included in the 80% basket.

The amendments also include specific recordkeeping requirements, requiring Registered Funds with an 80% investment policy requirement to document compliance with the amended Rule.

The compliance date is September 22, 2025 (24 months following the effective date) for larger entities and March 20, 2026 (30 months following the effective date) for smaller entities. The Adopting Release defines larger entities as funds that, together with other investment companies in the same “group of related investment companies” (as that term is defined in Rule 0-10 under the Investment Company Act) have net assets of $1 billion or more as of the end of the most recent fiscal year, and smaller entities are funds that together with other investment companies in the same “group of related investment companies” have net assets of less than $1 billion as of the end of the most recent fiscal year.

SEC ADOPTS MONEY MARKET FUND REFORMS

On July 12, the SEC adopted rule and form amendments concerning money market funds (“MMFs”) under Rule 2a-7 of the Investment Company Act. As noted in the Adopting Release, the amendments are designed to improve the resilience and transparency of money market funds and address concerns about prime and tax-exempt money market funds highlighted by raised by large outflows from money market funds during the COVID-19 pandemic.

Increase of the Minimum Daily and Weekly Liquidity Requirements

The amendments increase the minimum liquidity requirement to at least 25% of the fund’s total daily liquid assets and at least 50% of a fund’s total assets in weekly liquid assets. The increased thresholds are designed to provide a more substantial buffer to equip MMFs better to manage significant and rapid investor redemptions. The amendments also incorporate a new board reporting requirement for funds that fall below certain liquidly thresholds: an MMF holding less than 12.5% of its total assets or weekly liquid assets equal to less than 25% of its total assets will be required to notify its board within one business day of the shortfall and provide the board with a description of the circumstances leading to the shortfall within 4 business days of the event.

Removal of Temporary Redemption Gates

MMFs will no longer be able to impose temporary gates to suspend redemptions. Specifically, the amendments remove provisions in Rule 2a-7 that permit an MMF to impose a temporary redemption gate. The amendments also remove provisions in Rule 2a-7 that tied a money market fund’s ability to impose liquidity fees to its level of weekly liquid assets. Accordingly, MMFs will no longer be permitted to impose liquidity fees if their weekly liquid assets fall below a certain threshold.

Liquidity Fee Requirement

Under the new amendments, the SEC has introduced a revised framework for liquidity fees that incorporates both mandatory liquidity fees for institutional money funds and discretionary liquidity fees for non-government MMFs. The new framework separates the fee type from the fund’s weekly liquid assets, meaning that whether the fee is mandatory or discretionary will not depend on the fund’s weekly liquid assets. A money fund’s board will be responsible for making liquidity fee determinations under the mandatory and discretionary liquidity fee requirements and is permitted to delegate this responsibility to the fund’s investment adviser or officers, subject to certain oversight requirements.

Under the amendments, institutional prime and institutional tax-exempt MMFs will be required to impose mandatory liquidity fees when the fund experiences daily net redemptions over 5% of net assets. Accordingly, the amount of the liquidity fee must be a good faith estimate, supported by data, of the costs the fund would incur if it sold a pro-rata amount of each security in its portfolio (a “vertical slice”) to satisfy the amount of net redemptions, including transaction costs and market impacts.

The SEC retained the ability of a non-government MMF’s board to impose a discretionary liquidity fee. Accordingly, non-government MMFs must impose a discretionary liquidity fee of up to 2% if the fund’s board determines a fee is in the fund’s best interest.

Other Amendments

In addition to the changes detailed above, the amendments will require funds to calculate Weighted Average Maturity (“WAM”) and Weighted Average Life (“WAL”) based on the percentage of each security’s market value in the portfolio.

The amendments also address potential negative interest rates on the operation of government MMFs and retail MMFs that seek to maintain a stable share price. Under the amendments, retail and government money market funds may handle a negative interest rate environment either by converting from a stable share price to a floating share price or by reducing the number of shares outstanding to maintain a stable net asset value per share (a “reverse distribution mechanism”), subject to certain board determinations and disclosures to investors.

The amendments also incorporate corresponding changes to Form N-CR concerning reporting of liquidity threshold events and amend Form N-MFP to include additional information about shareholders, portfolio securities sold by institutional prime MMFs, liquidity fees, and use of share cancellation, as well as to make certain conforming changes to Form N-1A to reflect certain of the other amendments. The SEC also adopted amendments to reporting by large liquidity fund advisers in respect of the liquidity funds that they manage in Section 3 of Form PF, the confidential reporting form for certain SEC-registered investment advisers to private funds, to maintain consistency with the reporting requirements for registered MMFs under amended Form N-MFP and the final amendments.

The amendments also include amendments to the recordkeeping rule under the Investment Company Act (Rule 31a-2) to require money funds to preserve records that document how they determine the amount of any liquidity fee.

The SEC adopted a tiered approach to the transition periods for compliance with the amendments. MMFs will no longer be permitted to impose redemption gates immediately upon October 2, 2023, the effective date of the amendments. The effective and compliance date for the amendments to Forms N-MFP, N-CR, and PF is June 11, 2024. Further, on April 2, 2024, six months from the effective date of the amendments, MMFs will be required to comply with the increased daily and weekly liquid asset minimums.

Finally, funds will be required to comply with the amendment’s liquidity fee framework on October 2, 2024, 12 months from the effective date of the amendments.

SEC/SRO Update: SEC Adopts Amendments to Enhance Private Fund Reporting; SEC Brings Fraud Charges Against Trump-Related SPAC; SEC Charges Operator of Collectibles Marketplace with Operating an Unregistered Securities Exchange; SEC Proposes Amendments to the Broker-Dealer Customer Protection Rule

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Table of Contents:

SEC Adopts Amendments to Enhance Private Fund Reporting

SEC Charges Investment Adviser and Fund Trustees with Liquidity Rule Violations

SEC Charges PIMCO for Disclosure and Policies and Procedures Failures

SEC Adopts New Security-based Swap Rules to Prevent Fraud & Manipulation Promote CCO Independence

SEC ADOPTS AMENDMENTS TO ENHANCE PRIVATE FUND REPORTING

On May 3, the Commissioners of the Securities Exchange Commission (the “SEC” or the “Commission”) voted to adopt final amendments (the “Amendments”) to Form PF and Rule 204(b)-1 the under the Investment Advisers Act of 1940 (“Advisers Act”). Form PF is the confidential reporting form used by certain advisers to private funds to report information to the SEC and the Financial Stability Oversight Counsel (“FSOC”) about private funds.

By way of background, the SEC adopted Form PF in 2011 after the enactment of the Dodd-Frank Wall Street Reform and Accountability Act of 2012 (the “Dodd-Frank Act”), which directed the SEC to collect information about private funds for use by the FSOC to help in its assessment of systemic risk in the financial system. Generally, Rule 204(b)-1 requires advisers to hedge funds, private equity funds, and liquidity funds to file Form PF on a quarterly or annual basis, depending on the size and type of private funds they advise. As explained in the Adopting Release, the Amendments are designed to improve the FSOC’s ability to monitor systemic risk, bolster the SEC’s regulatory oversight of private fund advisers, and gather information for regulatory purposes, including enforcement, examinations, and rulemaking.

