This newsletter discusses recent key guidance releases, regulatory changes, noteworthy news and certain upcoming compliance deadlines. You are welcome to contact us to discuss any of the topics and deadlines.

SEC Withdraws Two No-Action Letters Regarding Investment Advisers’ Use of Proxy Advisory Firms

President Trump signed the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Growth Act”, which can be accessed here) in May 2018. The Growth Act had bipartisan support; receiving 258 votes in the House of Representatives and 67 votes in the Senate. The overall aim of the Growth Act was to roll back certain regulations first implemented in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”). Specifically, the Growth Act contains a number of provisions impacting how small venture capital funds are regulated under the Investment Company Act of 1940 (the “Investment Company Act”). This article summarizes what fund managers should know going forward, particularly now that the control of the United States House of Representatives has flipped to the Democratic Party.

In exciting news for small venture capital funds seeking to raise capital, the Growth Act amends Section 3(c)(1) of the Investment Companies Act to remove the requirement for those funds having more than 100 beneficial owner to register as an investment company. Instead, the 100 beneficial owner limit under 3(c)(1) has been increased to 250 so long as the fund (1) at all times has total capital contributions (and unfunded commitments) of less than $10 million, and (2) meets the definition of a venture fund under applicable Advisers Act rules. The various federal agencies, including the SEC, charged with implementing the provisions of the Act, are still in the process of issuing final rules as of publishing. Full implementation of the Act is expected in 2019.

These amendments are excellent news for venture capital funds raising less than $10 million. Before this amendment, funds relying on 3(c)(1) that are approaching the 100 beneficial owner limit previously needed to create a new fund relying on the section 3(c)(7) exemption to continue raising capital for the venture capital fund (that exemption has a 1,999 beneficial owner limit and may only have investors who meet substantial financial requirements). The new amendment to 3(c)(1) can reduce the need to create a separate fund that is exempt under 3(c)(7), thereby allowing the such funds to focus more on raising capital, rather than creating new funds to work around the 3(c)(1) beneficial owner limit.

Despite the new flexibility under the Growth Act, private fund managers are unlikely to see continued relaxation of Dodd-Frank and other regulations from Congress now that the control of the House of Representatives has flipped to the Democratic Party. Maxine Waters (D-CA), the new Chairwoman of the House Financial Services Committee, recently made this remark following the November elections, “[E]asing banking regulations…will come to an end” in January of 2019. On the other hand, continued Republican control of the Senate will likely result in no material financial regulatory increases over the next two years.

Takeaway: While the Growth Act became law in May of 2018, the new investor-limit flexibility only applies to small venture funds and it may take some time before funds and their managers can take advantage of these new rules as the SEC must still publish corresponding rules. However, the Republican-controlled Senate, under Senator Mike Crapo’s (R-ID) has already held public hearings to push agencies to expedite their implementation of the Growth Act. It is likely he will continue to be tenacious in his efforts to fully implement the Growth Act.

The Republican Party increased its majority in the United States Senate following the 2018 midterm elections to 53 seats. The implication of the Republican Senate majority is that President Trump is virtually guaranteed to have three Republican SEC Commissioners for at least another two years.

This article discusses what we expect are focus areas for the newly-configured Commission based on the Commissioners’ respective backgrounds and market philosophies.

One key expected development for the Republican majority Commission is the possible introduction of cryptocurrency exchange-traded funds (ETFs) on a regulated exchange such as the New York Stock Exchange. In July 2018, the Commission rejected a cryptocurrency exchange bid by Gemini Trust Co. (“Gemini”) to become the first crypto exchange listed on a regulated exchange. However, the Commission at the time was comprised of two Democrats, one Republican and the SEC Chairman who lists as an independent. The Chairman, Jay Clayton, joined the two Democrats in ruling against Gemini’s bid because of the perceived lack of regulation regarding cryptocurrency in addition to manipulation of the Bitcoin market. There is a belief that the Chairman’s vote against Gemini was based less on an aversion to cryptocurrency or need for increased regulation and more on avoiding a 2-2 vote gridlock if he had joined Republic Commissioner Hester Peirce in voting to approve Gemini’s bid.

