The SEC unanimously proposed rules on May 20, 2015 to enhance and modernize reporting by U.S. registered investment advisers and investment companies (Proposed Rules)1 and empower the SEC to gather data to better understand and monitor the effect market events may have on advisers and funds. The investment adviser proposal would amend Form ADV to require additional disclosure for separately managed accounts (SMAs) and relying advisers under an "umbrella" registration, and would also amend Rule 204-2 under the Investment Advisers Act of 1940 (Advisers Act) to require increased recordkeeping of communications regarding performance and rate of return calculations.
The investment company proposal would create two new reporting forms for companies registered under the Investment Company Act of 1940 (1940 Act): Form N-PORT for monthly portfolio holdings and the use of derivatives in lieu of quarterly reporting on the current Form N-Q, and Form N-CEN for annually reporting modernized census-type information in lieu of the current semi-annual Form N-SAR. The proposal also would amend Regulation S-X to require detailed disclosures about derivatives in financial statements. Finally, a proposed new Rule 30e-3 would permit registered investment companies to transmit shareholder reports via their websites.
The SEC, continuing its efforts to mine and monitor data as a means to regulate funds and advisers, proposed new rules designed to empower the SEC to better understand market events that affect fund and adviser performance. "Data is power," according to David Grim, the new Director of the SEC’s funds and advisers unit, "and we think that the data-gathering proposal will enhance our ability to understand and monitor" market events.
Advisers Act Proposals: The Proposed Rules amend Form ADV to: (i) enhance disclosures regarding SMAs, (ii) formally adopt "umbrella" registration for private fund advisers, and (iii) enhance disclosures about other client types. Rule 204-2 under the Advisers Act would be amended to increase recordkeeping requirements for performance and rate of return calculations. Below we have set out brief summaries of the significant aspects of the Proposed Rules.
- Form ADV Amendments to Enhance Reporting for SMAs. The Proposed Rules would increase disclosures for SMAs, defined as advisory accounts other than pooled investment vehicles. New required information required about SMAs includes types of assets held and the use of derivatives and borrowings. Advisers would be required to annually report the approximate percentage of regulatory assets under management (RAUM) attributable to SMAs invested in ten asset categories (e.g., exchange-traded equity securities, sovereign bonds, and derivatives). Those advisers with at least USD10 billion in RAUM attributable to SMAs would report this information for both mid-year and year-end information in the annual filing.
Advisers with at least USD10bn in RAUM attributable to SMAs would also be required to report information on gross notional exposure, the use of borrowings, and derivative exposure in 6 types of derivatives for SMAs with at least USD10 million of assets at mid-year and year-end. Those advisers with at least USD150m but fewer than USD10bn in RAUM attributable to SMAs would report only at year-end and would not be required to break out derivative exposure by type of derivative. In addition, all advisers would be required to identify any custodians accounting for at least 10% of separately managed account RAUM and information on the amount of such RAUM held at the custodian.
The new reporting requirements for SMAs may require investment advisers to aggregate and report information that their current operating systems may not be equipped to generate. As a result, advisers should think carefully about the practical aspects and costs of the proposed reporting obligations and consider commenting on this aspect of the Proposed Rule.
- Umbrella Registration. The Proposed Rules allow related, but legally separate, investment advisers to private funds (and certain SMAs) operating as a single advisory business to file a single Form ADV to register each related adviser (an umbrella registration). This change codifies the SEC’s position in the 2012 SEC staff no-action letter to the American Bar Association.2 Under the Proposed Rule, each relying adviser must file the new Schedule R to Form ADV, which requires identifying and ownership information and information on the relying advisers’ ability to register. Importantly, umbrella registration will not be available to exempt reporting advisers.
- Additional Enhanced Reporting Requirements: Advisers would be required to provide additional information regarding the number and location of branch offices and the use of social media. Additional disclosure requirements include information on the RAUM under each category of clients, approximate RAUM attributable to non-U.S. clients, and the total RAUM attributable to affiliations with wrap fee programs.
- Advisers Act Amendments on Maintenance of Performance Records. The proposal increases the recordkeeping requirements under Rule 204-2 under the Advisers Act (the books and records rule) by requiring advisers to maintain materials supporting performance or rate of return calculations distributed, directly or indirectly, to any person in written communications. Currently, such records are only required for distributions to at least 10 people. Additionally, the Proposed Rule requires advisers to maintain, for communications related to the performance or rate of return, originals of all written communications received and copies of written communications sent by adviser.
Investment Company Act Proposals: The investment company proposal consists of four primary changes, which are summarized below.
- New Form N-PORT. Form N-PORT will require monthly portfolio holdings by all registered management investment companies (i.e., mutual funds, closed-end funds, exchange traded funds (ETFs), and business development companies) and unit investment trusts that operate as ETFs, excluding money market funds and small business investment companies. The form would require a fund to list its complete portfolio holdings, as well as additional information regarding derivative investments, market liquidity, pricing of portfolio investments, and fund flows. Form N-PORT would replace the current Form N-Q.
- Amendments to Regulation S-X. The amendments to Regulation S-X seek to standardize the type and form of disclosure on derivatives and securities lending activities in investment company financial statements. The Proposed Rule would prescribe disclosure of specific types of derivatives, including holdings in open futures contracts and open forward foreign currency contracts.
- New Form N-CEN. Under the Proposed Rule, nearly all registered investment companies would be required to report "census-type" information annually on the new Form N-CEN. Form N-CEN would replace the current semi-annual Form N-SAR and modernize the information requested.
- Website Transmission of Shareholder Reports. The Proposed Rule would allow certain registered investment companies, under new rule 30e-3, to transmit shareholder reports through their website, in contrast to the existing printing and mailing transmission. A fund would have to comply with certain requirements, including obtaining shareholder consent, providing notice to shareholders, and maintaining shareholder ability to request paper reports.
Commissioner Aguilar, in his speech at the SEC’s open meeting, called attention to new rule 30e-3, which allows website transmission of shareholder reports, asking for comments that address whether online transmission may reduce accessibility of shareholder reports to certain investor groups. Commissioner Piwowar further voiced concerns that Form N-PORT and the amendments to Regulation S-X would require funds to disclose, in connection with derivative investments, the components of an underlying reference index if the components are not already disclosed publicly on a website, and that index providers may not be willing to allow the components of their indices publicly disclosed resulting in a potentially negative impact to funds that use the indices.
Comment Period: Comments are due 60 days after the Proposed Rules’ publication in the Federal Register.