Prior to the Amendments, Form PF comprised five (5) Sections. Most advisers are required to report in Section 1 more generalized information, such as the types of private funds advised (e.g., hedge funds, private equity funds, or liquidity funds), fund size, use of borrowings and derivatives, strategy, and types of investors. Three types of “Large Private Fund Advisers” are required to complete certain additional sections of Form PF, with large hedge fund, liquidity fund, and private equity fund advisers subject to more comprehensive reporting on their dedicated Sections 2, 3, and 4, respectively.

Following the Amendments, Form PF will have seven (7) Sections, creating two new separate Sections of Form PF, Section 5 and Section 6. Former Section 5, the request for temporary hardship exemption, will become new Section 7. A “current report” under the new Section 5 and a “private equity event report” under the new Section 6 will each be filed as a stand-alone document through the same system used to file the rest of Form PF, the Private Fund Reporting Depository (“PFRD”). The Amendments also add and alter questions to existing Form PF Section 4. As applicable, the quarterly and annual reporting timeline has been maintained for existing Sections 1 through 4, with the new Sections 5 and 6 requiring an accelerated timeline of some advisers.

As a result, the Amendments to Form PF will affect only the following categories of advisers:

• Large Hedge Fund Advisers (i.e., hedge fund advisers with at least $1.5 billion in hedge fund assets under management)
• Private Equity Fund Advisers (i.e., investment advisers with at least $150 million in private equity fund assets under management); and
• Large Private Equity Fund Advisers (i.e., private equity fund advisers with at least $2 billion in private equity assets under management).

With respect to the last category, and in a change from its January 2022 Form PF Proposing Release, the Commission has not adopted a lower $1.5 billion in private equity fund assets under management reporting threshold for Large Private Equity Fund Advisers. The existing threshold of $2 billion in private equity fund assets under management will remain.

As under current rules, Exempt Reporting Advisers will not be required to file Form PF as a result of the Amendments.

Section 5 Current Event Reporting For Large Hedge Fund Advisers

The Amendments to Form PF will require Large Hedge Fund Advisers to file a current report on Section 5 to Form PF as soon as practicable but no later than 72 hours from the occurrence of one or more triggering “current reporting events” by a qualifying hedge fund. A “qualifying hedge fund” is a hedge fund, individually or in combination with any feeder funds, parallel funds, and/or dependent managed account, having a net asset value of at least $500 million.

The 72-hour period is a departure from the timeline SEC’s January 2022 Form PF Proposing Release which would have required a private fund adviser to file reports as to certain events within one business day of the occurrence of any of such events, which would be the close of the business day following the day the event occurred.

Current reporting events include the following:

• Extraordinary Investment Losses: Advisers are required to file a current report if, as of any business day, the 10-business day holding period return of a reporting fund is less than or equal to 20% of the reporting fund aggregate calculated value.
• Significant Increases in Margin, Collateral or an Equivalent: Advisers are required to file a current report in connection with a significant increase in the value of a reporting fund’s requirements for margin, collateral or an equivalent of 20% or more within a rolling 10-business-day period.
• Inability to Meet a Margin Call or Margin Default: Advisers are required to file a current report in connection with a margin default or inability to meet a call for margin, collateral or an equivalent, taking into account any contractually agreed cure period.
• Default of a Counterparty: Advisers are required to file a current report in connection with a counterparty’s margin, collateral or equivalent default or failure to make other payment.
• Prime Broker Relationship Terminated or Materially Restricted: Advisers are required to file a current report following the termination or material restriction of a reporting fund’s relationship with a prime broker.
• Operations Event: Advisers are required to file a current report when the adviser or qualifying hedge fund experiences a “significant disruption or degradation” of the fund’s “critical operations,” whether as a result of an event at the fund, the adviser, or other service providers to the fund. For this purpose, “critical operations” means “operations necessary for (i) the investment, trading, valuation, reporting, and risk management of the fund; or (ii) the operation of the fund in accordance with federal securities laws and regulations.”
• Significant Withdrawals and Redemptions: Advisers are required to file a current report if the reporting qualifying hedge fund receives cumulative requests for withdrawals or redemptions from the reporting fund equal to or more than 50 percent of the most recent net asset value (after netting against subscriptions and other contributions from investors received and contractually committed).
• Inability to Satisfy Redemptions: Advisers are required to file a current report if the reporting fund (i) cannot pay redemption requests or, (ii) has suspended redemptions, and such suspension lasts for more than five consecutive business days.

In a departure from the proposed amendments, the SEC did not adopt a requirement that an adviser report as a current reporting event a significant decline in holdings of unencumbered cash.

Section 6 Private Equity Event Reporting For All Private Equity Fund Advisers

The Amendments to Form PF will require all Private Equity Fund Advisers to file an event report on Section 6 to Form PF within 60 days of each fiscal quarter end upon the occurrence of one or more of two (2) private equity reporting events.

Private equity reporting events include:

• Adviser-Led Secondary Transactions: Private Equity Fund Advisers are required to file a private equity report upon completing an “adviser-led secondary transaction.” An “adviser-led secondary transaction” is defined as any transaction initiated by the adviser or any of its related persons that offers private fund investors the choice to (i) sell all or a portion of their interests in the private fund, or (ii) convert or exchange all or a portion of their interests in the private fund for interests in another vehicle advised by the adviser or any of its related persons.
• General Partner Removal, Termination of the Investment Period, or Termination of a Fund: Private Equity Fund Advisers are required to file a private equity report when a fund receives notification that fund investors have (i) removed the adviser or an affiliate as the general partner (or similar control person) of the fund; (ii) elected to terminate the fund’s investment period, or (iii) elected to terminate the fund.

Revised Section 4 Reporting Requirements for Large Private Equity Fund Advisers

The Amendments to Form PF include a number of changes to the existing Section 4 of Form PF that requires Large Private Equity Fund Advisers to identify information about their private equity funds.

New questions have been added to Section 4. Question 66 now asks advisers to select from a list of common investment strategies and report the percent of deployed capital for each, even if the categories don’t perfectly match the fund’s specific strategies. Question 68 requires additional information on any fund-level borrowing, including details on each borrowing or cash financing available to the fund, the total dollar amount available, and the average amount borrowed during the reporting period. Question 82 now requires reporting on general partner and certain limited partner clawbacks.

Amendments have also been made to existing questions. Question 74 now requires more detailed information on reported events of default, specifying whether it’s a payment default of the private equity fund, a controlled portfolio company, or a default related to a failure to uphold terms of the borrowing agreement. Question 75 now requires reporting on the institutions providing bridge financing to the adviser’s controlled portfolio companies and the amount of financing provided. Lastly, Question 78 now requires reporting on the geographical breakdown of investments by private equity funds, listing all countries by ISO country code to which a reporting fund has exposure of 10% or more of its net asset value.

There are two effective and compliance dates for different Sections of Form PF. The Amendments to Section 4 take effect June 11, 2024. The Amendments for current and private equity event reporting in Sections 5 and 6 take effect December 11, 2023.

On August 10, 2022, the SEC and the Commodity Futures Trading Commission jointly released an August Proposal relating to technical changes to Form PF, which is still under consideration by the Commission.

SEC CHARGES INVESTMENT ADVISER AND FUND TRUSTEES WITH LIQUIDITY RULE VIOLATIONS

On May 5, the SEC announced charges against Pinnacle Advisors LLC (“Pinnacle Advisors”) for aiding and abetting violations of Rule 22e-4 (the “Liquidity Rule”) under the Investment Company Act of 1940 (the “Investment Company Act”) by a mutual fund it advised and whose liquidity risk management program it administered. Two of the fund’s independent trustees and two officers of both Pinnacle Advisors and the fund were also charged with aiding and abetting Liquidity Rule violations. A third trustee agreed to settle charges that he caused and willfully counseled the fund’s violations.