Since the Gemini decision, however, the Commission has completely flipped. There are now two Republican members, two Democratic members and the Chairman, who was appointed by a Republican and would likely tend to vote on Commission matters in lock-step with the two Republican members.

We also note that the SEC delegates initial ETF listing decisions to the Division of Trading and Markets (“DTM”). There is one intriguing case currently in front of the DTM: a physical Bitcoin ETF proposed by Cboe Global Markets, Inc. (Cboe) in conjunction with a blockchain technology company (SolidX) and an investment management firm (VanEck). If the DTM votes to disapprove the VanEck-SolidX listing, the Commission may hold a hearing to reverse the decision and approve the VanEck-SolidX listing. The new makeup of the Commission, with newly-appointed Elad Roisman (R), would likely create at least two votes in favor of allowing VanEck-SolidX to list as a regulated ETF. Hester Peirce (R) was the lone dissenter in the Gemini review this past July, and it is unlikely Chairman Clayton would vote to disapprove this time since there is most likely no possibility of a 2-2 tie.

In addition to the cryptocurrency concerns, the current Commission will likely look to decrease the number of enforcement actions and pursue deregulatory measures as long as companies disclose enough information so investors can make informed decisions. See below for background information on each of the current Commissioners.

Chairman Jay Clayton (I) – but most likely voting with Republican Members

Jay Clayton has been the Chairman of the SEC since his appointment by President Trump in 2017. Clayton had previously been a partner at Sullivan & Cromwell where his practice focused on mergers and acquisitions and capital market offerings. While at Sullivan & Cromwell he represented Goldman Sachs, Barclays Capital and Alibaba Group among others. He also represented Bear Stearns in its sale to J.P. Morgan during the financial crisis of 2007-08.

Clayton has expressed his view that levying big fines and punishments on corporations should not necessarily be a priority, because, as part of such punishments, shareholders ultimately suffer rather than the corporations. Clayton has stated he wants to take a broader, holistic approach during his time as Chairman. He has also stated that focusing on any particular aspect of the SEC’s mission over another will ultimately be ineffective: “investors, companies (large and small), the U.S. capital markets, and ultimately the economy will suffer.” Furthermore, Clayton’s philosophy as SEC Chairman has focused on protecting retail investors and retirees from scams and other suspect practices. Clayton intends to use SEC resources to educate investors about fraud and how they can protect themselves. Clayton is committed to the idea of materiality and disclosure as the key protective mechanisms for investors. Firms will have to disclose material events and it will be up to investors to make a choice about whether to invest.

Clayton’s philosophy is considered a relatively conservative “buyer beware” view of how the market should work. So long as a public company is disclosing all material events and other necessary disclosures allowing investors all of the necessary information to make an informed decision, then (barring a crime) the SEC may not levy an enforcement action.

Hester Peirce (R)

Hester Peirce is the champion of economic freedom on the SEC Commission. President Trump nominated, and the Senate confirmed, Peirce earlier this year to fill a Republican seat vacancy. During the early 2000s, Peirce was a counsel to the SEC before serving on Senator Richard Shelby’s (R-MS) staff on the Senate Committee on Banking, Housing, and Urban Affairs during the financial crisis of 2007-08 through the implementation of Dodd-Frank. From 2012-17, she was a law professor at Antonin Scalia Law School at George Mason University in addition to being a research fellow at the school, where she focused her efforts on financial markets.

