The following brief updates exemplify trends and areas of current focus of relevant regulatory authorities:
Massachusetts Investigates State-Registered Advisers’ Recommendations of Alternative Funds
On July 15, 2015, the Massachusetts Securities Division (the “Division”), led by Massachusetts Secretary of the Commonwealth William Galvin, announced that it was beginning an open-ended investigation into the recommendations that state-registered investment advisers make to retail investors about “alternative” registered funds. In its announcement of the sweep, the Division listed 25 alternative funds about which it will ask the RIAs, based on the funds’ sales volume and investment strategy. The examination includes, among others, large alternative funds from many well-known fund complexes. The Division requested information on the diligence that advisers conduct when recommending alternative funds to retail investors. In an accompanying press release, Secretary Galvin described alternative funds as “accidents waiting to happen” when sold to retail investors without adequate disclosure of potential risks.
Investments in alternative mutual funds have increased six fold since 2008 to over $300 billion. This rapid growth has led to increased regulatory focus on alternative mutual funds, including the SEC’s continuing examinations of such funds.
SEC Commissioner Discusses Cybersecurity Priorities
On June 25, 2015, SEC Commissioner Luis Aguilar addressed cybersecurity issues within the securities industry while speaking at the SINET Innovation Summit in New York City. Commissioner Aguilar discussed a variety of issues, including recent enforcement actions and the results of the SEC’s cybersecurity sweep exam of broker-dealers and investment advisers published in February. In particular, he noted that the sweep exam revealed that firm cybersecurity policies and procedures generally failed to specify how firms would determine responsibility for client losses stemming from a cyber-attack, that some firms were not conducting periodic risk assessments of their vendors’ systems, and that cybersecurity insurance was not carried by many broker-dealers and investment advisers. Most notably, he emphasized that the SEC continues to perceive cybersecurity as a serious and persistent threat, and that it will proactively examine how it can bring more cybersecurity enforcement actions using its existing authority.
Federal Reserve Board and SEC Clarify Seed Capital Period for Registered Funds
On July 16, 2015, the staff of the SEC’s Divisions of Trading and Markets, Investment Management, and Corporation Finance1 amended their FAQ on the final rule (the “Final Rule”)2 implementing Section 13 of the Bank Holding Company Act, commonly referred to as the “Volcker Rule.” The FAQ responds to industry concerns that, although the Final Rule excludes registered investment companies, foreign public funds and SEC-regulated business development corporations (collectively “Public Funds”) from the definition of “covered funds,” a Public Fund could nevertheless become subject to the Volcker Rule’s restrictions on proprietary trading if the Public Fund were deemed to be a “banking entity” as defined in the Final Rule. A “banking entity” is defined to include, among other things, any entity (such as a Public Fund) that is “controlled” by a bank and/or its affiliates. Such control can arise if a bank and/or bank affiliates own 25 percent or more of the entity’s outstanding voting securities. Although the Final Rule provides an exception for investments in covered funds during a seed capital period, there is no similar provision in the Final Rule for seed capital investments in Public Funds. Under existing banking law precedents, banks and their affiliates are permitted to make seed capital investments of 25 percent or more of voting shares of a registered investment company during a limited seeding period.
The FAQ states that the staffs of the Agencies would not advise the Agencies to treat a Public Fund as a banking entity solely because of the level of ownership in a Public Fund of its bank-affiliated sponsor during a limited seeding period. The staff further recognized that the seeding period for Public Funds “may take some time, for example, three years, the maximum period of time expressly permitted for seeding a covered fund under the [Final Rule].” The FAQ also states that the staff does not expect that it would be necessary for an application to be submitted to the Federal Reserve Board by a banking entity to determine the length of the seeding period.
The general compliance date under the Final Rule was July 21, 2015.
SEC Considers Audit Committee Disclosure
On July 1, 2015, the SEC issued a concept release (the “Release”) soliciting public comment on expanding audit committee reporting requirements. In particular, the Release focused on expanding an audit committee’s reporting of its responsibilities and activities with respect to its oversight of a firm’s independent auditor. The SEC posited that disclosure of additional information by the audit committee with respect to its oversight of the auditor may provide useful information to investors as they evaluate the audit committee’s performance in connection with investors’ “vote for or against directors who are members of the audit committee, the ratification of the auditor, or their investment decisions.” The Release is a “concept” release intended only to provide the SEC with information regarding audit committee reporting. Any changes to the SEC rules concerning audit committee reporting would require the SEC to publish the proposed rule changes for public comment.
The Release solicited public comment on potential disclosure changes in four areas: (i) the audit committee’s oversight of the auditor; (ii) the audit committee’s processes for appointing or retaining an auditor; (iii) the qualifications of the auditor and members of the engagement team selected by the audit committee; and (iv) the location of audit committee disclosure in SEC filings.
The Release discussed only listed operating companies, the boards of which are required to have an audit committee. However, listed closed-end funds’ boards, which are also required to have an audit committee, could be affected by any rule changes ultimately resulting from the Release and subsequent rulemaking. Open-end funds are not required to provide an audit committee report, and the Release does not refer to open-end funds. However, the Release does ask for comment on whether new disclosure requirements should extend to “all issuers.” Therefore, it is conceivable that any rule changes resulting from the Release could extend to open-end fund disclosures.
Comments on the Release must be submitted no later than September 8.