Under the Liquidity Rule, mutual funds are required to classify each of its investments into one of four categories: “highly liquid,” “moderately liquid,” “less liquid,” and “illiquid.” The Liquidity Rule prohibits mutual funds from investing more than 15% of their net assets in “illiquid” investments. If a fund holds more than 15% of its net assets in illiquid investments, the Liquidity Rule requires the fund to take remedial steps, including requiring the administrator of the fund’s liquidity risk management program (the “Program Administrator”) to report such occurrence to the fund’s board within one business day, with an explanation of the extent and causes of the occurrence and how the fund plans to bring its illiquid investments back into compliance with the 15% limit. If the amount of the fund’s illiquid investments is still in excess of 15% of its net assets thirty (30) days from the occurrence, the fund’s board of directors must assess whether the plan provided to the board in connection with the Program Administrator’s initial notification to the board continues to be in the best interest of the fund.

According to the SEC’s complaint, from June 2019 to June 2020, the fund in question held approximately 21-26% of its net assets in in illiquid investments. The SEC alleges that Pinnacle Advisors and two of its officers classified the fund’s largest illiquid investment as “less liquid” despite there being restrictions, transfer limitations, and no market for the shares representing that investment, and disregarding the advice of fund counsel who resigned over the issue and the fund’s auditors. Additionally, the SEC’s complaint also alleges that Pinnacle Advisors and its officers did not present the fund’s board with a plan to reduce the fund’s illiquid investments below the 15% maximum, or make other filings with the SEC required by the Liquidity Rule. Further, the SEC’s complaint alleges that Pinnacle and the same two officers made false and misleading statements to SEC staff, and aided and abetted the fund’s violations by failing to have the fund submit required reports to the board of trustees and the Commission in a timely manner.

With respect to the fund’s board of trustees, the SEC’s complaint alleges that two of the independent trustees also aided and abetted the fund’s Liquidity Rule violations because they were aware of the facts that rendered the shares illiquid based on their roles as members of the fund’s valuation and audit committees and the advice of the fund’s counsel and auditors, but allowed the fund to improperly classify the shares as “less illiquid” instead of “illiquid.”

This is the first enforcement action involving the Liquidity Rule. Without admitting or denying the findings, one of the trustees consented to an order requiring him to cease and desist from violations of the Liquidity Rule, pay a civil penalty of $20,000, and suspending him from association with any investment adviser or registered investment company, among others, for a six-month period.

SEC CHARGES PIMCO FOR DISCLOSURE AND POLICIES AND PROCEDURES FAILURES

On June 16, the SEC announced that Pacific Investment Management Company LLC (“PIMCO”) will pay $9 million to settle two enforcement actions relating to disclosure and policies and procedures violations involving two funds PIMCO advises.

Rule 206(4)-7 under the Advisers Act requires investment advisers to adopt and implement written policies and procedures that are reasonably designed to prevent violations by the investment adviser and its supervised persons of the Advisers Act and the rules thereunder. Section 34(b) of the Investment Company Act makes it unlawful for any person to make an untrue statement of a material fact, in any registration statement or other document filed or transmitted under the Investment Company Act, or for a person filing or transmitting such documents to omit to state a fact necessary to prevent the statements made therein, in light of the circumstances, from being materially misleading. Rule 206(4)-8 states that it shall constitute a fraudulent, deceptive, or manipulative act, or course of business by an investment adviser to (i) make any untrue statement of a material fact or omit a material fact necessary to make the statements, in light of the circumstances, not misleading, to an investor or prospective investor in the pooled investment vehicle, or (ii) engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative with respect to an investor or prospective investor in the pooled investment vehicle.

In the SEC’s first order (“Order 1”), the SEC found that between April 2011 and November 2017, PIMCO failed to accurately waive certain advisory fees consistent with an agreement between PIMCO and a mutual fund for which it serves as the investment adviser. The fund in question is a “fund of funds” and primarily invests in other funds managed by PIMCO (“PIMCO-managed funds”). PIMCO receives an advisory fee from the fund and the other PIMCO-managed funds. According to Order 1, PIMCO entered into a fee waiver agreement providing that PIMCO reduce its advisory fee on the fund to the extent PIMCO receives a certain amount of advisory, supervisory, and administrative fees from other PIMCO-managed funds in which the fund invests. Order 1 states that while PIMCO waived a portion of the agreed upon fee waiver, over the period in question, PIMCO failed to waive approximately $27 million of the fund’s advisory fees due to an error in a formula PIMCO created and provided to its sub-administrator to calculate the fee waiver amount. The miscalculation was discovered by the sub-administrator, who notified PIMCO of the of the error in 2017. In response to the error, PIMCO implemented a remediation plan to reimburse the effected fund over $30 million in unwaived fees, lost performance, and interest and took other steps to enhance its policies and procedures.

Order 1 found that as a result of the conduct described above, until at least 2018, PIMCO did not have reasonably designed policies and procedures to prevent violations of the Investment Advisers Act in relation to its oversight of advisory fee calculations and fee waivers in violation of Section 206(4) of the Advisors Act and Rule 206(4)-7 thereunder.

The SEC’s second order (“Order 2”) related to material omissions regarding PIMCO’s use of paired interest rate swaps for a closed-end fund advised by PIMCO. Order 2 found that from September 2014 to August 2016, PIMCO inadequately disclosed that paired interest rate swaps in a closed-end fund advised by PIMCO had become a material source of distributable income, enabling PIMCO to maintain the fund’s dividend rate. Order 2 also includes that the continued use of paired swaps also contributed to a decline on the net asset value of the fund, and that PIMCO failed to adequately disclose that a significant portion of the fund’s distributions came from paired interest rate swaps.

As described in Order 2, according to PIMCO, a paired swap involves two or more interest rate swaps that have certain offsetting characteristics. Typically, PIMCO entered into an agreement to make floating rate payments and receive fixed income payments for a certain number of years (the “initial leg”), and then agreed that the fund would make fixed rate payments and receive floating rate payments for a certain number of years (the “floating leg”). According to Order 2, the fixed interest payments the fund received on the initial leg were usually greater than the floating rate payments the fund owed, causing the fund to typically receive net interest rate payments, which could be used as a source for investor distributions. In most cases, PIMCO would close out the forward leg of the paired swap before the fund began making the fixed rate payment to the counterparty. In connection with closing out the forward leg, PIMCO typically would make a closeout payment for the fund, resulting in a capital loss to the fund. As a result, when the fund held two interest rate swap legs, the initial leg produced investment income that contributed to the fund’s distributions, but the later closeout of a forward leg typically produced a capital loss. According to the Order, during certain quarters within the period such paired swaps generated capital losses without there being sufficient offsetting returns from other fund investments. As further described in Order 2, under those circumstances, portions of the fund’s dividends derived from payments received by the fund on the initial leg were taxable as ordinary income, but were economically equivalent to a return of capital.

In addition, Order 2 describes inadequate disclosures about paired interest rate swaps. The Order states that the prospectus in connection with the fund’s initial public offering included disclosure that income would be generated by “active[ly] manag[ing] duration and yield curve exposure” of its debt portfolio. According to Order 2, by at least 2014, the fund’s paired swaps produced a material portion of distributable income and many of which did not reflect active duration or yield curve management strategies. Additionally, the Order notes that while the initial prospectus and shareholder reports included risks associated with the fund’s use of interest rate swaps, PIMCO inadequately disclosed information concerning paired interest rate swaps in the fund’s annual shareholder reports during 2014 and 2015.