President Obama originally nominated Pierce to the Commission in 2016, but her nomination stalled when she refused to commit to requiring public companies to disclose political contributions. Peirce is also a sharp critic of Dodd-Frank and other financial regulatory measures enacted by the Obama administration and Congress. In 2012, she wrote a book entitled, “Dodd-Frank, What It Does and Why It’s Flawed,” arguing Dodd-Frank micromanages the market to death. Her response to the financial crisis of 2008, she argues in her book, would have been to avoid punitive regulatory measures because, when banks are too focused on complying with regulations, they ignore their duty to service customers with financial opportunities.

She also, notably, dissented from her fellow Commissioners in the 2018 decision on Gemini’s ETF listing as described above. In her dissent, she argued more institutional participation of the bitcoin market would help the SEC further understand bitcoin is a new innovative product that should be welcomed to regulated exchanges and financial markets.

Peirce, like Chairman Clayton, has a conservative view of financial markets. Her dissent in the Gemini decision also demonstrated her libertarian, economic freedom views when it relates to cryptocurrency and other new products developed within the last few years.

Elad Roisman (R)

Roisman was nominated by President Trump and confirmed by the Senate in September 2018. Roisman, much like Peirce, spent significant time working for the Senate Committee on Banking, Housing, and Urban Affairs as part of Senator Mike Crapo’s (R-ID) staff where he spent considerable efforts drafting legislation designed to neuter and roll back many of Dodd-Frank’s provisions.

Before joining the public sector, Roisman was the Chief Counsel at NYSE Euronext and spent several years working at Millbank Tweed in New York. Roisman and Peirce share similar views regarding economic freedom and disclosure, with an aversion to overbearing regulation and punitive enforcement actions.

During his Senate confirmation hearing, Roisman said his priorities as a Commissioner will include enlisting more comments from small businesses when it concerns proposed regulations, increasing investor confidence in the markets (a commitment he shares with Peirce and Chairman Clayton) and capital formation. When asked why SEC enforcement actions are down since 2016, Roisman responded that the number of enforcements should not be a measuring stick, but rather investors and interested parties should look at the type of enforcement action (emphasis added).

Roisman clearly shares Chairman Clayton’s and Peirce’s conservative view when it comes to financial market regulations.

Robert Jackson, Jr. (D)

President Trump nominated Robert Jackson Jr. to fill an open Democratic seat on the Commission, and the Senate confirmed his nomination in January 2018. Since 2009 (and continuing today), Jackson has served as a professor at Columbia Law School in New York. Prior to joining the faculty at Columbia Law, Jackson was an associate at Wachtell Lipton working primarily on executive compensation and corporate governance matters. He also spent time at Bear Stearns in the early 2000s before working as a Deputy Director at the U.S. Department of Treasury. Jackson receives credit for establishing executive pay rules for public companies following the 2007-08 financial crisis. Furthermore, Jackson also authored several executive pay rules used in Dodd-Frank.

Jackson’s published editorials and papers focus on insider trading and how current SEC rules might benefit company insiders given the four-day window from the time insiders learn of material information and the Company has to disclose by filing an 8-K. His work was repeatedly cited during the Equifax scandal following the largest personal data breach in company history in 2017.

During his first year on the Commission, Jackson has been critical of the SEC’s decision not to release new disclosure rules surrounding cyber-attacks (Chairman Clayton and a majority of Commissioners believe such mandatory disclosures rules would be unnecessary due to the mandatory materiality disclosure rules that currently exist).

Jackson is very much a liberal, pro-heavy enforcement, anti- economic freedom democrat in his view of regulating financial markets.

Kara Stein (D)

Stein has been a Democratic member of the Commission since her appointment by President Obama in 2013. Her term expires after December 2018. There is an unconfirmed rumor that President Trump will nominate Allison Lee, considered among the favorites of Senator Elizabeth Warren (D-MA), to fill the Democratic seat Stein will vacate in 2019. However, President Trump has not made an announcement on the forthcoming vacancy. It is also possible President Trump will delay nominating anyone to fill that vacancy for some time, giving the Republicans a solid 3-1 majority.