As a result of PIMCO’s conduct, Order 2 states that PIMCO violated Section 34(b) of the Investment Company Act and Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder.

Without admitting or denying the SEC’s findings relating to each action, PIMCO agreed to a cease-and-desist order and a censure in each action, and to pay a penalty of $2.5 million in connection with Order 1 and $6.5 million in connection with Order 2.

SEC ADOPTS NEW SECURITY-BASED SWAP RULES TO PREVENT FRAUD & MANIPULATION PROMOTE CCO INDEPENDENCE

On June 7, the SEC adopted new Rule 9j-1 under the Securities Exchange Act of 1934 (the “Exchange Act”) to seek to prevent fraud, manipulation, and deception in connection with security-based swap (“SBS”) transactions. As described in detail below, the new Rule 9j-1 includes various anti-fraud and anti-manipulation provisions on categories of deceptive or manipulative misconduct related to security-based swap transactions. The new Rule also includes a price manipulation provision and two provisions aimed at ensuring that market participants cannot avoid liability under the new Rule. Lastly, the new Rule includes two affirmative defenses from the liability under the various anti-fraud and anti-manipulation provisions of the new Rule.

The Commissioners also adopted new Rule 15fh-4(c) under the Exchange Act to prohibit undue influence over the Chief Compliance Officer (“CCO”) of a security-based swap dealer or a major security-based swap participant (each, an “SBS Entity”).

As explained in the Adopting Release, the Commission’s particular aspects and characteristics of security-based swaps provide opportunities and incentives for misconduct. The SEC gave several examples of misconduct, noting that, in general, parties to a security-based swap may engage in misconduct in connection with the security-based swap (including in the reference underlying such security-based swap) to trigger, avoid, or affect the value of ongoing payments or deliveries. Accordingly, the new rules are intended to seek to augment the Commission’s oversight of the security-based swap market, which has a gross notional amount outstanding of approximately $8.5 trillion as of late 2022.

Rule 9j-1(a)

Rule 9j-1(a) makes it unlawful for any person, directly or indirectly, to effect any transaction in, or attempt to effect any transaction in, any security-based swap, or to purchase or sell, or induce or attempt to induce the purchase or sale of any security-based swap in connection with the following misconduct:

(1) Employing or attempting to employ any device, scheme, or artifice to defraud or manipulate;

(2) Making or attempting to make any untrue statement of a material fact or omitting a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading;

(3) Obtaining money or property by means of any untrue statement of a material fact or any omission of a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading;

(4) Engaging in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any person;

(5) Attempting to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or attempting to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person; or

(6) Manipulating or attempting to manipulate the price or valuation of any security-based swap or any payment or delivery related thereto.

Violations of subsections (1), (2), (5), and (6) require a showing of scienter. Violations of subsections (3) and (4) do not require a showing of the scienter and extend to conduct that is at least negligent.

For purposes of anti-fraud and anti-manipulation provisions, the definitions of purchase and sale encompass, among other things, partial executions, terminations, assignments, exchanges, transfers or conveyances of, or extinguishing of any rights or obligations under, a security-based swap, as the context may require.

Next, new Rule 9j-1(b) provides that wherever communicating purchasing, or selling a security (other than a security-based swap) while in possession of, material nonpublic information would violate or result in liability to any purchaser or seller of the security under either the Exchange Act or the Securities Act of 1933, or any rule or regulation thereunder, such conduct in connection with a purchase or sale of a security-based swap with respect to such security or with respect to a group or index of securities including such security shall also violate, and result in comparable liability to any purchaser or seller of that security under such provision, rule, or regulation. Likewise, the Commission adopted Rule 9j-1(c) which prevents a person from escaping liability under section 9(j) or the new Rule with respect to a security-based swap by limiting all of its actions to purchases or sales of the security, loan, or narrow-based security index underlying that security-based swap.

Lastly, new Rule 9j-1(e) includes two affirmative defenses from the liability under the anti-fraud and anti-manipulation provisions. The first defense is available under Rule 9j-1(e)(1), where the action was taken pursuant to binding rights and obligations in written security-based swap documentation, so long as the security-based swap transaction occurred before the person became aware of the material nonpublic information, and the person acted in good faith. The second defense is available, under Rule 9j-1(e)(2), to entities that demonstrate that the investment decision-maker was not aware of material nonpublic information and that the entity had reasonable policies and procedures in place to prevent violations of the anti-fraud and anti-manipulation provisions.

Rule 15fh-4(c)

Rule 15fh-4(c) will prohibit any officer, director, supervised person, or employee of an SBS Entity, or any person acting under such person’s direction, to take any action to coerce, manipulate, mislead, or fraudulently influence the SBS Entity’s CCO in the performance of their duties under the federal securities laws.

The new Rules 9j-1 and 15fh-4(c) will both go into effect August 29, 2023.

Table of Contents

Divison of Examinations Releases 2023 Examination Priorities

Division of Examinations Release Observations from Examinations of Newly-Registered Advisers Ricks Alert

SEC Adopts Final Rule Shortening the Securities Transaction Settlement Cycle

SC Proposes Amendments to the Custody Rule

Division of Examinations Releases 2023 Examination Priorities

On February 7, 2023, the Securities and Exchange Commission’s (the “SEC” or the “Commission”) Division of Examinations (the “Division”) announced its 2023 examination priorities (the “2023 Priorities”). Below is a summary of certain aspects of the 2023 Priorities.

Notable New and Significant Focus Areas

Compliance with Recently Adopted Rules Under the Investment Advisers Act of 1940 (the “Advisers Act”) and Investment Company Act of 1940 (the “Investment Company Act”). Referencing recent SEC rulemakings, the 2023 Priorities includes that the Division is prioritizing examining for compliance with recently adopted rules, including:

• Rule 206(4)-1 under the Advisers Act (the “Marketing Rule”). The 2023 Priorities note that the Division will assess whether RIAs have: (1) adopted and implemented written policies and procedures that are reasonably designed to prevent violations by the advisers and their supervised persons of the Marketing Rule; and (2) complied with the substantive requirements of the Marketing Rule, including the requirement that RIAs have a reasonable basis for believing they will be able to substantiate material statements of fact and requirements for performance advertising, testimonials, endorsements and third-party ratings.
• Rule 18f-4 under the Investment Company Act (the “Derivatives Rule”). Where a fund relies on the Derivatives rule, the Division will, among other items: (1) assess whether registered investment companies, including mutual funds (other than money market funds), exchange-traded funds (“ETFs”) and closed-end funds, as well as business development companies (“BDCs”), have adopted and implemented policies and procedures reasonably designed to manage derivatives risks and to prevent violations of the Derivatives Rule pursuant to Investment Company Act Rule 38a-1; and (2) review for compliance with Rule 18f-4, including the adoption and implementation of a derivatives risk management program, board oversight, and whether disclosures concerning the fund’s use of derivatives are incomplete, inaccurate or potentially misleading.
• Rule 2a-5 under the Investment Company Act (the “Fair Valuation Rule”). With respect to the Fair Valuation Rule, the Division will among other items: (1) assess funds’ and fund boards’ compliance with the Fair Valuation Rule’s requirements for determining fair value, implementing board oversight duties, setting recordkeeping and reporting requirements, and permitting the funds’ board to designate valuation designees to perform fair value determinations subject to oversight by the board; and (2) review whether adjustments have been made to valuation methodologies, compliance policies and procedures, governance practices, service provider oversight, and/or reporting and recordkeeping.

Registered Investment Advisers (“RIAs”) to Private Funds. Citing the growth in private fund assets in recent years, the 2023 Priorities include that the Division will focus on the following with respect to private fund RIAs: (1) conflicts of interest; (2) calculation and allocation of fees and expenses; (3) compliance with the new Marketing Rule, including performance advertising and compensated testimonials and endorsements, such as solicitations; (4) policies and practices regarding the use of alternative data and compliance with Advisers Act Section 204A; and (5) compliance with the Advisers Act Rule 206(4)-2 (Custody Rule), where applicable, including timely delivery of audited financials and selection of permissible auditors.

Standards of Conduct: Regulation Best Interest, Fiduciary Duty, and Form CRS. The Division will continue to prioritize examinations of broker-dealers and RIAs for compliance with their applicable standard of conduct. These and other examinations will continue to focus on: (1) investment advice and recommendations with regard to products, investment strategies, and account types; (2) disclosures made to investors and whether such disclosures include all material facts relating to the conflicts of interest associated with the advice and recommendations; (3) processes for making best interest evaluations, including those for reviewing reasonably available alternatives, evaluating costs and risks, and identifying and addressing conflicts of interest; and (4) factors considered in light of the investor’s investment profile, including investment goals and account characteristics.

With respect to Form CRS, the 2023 Priorities note that SEC rules require firms to deliver their relationship summaries to retail investors, file their relationship summary with the Commission, and post the summary on the firm’s website, if applicable. The 2023 Priorities state that the Division will continue to prioritize compliance with Form CRS in the Divisions examination of broker-dealers and RIAs.

Environmental, Social, and Governance (“ESG”) Investing. Noting competition among RIAs and registered funds for demand for ESG investments and strategies, the 2023 Priorities include that the Division will continue to focus on ESG-related advisory services and fund offerings, including whether ESG funds and funds that incorporate ESG criteria are operating in the manner described in their disclosures. The Division will also assess whether ESG products are appropriately labeled and whether recommendations of such products to retail investors are made in such investors’ best interest.

Information Security and Operational Resiliency

The 2023 Priorities also include risks related to information security and operational resiliency as an area of focus for the Division. The Division’s examinations will focus on firms’ policies and procedures, governance practices, cyber-related event responses (including to ransomware attacks), and compliance with Regulations S-P and S-ID, as applicable. With respect to policies and procedures, the Division will review whether such policies and procedures are designed to safeguard customer records and information, whether stored on registrants’ systems or with third-party providers. The Division will also focus on cybersecurity issues associated with firms’ use of third-party vendors.

Crypto Assets and Emerging Financial Technology

The 2023 Priorities include that examinations of registrants will focus on the offer, sale, or recommendation of, advice regarding and trading in crypto or crypto-related assets. More specifically, the 2023 Priorities state that Division staff will assess whether market participants involved with crypto or crypto-related assets: (1) met and followed their respective standards of care when making recommendations, referrals, or providing investment advice, to the extent required; and (2) routinely reviewed, updated, and enhanced their compliance, disclosure, and risk management practices. The Division also will focus on new or never before examined registrants offering crypto or crypto-related assets. Broker-dealer and RIA examinations will also focus on firms that employ digital engagement practices and the related tools and methods.

Investment Advisers and Investment Companies

Examinations of RIAs. The 2023 Priorities state that during a typical examination of and RIA, the Division reviews the firm’s compliance programs and related disclosures in certain core areas, such as custody and safekeeping of client assets, valuation, portfolio management, and brokerage and execution. Examinations also include a review for conflicts, compliance issues and the oversight and approval process related to RIA fees and expenses, including: (1) the calculation of fees; (2) alternative ways that RIAs may try to maximize revenue, including revenue earned on clients’ bank deposit sweep programs; and (3) excessive fees. In addition to reviewing these “core focus areas,” Division staff also will review RIA policies and procedures for retaining and monitoring electronic communications and selecting and using third-party service providers.

Registered Investment Companies, Including Mutual Funds and ETFs. The perennial focus areas for examinations of registered investment companies, include, among other topics, an assessment of registered investment companies’ compliance programs and governance practices, disclosures to investors, and accuracy of reporting to the SEC. The 2023 Priorities note that the Division will continue to evaluate boards’ processes for assessing and approving advisory and other fund fees, particularly for funds with weaker performance relative to their peers. In addition, the Division will assess the effectiveness of funds’ derivatives risk management programs and liquidity risk management programs, if applicable. The 2023 Priorities note that the Division will also focus on funds with specific characteristics, such as: (1) turnkey funds, to review their operations and assess effectiveness of their compliance programs; (2) mutual funds that converted to ETFs, to assess governance and disclosures associated with the conversion to an ETF; (3) non-transparent ETFs, to assess compliance with the conditions and other material terms of their exemptive relief; (4) loan-focused funds, such as leveraged loan funds and funds focused on collateralized loan obligations, for liquidity concerns and to review whether the funds have been significantly impacted by, and have adapted to, elevated interest rates; and (5) medium and small fund complexes that have experienced excessive staff attrition, to focus on whether such attrition has affected the funds’ controls and operations.

Division of Examinations Releases Observations From Examinations of Newly-Registered Advisers Risk Alert

On March 27, 2023, the Division released its observations from examinations of advisers that are newly-registered with the SEC (the “Risk Alert”). As stated in the Risk Alert, the Division’s examinations of newly-registered advisers often focus on whether these firms have: (1) identified and addressed conflicts of interest; (2) provided clients with full and fair disclosure such that clients can provide informed consent; and (3) adopted effective compliance programs.

Examination Scope

In recent years, the Division has prioritized examining newly-registered advisers within a reasonable period after the adviser’s SEC registration has become effective. Generally, such examinations involve document requests and interviews of advisory personnel that address: (1) business and investment activities; (2) organizational affiliations; (3) compliance policies and procedures; and (4) disclosures to clients. As stated in the Risk Alert, Division staff requests information and documents to assess compliance with the Advisers Act and to determine whether the advisers representations and disclosures to clients in filings with the SEC are consistent with the adviser’s actual practices. The Risk Alert notes the following as examples of information the Division staff typically requests:

General information to provide the staff with an understanding of the adviser’s business and operations, such as: (1) organizational charts; (2) documentation to support eligibility for SEC registration; (3) information about ownership and control of the adviser and its affiliates; (4) information about current and former advisory personnel; (5) financial information; and (6) information about litigation or arbitration involving the adviser or any of its supervised persons.

Demographic and other specific data regarding each advisory client account, including information about: (1) advisory services provided, such as portfolio management, financial planning, and/or bundled wrap fee arrangements; (2) types of client accounts serviced; (3) advisory authority to trade in the account, such as whether it has discretionary authority; (4) advisory personnel servicing and overseeing the account; (5) assets under management advised by the firm; (6) third-party service providers; and (7) investment strategies. The staff often also requests documents supporting the adviser’s representations, such as copies of certain contracts, agreements, or third-party account statements.

Information regarding the adviser’s compliance program, risk management practices and framework, and internal controls, including written compliance policies and procedures and the adviser’s code of ethics.