Stein has been a staunch advocate for increased regulatory oversight in the financial markets and very much fits the mold of the Obama-era Democrats on the Commission. She has published editorials and focused her time on the Commission advocating updating SEC rules for the digital age and increasing mandatory disclosure requirements to include cyber-security threats and corporate political contributions.

Stein has liberal, pro-heavy enforcement, anti-economic freedom views of the way to regulate financial markets. If President Trump nominates Allison Lee, her views are thought to be very similar to those of Stein.

Enforcement actions can provide valuable insight as to where regulators are focusing their examination and enforcement efforts. Summaries of select recent enforcement actions against investment advisers are summarized below.

SEC Sanctions Private Fund Advisers for Form PF Failures. In June 2018, the SEC settled charges against thirteen investment advisory firms for their repeated failures to file Form PF as required under Rule 204(b)-1(a) of the Advisers Act. An SEC-registered investment adviser who manages more than $150 million of private fund assets is required to file Form PF with the SEC on an annual or quarterly basis, depending on the adviser’s private fund assets under management. The information collected in the filing, such as the types of investors in each private fund and the extent to which each private fund is leveraged, is used by the SEC to better understand and monitor systemic risk in the private fund industry. Each of the thirteen investment advisory firms named in the enforcement actions had failed to file Form PF over a multi-year period. Each firm agreed to be censured, cease and desist from continued violations of the Form PF filing requirement, and pay a $75,000 fine as part of the settlements.

Takeaway: All SEC-registered investment advisers who manage more than $150 million of assets of private fund(s) must timely file Form PF with the SEC.

SEC Settles Cybersecurity Enforcement Action. In September 2018, the SEC settled charges against Voya Financial Advisors (“VFA”) arising from a cybersecurity data breach that occurred in 2016. Individuals impersonating VFA representatives were able to obtain customer passwords from VFA’s technical support line that were then used to access information about more than 5,000 VFA customers, including personally identifiable information such as social security numbers. While the data breach was resolved in just a few days and corrective measures were implemented by VFA immediately thereafter, the SEC concluded that VFA’s cybersecurity policies and procedures in effect at the time of the breach were inadequate. Specifically, the SEC found, amongst other violations, that VFA had failed to (1) adopt policies that were reasonably designed to protect the confidentiality of customer information, (2) adequately update its policies in light of changing cybersecurity risks, and (3) provide identity theft and cybersecurity training to its employees. As part of the settlement, VFA agreed to pay a $1 million fine as well as engage an independent consultant to review and revise VFA’s cybersecurity policies and procedures. The SEC’s Order for this matter can be found here.

Takeaway: The SEC continues to focus on cybersecurity, including whether an advisory firm has appropriate policies and procedures to protect against cybersecurity threats as well as how advisory firms respond to cybersecurity breaches.

SEC Sanctions Investment Adviser for Advertisements. In August 2018, Massachusetts Financial Services Company (“MFS”) settled the SEC’s claims that MFS violated Section 206(2) and 206(4) of the Advisers Act by (1) making material misstatements and omissions in advertisements to some of its advisory clients and others and (2) failing to adopt and implement policies and procedures that were reasonably designed to prevent inaccuracies in its advertisements.

MFS advertised the superior returns of a hypothetical stock portfolio using its blended research strategies based on both fundamental and quantitative analysis, claiming that the blending would yield better returns over time than either strategy alone. However, the advertisements misled investors because the materials failed to disclose that some of the quantitative ratings were determined using a retroactive, back-tested application. In addition, MFS also falsely claimed that it had employed its own quantitative stock ratings dating back to the mid-1990s, even though MFS did not have a quantitative research department or generate its own quantitative ratings before 2000. The SEC alleged that the MFS advertisements violated the prohibitions on deceptive, fraudulent and misleading advertisements under the Advisers Act.