• Information to facilitate the staff testing for regulatory compliance in certain areas, including portfolio management and trading activities, such as a record of specific information for advisory clients’ securities holdings and transactions.
• Communication used by the adviser to inform or solicit new and existing clients, including disclosure documents and advertising, such as pamphlets, social media, mass mailings, websites, and blogs.

Staff Observations from Recent Newly-Registered Adviser Examinations

The Risk Alert identifies staff observations in the following areas:

Compliance Policies and Procedures. Division staff observed compliance policies and procedures that: (1) did not adequately address certain risk areas applicable to the firm, such as portfolio management and fee billing; (2) omitted procedures to enforce stated policies, such as stating the advisers’ policy is to seek best execution, but not having any procedures to evaluate periodically and systematically the execution quality of the broker-dealers executing their clients’ transactions; and/or (3) were not followed by advisory personnel, typically because the personnel were not aware of the policies or procedures or the policies or procedures were not consistent with their businesses or operations. Additionally, the staff observed advisers’ annual compliance reviews that did not address the adequacy of the advisers’ policies and procedures and the effectiveness of their implementation. For example, Division staff observed advisers that:

• Used off-the-shelf compliance manuals that were not tailored for consistency with the advisers’ operations and business.
• May not have devoted sufficient resources to comply with regulatory requirements and their own policies and procedures (e.g., advisers may have assigned additional and unrelated responsibilities to the chief compliance officer (“CCO”), resulting in limited time for the CCO to dedicate to compliance), or to ensure compliance personnel understood actual business practices.
• Had undisclosed conflicts of interest created by the multiple roles and responsibilities of advisory personnel carrying out the assigned duties, and these conflicts were not mitigated.
• Outsourced certain business and compliance functions without assessing how outsourced responsibilities were being performed or whether they were consistent with the advisers’ compliance policies and procedures.
• Did not have adequate business continuity plans, including succession plans.

Disclosure Documents and Filings. As noted in the Risk Alert, Division staff observed disclosure documents with omissions or inaccurate information and untimely filings related advisers’: (1) fees and compensation; (2) business or operations (including affiliates, other relationships, number of clients, and assets under management); (3) services offered to clients, such as disclosure regarding advisers’ investment strategy (including the use of models), aggregate trading, and account reviews; (4) disciplinary information; (5) websites and social media accounts; and (6) conflicts of interest.

Marketing. According to the Risk Alert, Division staff observed adviser marketing materials that appeared to contain false or misleading information, including inaccurate information about advisory personnel professional experience or credentials, third-party rankings, and performance. The Risk Alert also stated that advisers were also unable to substantiate certain factual claims.

SEC Adopts Final Rule Shortening the Securities Transaction Settlement Cycle

On February 15, 2023, the SEC Commissioners voted to adopt final amendments to Rule 15c6-1(a) under the Securities Exchange Act of 1934 (the “Exchange Act”) to shorten the standard settlement cycle for most securities transactions from two business days after the trade date (T+2) to one business day after the trade date (T+1). The Commissioners also adopted amendments to Exchange Act Rule 15c6-1(c) to shorten the separate standard settlement cycle for firm commitment offerings priced after 4 30 p.m. ET, from four business days after the trade date (T+4) to T+2. The amended Exchange Act rules do not alter the existing ability of underwriters and the parties to a transaction to vary the standard settlement cycle specified in paragraphs (a) and (c) of Rule 15c6-1 under Rule 15c6-1(d) by express agreement in advance of the transaction. The SEC also amended Rule 15c6-1(b) to exclude security-based swaps from the scope of the securities T+1 settlement cycle under Rule 15c6-1(a).

In connection with the shortened settlement timelines, the SEC adopted a new Rule 15c6-2 under the Exchange Act. As explained in the Adopting Release, new Rule 15c6-2 is intended to improve the processing of institutional trades through new requirements for broker-dealers and registered investment advisers related to same-day affirmations. For transactions that require completion of the allocation, confirmation, or affirmation process, broker-dealers must either: (i) enter into written agreements with the relevant parties or (ii) establish, maintain, and enforce written policies and procedures reasonably designed to ensure completion of allocations, confirmations and affirmations “as soon as technologically practicable” and no later than the end of the day on trade date. In addition, in connection with new Rule 15c6-2, the SEC amended Rule 204-2 under the Advisers Act to require investment advisers who are parties to a contract under Rule 15c6-2 maintain records of each confirmation received.

Lastly, the SEC adopted a new Rule 17Ad-27 to require clearing agencies acting as central matching service providers (“CMSPs”) and their users to facilitate straight-through processing (“STP”) through new policies and procedures and ongoing assessments of STP processes and annual reporting to the Commission via EDGAR.

The Commission’s move to shorten the settlement cycle was partly informed by the increased market volatility resulting from the COVID-19 pandemic and heightened interest in certain “meme” stocks that highlighted potential vulnerabilities in the U.S. securities markets. As explained in the Adopting Release, the Commission’s intention behind shortening the settlement cycle from T+2 to T+1 was to promote investor protection, reduce risk, and increase operational and capital efficiency. The SEC has shortened the settlement timelines twice in recent history, from five business days after the trade date (T+5) to three business days after the trade date (T+3) in 1993 and from T+3 to T+2 in 2017 in response to changes in technology, markets, trading practices, and participant’s operations. As mentioned in the Adopting Release, the SEC readily observed that the industry and market participants have already taken significant steps to operate in a T+1 environment. Accordingly, the SEC is “actively assessing” the feasibility of an eventual shift to a “same-day settlement” (T+0) standard cycle.

The amendments and new rules will be effective 60 days after publication in the Federal Register, and the compliance date is Tuesday, May 28, 2024.

SEC Proposes Amendments to the Custody Rule

On February 15, 2023, the SEC Commissioners voted to propose new rules and amendments (the “Proposal” or Proposed Rule”) to Rule 206(4)-2 (known as the “Custody Rule”) under the Advisers Act. As proposed, new Rule 223-1 (the “Safeguarding Rule”) would redesignate the Custody Rule and enhance the scope of custodial requirements on all registered investment advisers and their qualified custodians. The SEC Proposal also includes complementary amendments to the Advisers Act books and records rule (Rule 204-2) and Form ADV (namely, to amend Item 9 of Part 1A to require new information corresponding to proposed Rule 223-1). The proposed Safeguarding Rule would significantly change the scope and requirements of the Custody Rule and would seek to enhance the vitality of the role of qualified custodians and auditors in many ways.

The Custody Rule, first adopted in 1962 and last amended by the SEC in 2009, is intended to protect advisory clients from the misuse or misappropriation of their funds and securities over which the adviser has “custody.” Currently, a registered investment adviser (and any of its related persons) with “custody” of “client funds or securities” is required by Rule 206(4)-2 to establish a set of controls to safeguard those client assets. Under the current Rule, “custody” means “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them.” With very limited exceptions, the current Rule 206(4)-2(a)(1) requires that an adviser with custody must maintain client funds and securities with “qualified custodians” either under the client’s name or under the adviser’s name as agent or trustee for its clients. “Qualified custodians” are defined generally as broker-dealers, banks, savings associations, futures commission merchants, and non-U.S. financial institutions that customarily hold financial assets for their customers if the institutions keep the advisory assets separate from their own.