As part of its settlement, MFS agreed to be censured and to pay a civil penalty in the amount of $1,900,000. MFS also agreed to retain a compliance consultant to review its written compliance policies and procedures with respect to its advertisements concerning investment models, research ratings or strategies. The SEC’s Order for this matter can be found here.

Takeaway: If an investment adviser intends to present hypothetical or back-tested performance data in its marketing materials (including its PPM), appropriate disclosures must be made.

SEC Sanctions Private Fund Manager for Redemption Program. In August 2018, Aria Partners GP, LLC (“Aria Partners”) settled the SEC’s claims that Aria Partners failed to properly disclose to all of the investors in its fund that redemptions could be made with reduced notice. Specifically, while the fund’s offering documents required 90 days’ advance notice for redemptions, Aria Partners informally permitted certain investors to redeem with significantly less notice. While it is common for fund managers to waive or reduce notice requirements for redemptions from open-ended funds, the SEC alleged that Aria Partners had failed to appropriately disclose their flexible redemption policy to all investors. In settling this charge and related compliance violations, Aria Partners was censured and paid a civil money penalty in the amount of $150,000 to the SEC. The SEC Order for this matter can be found here.

Takeaway: If a private fund manager would like the ability to waive or vary the terms set forth in a fund’s governing documents with respect to certain investors, it must clearly disclose this possibility to all investors.

Private Fund Manager Sanctioned for LP Buy-outs. In September 2018, VSS Fund Management LLC (“VSS”) and Jeffrey T. Stevenson, the owner and managing partner of VSS (“Stevenson”), settled the SEC’s claims that VSS and Stevenson violated Section 206(4) of the Advisers Act for failing to provide material information related to a change in the valuation of fund assets in connection with Stevenson’s offer to buy-out investors in the fund.

In April 2015, several limited partners expressed an interest for a liquidity option that would allow them to exit the VS&A Communication Partners III, L.P. (“Fund III”), a private equity fund advised by VSS. The VSS investment committee decided to dissolve Fund III and distribute its assets in-kind to its partners, while simultaneously presenting to the limited partners an option to sell their limited partnership interests to Stevenson for cash based on Fund III’s 2014 year-end Net Asset Value (“NAV”) rather than receive the in-kind assets. In early May 2015, VSS and Stevenson received information that Fund III’s NAV had likely increased substantially during the first quarter of 2015. In mid-May 2015, VSS notified the Fund III limited partners that it no longer planned to liquidate Fund III, but maintained Stevenson’s offer to buy-out limited partners based on the 2014 year-end NAV. However, VSS and Stevenson neglected to disclose to the limited partners information related to the material increase in Fund’s Q1 2015 NAV from the 2014 year-end NAV. In settling these charges, VSS and Stevenson were censured and agreed to pay a civil money penalty in the amount of $200,000 to the SEC. The SEC Order for this matter can be found here.

Takeaway: In any transaction involving a fund manager and an investor, investors must be made aware of all material facts relating to the transaction.

On September 13, 2018, the SEC’s Division of Investment Management (the “Division”) withdrew two no-action letters issued in 2004 to Egan-Jones Proxy Services (“Egan-Jones”) and Institutional Shareholder Services, Inc. (ISS). The withdrawn letters described the circumstances under which an investment adviser may rely on a proxy advisory firm as an independent third party under Advisers Act Rule 206(4)-6 for purposes of making proxy voting recommendations. The Division stated it withdrew these no-action letters to facilitate discussion at the SEC’s November 2018 Roundtable on the Proxy Process.


Advisers Act Rule 206(4)-6 generally requires investment advisers to implement written policies and procedures that are both reasonably designed to ensure client proxies are voted in the client’s best interest and describe the process to be followed in resolving material conflicts that may arise in voting client proxies.

In Egan-Jones, the SEC staff stated that an investment adviser relying on a proxy advisory firm for voting recommendations should have procedures in place to ensure that the proxy advisory firm is independent, and outlined certain additional conditions that should be satisfied by an investment advisers relying on proxy advisory firms. The SEC staff also confirmed that a proxy advisory firm could be considered independent even if the firm received compensation from an issuer for providing advice on corporate governance issues.

In ISS, the SEC staff noted that an investment adviser relying on a proxy advisory firm may fulfill its duty of care to clients through either (1) a case-by-case evaluation of the proxy advisory firm’s relationship with issuers, or (2) a review of the proxy advisory firm’s conflict procedures and the effectiveness of their implementation. The SEC staff also noted that an investment adviser should have a thorough understanding of the proxy advisory firm’s business, the nature of its conflicts, and whether its procedures appropriately address those conflicts.

In 2014, the Division issued Staff Legal Bulletin No. 20 (“SLB 20”), which provided additional guidance to investment advisers retaining proxy advisory firms. SLB 20 both cites Egan-Jones and ISS and affirms the SEC staff guidance provided in those letters.

Observations and Implications

The Division’s withdrawal of the Egan-Jones and ISS letters is puzzling in that the SEC did not also withdraw SLB 20. Because SLB 20—which largely memorializes the SEC staff’s guidance provided in the Egan-Jones and ISS letters—is still in effect, it does not appear that the Division’s withdrawal of these two letters should have any practical impact on investment advisers relying on proxy advisory firms. Indeed, the day after the Division announced the withdrawal of the Egan-Jones and ISS letters, SEC Commissioner Robert J. Jackson Jr. issued a public statement regarding the withdrawal, stating that:

[T]he law governing investor use of proxy advisors is no different today than it was yesterday. The Commission has long recognized that proxy advisors—the companies that develop recommendations regarding how investors should vote on corporate questions—serve an important role in the shareholder-voting process, and today’s statements do nothing to change that.

Additionally, the Division’s stated rationale for withdrawing the Egan-Jones and ISS letters was to facilitate discussion at the SEC’s November 15, 2018 Roundtable on the Proxy Process. While the role of proxy advisory firms and their involvement in the proxy voting process was discussed at this Roundtable, there was little discussion of investment advisers relying on proxy advisory firms, however.

Takeaway: Longer-term, we expect the SEC and its staff to reexamine the role of proxy advisory firms, investment adviser’s reliance on proxy advisory firms, and earlier SEC staff guidance in this area. This may lead to additional SEC guidance or rulemaking, or increased scrutiny by SEC examination staff of investment advisers’ use of proxy voting firms. In light of this, investment advisers relying on proxy advisory firms may want to reexamine their policies and procedures for overseeing these firms and related conflicts.

The table below lists selected upcoming filing deadlines that may be relevant for SEC-registered investment advisers. It does not address all potential regulatory deadlines or compliance obligations. The dates provided are based on a December 31 fiscal-year end, and certain dates will need to be adjusted for firms with different fiscal-year ends. Please contact us to discuss your own filing and compliance obligations.


Action or Filing

December 17, 2018

IARD account funding deadline for amounts necessary to cover annual state notice filing and investment adviser representative fees.

January 15, 2019

Form PF quarterly filing due for large liquidity fund advisers.

February 14, 2019

Form 13F quarterly filing due for certain institutional managers.

Form 13H annual filing due for large traders.

March 1, 2019

Form PF quarterly filing due for large hedge fund advisers.

Form CPO-PQR filing due for large commodity pool operators.

Annual NFA filing due for advisers claiming an exemption from commodity pool operator registration under CFTC Rules 4.5 or 4.13, and advisers claiming an exemption from commodity trading advisor registration under CFTC Rule 4.14.

March 31, 2019

Form ADV annual amendment due for investment advisers.

Form CPO-PQR filing due for small and mid-sized commodity pool operators.

Deadline for commodity pool operators relying on CFTC Rule 4.7 exemption to file pool annual financial reports with the NFA and distribute to pool participants.