Scope of Client Assets and Expanded Coverage of Custody

The Safeguarding Rule would change the Custody Rule’s definition and scope in two critical ways. First, the proposed Safeguarding Rule would extend the coverage beyond client “funds and securities” to client “assets,” including additional investments held in a client’s account. Consequently, the proposed rule’s definition of assets covers a broader array of client assets and investment activities. For example, it would include investments such as all crypto assets (even in the instances where such assets are neither funds nor securities), financial contracts held for investment purposes, collateral posted in connection with a swap contract on behalf of the client, and physical assets, including artwork, real estate, precious metals, or physical commodities (e.g., wheat or lumber). Second, the proposed rule would make explicit that the current rule’s defined term “custody” includes discretionary authority. Under the current Rule 206(4)-2(d)(2) definition of “Custody,” three prongs serve as examples of custody: (i) physical possession of client funds or securities; (ii) any arrangement under which the adviser is authorized or permitted to withdraw client funds or securities maintained with a custodian upon the adviser’s instruction to the custodian; and (iii) any capacity that gives the adviser or its supervised person legal ownership of or access to client funds or securities. The Safeguarding Rule would retain these three prongs but would amend prong (ii), the “arrangement category,” to state explicitly that discretionary trading authority is an arrangement that triggers the rule.

Qualified Custodians Written Arrangements, Reasonable Assurances, and Qualifications

Like the Custody Rule, the Safeguarding Rule would continue with the qualified custodian requirement but would add new conditions governing the relationship between advisers and their qualified custodians. Specifically, an institution may serve as an adviser’s qualified custodian only if they have “possession or control” of client assets pursuant to a written agreement between the qualified custodian and the investment adviser. “Possession or control” would be defined to mean holding assets such that the qualified custodian is required to participate in any change in beneficial ownership of those assets, the qualified custodian’s participation would effectuate the transaction involved in the change in beneficial ownership, and the qualified custodian’s involvement is a condition precedent to the change in beneficial ownership.

Moreover, under the Proposal, a qualified custodian and adviser would be required to enter into a written agreement containing certain contractual provisions addressing recordkeeping, client account statements, internal control reports, and the adviser’s agreed-upon level authority to effect transactions in the account. It would further require the adviser to obtain “reasonable assurances” in writing from the custodian regarding certain vital protections for the safeguarding of client assets, including, among others, that the custodian: (i) will exercise due care in accordance with reasonable commercial standards; (ii) will indemnify the client against losses caused by its own negligence, recklessness or willful misconduct; (iii) the custodian will not be relieved of its responsibilities to an advisory client as a result of sub-custodial arrangements; and (iv) the custodian will identify and segregate client assets from the custodian’s assets and liabilities. In the Proposal, the SEC acknowledged that a written agreement between an adviser and its custodian would be a “substantial departure from current industry practice” as under existing market practices, advisers are rarely parties to the custodial agreement, which is generally between an advisory client and a qualified custodian.

The proposed Safeguarding Rule would require a more robust set of qualification requirements for banks, savings associations, and foreign financial institutions to serve as qualified custodians. Specifically, under the proposed Safeguarding Rule, to serve as a qualified custodian, a bank or a savings association would be required to hold client assets “in an account designed to protect such assets from creditors of the bank or savings association in the event of the insolvency or failure of the bank or savings association.” Likewise, to serve as a qualified custodian, a foreign financial institution would have to satisfy seven new conditions, one of which is for the foreign financial institution to comply with anti-money laundering and related provisions similar to those of the U.S. Bank Secrecy Act.

Exceptions for Privately Offered Securities and Physical Assets

The Proposed Rule would also modify the current Custody Rule’s limited exception from the obligation to maintain client assets with a qualified custodian for certain “privately offered securities,” including expanding the exception to include certain physical assets. As explained in the Proposed Rule Release, the Commission “believe[s] that the bulk of advisory client assets are able to be maintained by qualified custodians; however, we understand that is not universally the case, particularly for two types of assets: certain physical assets and certain privately offered securities.” The safeguarding rule’s definition of “privately offered securities” would retain the core elements of the current definition (i.e., un-certificated securities acquired in a private placement that are recorded in the name of the client only on the books of the issuer or its transfer agent and transferrable only with the consent of the issuer or holders of the securities) but amends the second prong of the definition to provide the securities be capable of only being recorded on the non-public books of the issuer or its transfer agent in the name of the client as it appears in the records the adviser is required to keep under Rule 204-2, the books and records rule. As proposed, advisers can utilize the exception provided they meet the following conditions: (1) the adviser reasonably determines documents in writing that ownership cannot be recorded and maintained by a qualified custodian; (2) the adviser reasonably safeguards the assets from loss, theft, misuse, misappropriation, or the adviser’s financial reverses, including the adviser’s insolvency; (3) under a written agreement between an independent public accountant and the adviser, the accountant, upon receipt of notice from the adviser, who in turn is obligated to give notice within one business day of such transfer, performs verification of any asset transfers and notifies the Division within one business day upon finding any material discrepancies; and (4) the existence and ownership of the assets are verified during a surprise examination or as part of a financial statement audit by an independent public accountant.

Surprise Exam and Annual Audit Exemption

Finally, the proposed Safeguarding Rule would amend the surprise exam requirement of the Custody Rule and the audited financial statement exception.

Under the Proposal, the surprise examination requirement would be amended to state that the adviser must reasonably believe that a written agreement has been implemented. The current Custody Rule requires a written agreement between the adviser and the accountant. However, it does not expressly require an investment adviser to have a reasonable belief about implementing the written agreement between the adviser and the accountant.

The Custody Rule’s annual audit exception would also be modified by expanding its availability to “any other entity” (i.e., not just pooled investment vehicles). For single-purpose vehicles established to hold investments of a pooled investment vehicle (“SPV”), an adviser would have the choice of whether to treat the SPV as a separate client or treat the SPV’s assets as the pooled investment vehicle’s assets, which it has custody indirectly. However, if the SPV has third-party investors, the adviser would be required to treat the SPV’s assets as a separate client for purposes of the Safeguarding Rule. As is the case with the current Custody Rule, the proposed Safeguarding Rule would require all audited financial statements to be prepared in accordance with U.S. GAAP and be distributed within 120 days of fiscal year end but would extend the delivery deadline to 180 days in the case of a fund of funds or 260 days in the case of a fund of funds of funds of the entity’s fiscal year-end. The Safeguarding Rule would, however, add a new requirement for the auditor’s engagement letter to require the auditor to notify the SEC upon the auditor’s termination or the issuance of a modified opinion.

Timing and Comment Period on the Proposal

The SEC proposed a one-year transition period, with a more extended 18-month period for advisers with up to $1 billion in regulatory assets under management following the Proposals’ effective date. The comment period will remain open until 60 days after the publication of the Proposal release in the Federal Register.

SEC/SRO Update: SEC Brings Enforcement Action For Undisclosed CEO Perks; DOJ And SEC Charge Executive With Insider Trading And Misuse Of 10b5-1 Trading Plan; SEC Proposes Changes To Regulation S-P To Enhance Protection Of Customer Information

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This week, the U.S. Fish and Wildlife Service (“USFWS”) extended the effective dates of its decisions to list populations of the lesser prairie-chicken as threatened and endangered and to reclassify the northern long-eared bat as endangered under the Endangered Species Act (“ESA”).

Last year, the USFWS announced a final rule listing a distinct population segment of the lesser prairie-chicken as threatened and another distinct population segment as endangered. At the same time, the USFWS announced a rule under section 4(d) of the ESA that prohibited take of threatened lesser prairie-chicken, with limited exceptions. The listing rule and accompanying 4(d) rule were scheduled to take effect on January 24, 2023. In other words, as of January 24, 2023, take of endangered and threatened lesser prairie-chicken would be prohibited, except as provided in the 4(d) rule.

On January 24, 2023, the USFWS published a rule
extending the effective date of the listing rule and 4(d) rule by 60 days until March 27, 2023. The USFWS extended the effective date in part to allow land users to enroll in conservation mechanisms such as Candidate Conservation Agreements with Assurances. Thus, the prohibitions of take of lesser prairie-chicken under the ESA and 4(d) rule will become effective on March 27, 2023.

Last year, the USFWS also announced a final rule that reclassified the northern long-eared bat, which had been listed as threatened, as endangered. The reclassification was scheduled to become effective on January 30, 2023. On January 26, 2023, the USFWS published a rule
extending the effective date of the reclassification rule until March 31, 2023. The USFWS cited a need to finalize tools to facilitate section 7 consultation over projects such as wind energy development as justification for delaying the effective date of the reclassification.

Please contact Katie Schroder with questions about these listing decisions or delayed effective dates.

The U.S. Fish and Wildlife Service (FWS) published a proposed rule in the Federal Register that, if adopted, would revise the regulations related to eagle take permitting under the Bald and Golden Eagle Protection Act.[1] The proposed rule has garnered a lot of attention from multiple stakeholders. Indeed, the FWS was forced to increase the comment period by 30 days to accommodate the high number of responses.

The stated purpose of the proposed rule is “to increase the efficiency and effectiveness of permitting, facilitate and improve compliance, and increase the conservation benefit for eagles.” The rationale behind the purpose is due to a couple of factors. First, as the FWS notes in the proposed rule, bald eagle populations are increasing at a sizable rate, which has led to more interactions with humans, creating a surge in demand for eagle take permits. Second, while the bald eagle population continues to grow, the golden eagle population has decreased in recent years. According to the proposed rule, the decrease is due, in part, to the fact that while there are over 1,000 wind-energy projects, the FWS has issued only 26 permits since the promulgation of the 2016 eagle permit rule, far fewer than anticipated. As a result of the lack of permitting, there has been an unauthorized golden eagle take without any mitigating conservation. Finally, the current permitting process is seen as burdensome and creates uncertainty for those individuals and entities hoping to obtain a permit.

If adopted, the proposed rule would fall under a newly created Subpart E in 50 C.F.R. Part 22. Some provisions of the new rule include (1) the administration of specific and general permits for incidental take, (2) specific activity-specific eligibility criteria and permit requirements in four sections based on activity and type of eagle, (3) changes to monitoring requirements, (4) compensatory mitigation, and (5) changes to the application fees. A summary of the key terms is set forth below.

General Permits

Pursuant to the proposed rule, a “general permit” is defined as “a permit that is issued to an individual or entity with nationwide or regional standard conditions for a category or categories of activities that are substantially similar in nature.” FWS is proposing general permits for four types of activities: incidental take at wind-energy generation facilities, incidental take by power-line infrastructure, disturbance take of bald eagles and bald eagle nest take. Under the proposed rule, the FWS hopes to simplify and expedite the permitting process for activities that have relatively consistent and low effects on eagles by allowing general permit applicants to self-identify eligibility, register with FWS, and certify that they (1) meet the eligibility criteria and (2) will implement permit conditions and reporting requirements. The FWS would ensure that applicants are interpreting and using the general permit process properly by conducting annual audits for a small percentage of all general permits. Further, the FWS proposes limiting the duration of general permits for incidental take to a maximum of five years and for disturbance take or nest removal to a maximum of one year.

Incidental Take for Permitting Wind Energy. Eligibility for general permits for wind-energy generation projects, must be located in areas characterized by seasonal relative abundance values specified in the regulations for each species, be placed greater than 660 feet from bald eagle nests and greater than two miles from golden eagle nests, and have had less than four eagle mortalities of either species discovered at the project. Take of both species would be authorized under the general permit without a specific number listed on the permit.

Incidental Take for Permitting Power Lines. To be eligible for a general permit for incidental take of eagles by power lines, the applicant must (1) ensure that all new construction and reconstruction of poles is electrocution-safe, as limited by the need to ensure human health and safety; (2) must consider eagle nesting, foraging, and roosting areas in siting and design, as limited by human health and safety; (3) develop reactive retrofit strategy that governs retrofitting of high-risk poles when an eagle electrocution is discovered; (4) implement a proactive retrofit strategy to convert all existing infrastructure to electrocution-safe; (5) implement an eagle collision response strategy; (6) implement an eagle-shooting response strategy; and (7) adequately train personnel to scan for eagle remains when onsite and implement internal reporting and recordkeeping procedures.

Eagle Disturbance Take Permits. This proposed general permit would authorize disturbance of bald eagles by specific activities taken near bald eagle nests, generally within the distances outlined in the National Bald Eagle Management Guidelines; such activities include building and linear infrastructure construction, alteration of shorelines or vegetation, recreation activities, etc. Under the proposed new rule, permitees would have to implement measures to avoid and minimize nest disturbance, however it does not specify what those measures would involve. General permits for disturbance take of golden eagles would not be available.

Permits for Take of Bald Eagle Nests. This proposed general permit would authorize bald eagle nest take for four purposes: emergency, health and safety, removal from human-engineered structures, and other purposes. In addition to the first four stated purposes, FWS proposes an exception to this specific permit for other purposes by authorizing a general permit only in Alaska for bald eagle nest take for other purposes. General permits for disturbance take of golden eagles would not be available.

Monitoring Requirements

Industry stakeholders will be pleased that FWS is proposing to remove the current third-party monitoring requirement from eagle incidental take permits, including specific permits.

Under the proposed rule, for general incidental take permits, to better understand the program’s impacts and to verify that the general permit program is compatible with the preservation of eagles, FWS plans to use the permit application and administration fees for program-scale monitoring (instead of the current project-scale monitoring required of the permittee). FWS plans to compile information on general permits issued on an annual basis.

Some monitoring requirements will still apply to most general permit holders. For the wind-energy and power-line incidental take general permits, training relevant employees to recognize and report eagle take as part of their regular duties, including scanning for injured eagles and eagle remains during inspections, maintenance, repair, and vegetation management at and around project infrastructure would be required. For disturbance permits, implementation of monitoring of in-use nests that is sufficient to determine whether nestlings have fledged from the nest would be required and this information would have to be included on its annual report. For a one-year nest removal general permit, no monitoring would be required.

Compensatory Mitigation

Any permit authorizing take that would exceed the applicable Eagle Management Unit (EMU) take limit will require compensatory mitigation. Additionally, a permit may require compensatory mitigation if FWS determines that the persistence of the local area population of an eagle species in the project area may not be maintained.

Permit Fees

The proposed general permit fees vary by general permit type. For incidental take by wind-energy generation, the application fee is $500, and the permit-administration fee is $2,625 per turbine. For incidental take by power lines, the proposed application fee is $500, and the proposed permit-administration fee is $5,000 for each state for which the power-line entity is seeking authorization. For the bald eagle disturbance and nest-take general permits, the application fee is $100, with no administration fee.

[1]Fish and Wildlife Service, Permits for Incidental Take of Eagles and Eagle Nests, Proposed Rule, 87 Fed. Reg. 59,598, 59,599 (Sept. 30, 2022).