Asset Management

SEC Announces 2016 Examination Priorities

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On January 11, the SEC announced its Office of Compliance Inspections and Examinations’ (OCIE) 2016 priorities.  New areas of focus include liquidity controls, public pension advisers, product promotion, and two popular investment products – exchange-traded funds and variable annuities.  The priorities also reflect a continuing focus on protecting investors in ongoing risk areas such as cybersecurity, microcap fraud, fee selection, and reverse churning.

The 2016 examination priorities address issues across a variety of financial institutions, including investment advisers, investment companies, broker-dealers, transfer agents, clearing agencies, and national securities exchanges.  Areas of examination include:

  • Retail Investors –  OCIE will continue several 2015 initiatives to assess risks to retail investors seeking information, advice, products, and services to help them plan for and live in retirement. It also will undertake examinations to review exchange-traded funds (ETFs) and ETF trading practices, variable annuity recommendations and disclosure, and potential conflicts and risks involving advisers to public pension funds.
  • Market-Wide Risks –  OCIE will continue its focus on cybersecurity controls at broker-dealers and investment advisers.  New initiatives for 2016 include an evaluation of broker-dealers’ and investment advisers’ liquidity risk management practices, and firms’ compliance with the SEC’s Regulation SCI, designed to strengthen the technology infrastructure of the U.S. securities markets.
  • Data Analytics – OCIE’s enhanced ability to analyze large amounts of data will assist examiners’ ongoing initiatives to assess anti-money laundering compliance, detect microcap fraud, and review for excessive trading.  Data analytics also will help examinations focused on promotion of new, complex, and high-risk products.

The published priorities for 2016 are not exhaustive and may be adjusted in light of market conditions, industry developments and ongoing risk assessment activities.

SEC Issues Staff Report on Accredited Investor Definition

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On December 18, the Securities and Exchange Commission issued a staff report (the “Report”) on the definition of “accredited investor” set forth in Rule 501(a) of Regulation D under the Securities Act of 1933. The Dodd-Frank Wall Street Reform and Consumer Protection Act directs the Commission to review the accredited investor definition as it relates to natural persons every four years to determine whether the definition should be modified or adjusted. Staff from the Divisions of Corporation Finance and Economic and Risk Analysis prepared the Report in connection with the first review of the definition.

The Report examines the history of the accredited investor definition and considers comments on the definition received from a variety of sources, including public commenters, the SEC’s Investor Advisory Committee and its Advisory Committee on Small and Emerging Companies. The Report considers alternative approaches to defining “accredited investor,” provides staff recommendations for potential updates and modifications to the existing definition and analyzes the impact potential approaches may have on the pool of accredited investors.

The primary recommendations of the Report are:

  • The Commission should revise the financial thresholds, requirements for natural persons to qualify as accredited investors and the list-based approach for entities to qualify as accredited investors.
  • The Commission should revise the accredited investor definition to allow individuals to qualify  as accredited investors based on other measures of sophistication besides their net worth and income.

The Report suggests detailed alternate approaches to implementing these recommendations.

The Commission is inviting members of the public to provide comments on the accredited investor definition, generally, and specifically on the staff recommendations contained in the Report, although a deadline for submitting comments has not been set.

Advisory on Effective Risk Management Practices for Purchased Loans and Purchased Loan Participations

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On November 6, 2015, the Federal Deposit Insurance Corporation issued an Advisory (the “Updated Advisory”) (FIL-49-2-15) to update information contained in the FDIC Advisory on Effective Credit Risk Management Practices for Purchased Loan Participations (FIL-38-2012).  The Updated Advisory addresses purchased loans and loan participations and reminds FDIC-supervised institutions of the importance of underwriting and administering these purchased credits as if the loans were originated by the purchasing institution. The Updated Advisory also reminds institutions that third-party arrangements to facilitate loan and loan participation purchases should be managed by an effective third-party risk management process.  This Financial Institution Letter applies to all FDIC-supervised banks and savings associations, including community institutions.

Of particular relevance to the marketplace lending industry, is that the Updated Advisory is applicable to banks that rely on to perform risk management functions when purchasing: loans and loan participations, including out-of-territory loans; loans to industries or loan types unfamiliar to the bank; leveraged loans; unsecured loans; or loans underwritten using proprietary models.  Letter.

SEC Adopts Rules to Permit Crowdfunding: Proposes Amendments to Existing Rules to Facilitate Intrastate and Regional Securities Offerings

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On October 30, the Securities and Exchange Commission adopted final rules under Title III of the JOBS Act (“Regulation Crowdfunding”) to permit a company to offer and sell securities through crowdfunding transactions that raise a maximum aggregate amount of $ 1 million in a 12-month period.  Title III of the JOBS Act, enacted on April 5, 2012, created a federal exemption from the requirement that securities offerings be registered under the securities laws.  In the words of the Commission:   “Crowdfunding is an evolving method of raising capital that has been used to raise funds through the Internet for a variety of projects.”

Specifically, Regulation Crowdfunding permits individuals to invest in securities-based crowdfunding transactions subject to certain investment limits.  In addition to limiting the amount of money an issuer can raise using the crowdfunding exemption, the rules impose disclosure requirements on issuers for certain information about their business and securities offerings, and create a regulatory framework for the broker-dealers and funding portals that facilitate the crowdfunding transactions.

The Commission also proposed amendments to existing Rule 147 under the Securities Act of 1933 to modernize the rule for intrastate offerings to further facilitate capital formation, including through intrastate crowdfunding provisions.  The proposal also would amend Securities Act Rule 504 to increase the aggregate amount of money that may be offered and sold pursuant to the rule from $1 million to $5 million and apply bad actor disqualifications to Rule 504 offerings to provide additional investor protection.

Regulation Crowdfunding and its related forms will be effective 180 days after they are published in the Federal Register. The forms enabling funding portals to register with the Commission will be effective Jan. 29, 2016.

The SEC is seeking public comment on the proposed rule amendments for a 60-day period following their publication in the Federal Register.

A copy of Regulation Crowdfunding and Adopting Release (33-9974) can be found here.

No-Action Letter Guidance Under Rule 506(b) of Regulation D.

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On August 6, the Staff of the Division of Corporation Finance of the Securities and Exchange Commission issued a no-action letter to Citizen VC, Inc. (“Citizen VC”), the manager of a venture capital investment platform through which it aggregates investments of prospective investors in special purpose vehicles (“SPVs”) that invest in seed, early-stage, emerging growth and late-stage private companies.  The private placement offerings of the SPVs are made in reliance on Rule 506(b) of Regulation D which requires, among other things, that the issuer not “engage in any form of general solicitation or general advertising.”

Citizen VC requested no-action letter confirmation that the policies and procedures described in its letter “will create a substantive, pre-existing relationship between Citizen VC and prospective investors such that the offering and sale on the [website] of Interests in the SPVs . . . will not constitute general solicitation or general advertising within the meaning of Rule 506(c) of Regulation D.”

The request letter also stated the understanding that “issuers and/or their agents relying on Rule 506(b) will have to take additional steps beyond the circulation of a brief accreditation questionnaire in order to create a substantive relationship with their prospective investors.”

The Staff agreed that the “quality of the relationship between an issuer (or its agent) and an investor is the most important factor in determining whether a ‘substantive’ relationship exists.”  The Staff also stated that it agrees that “there is no specific duration of time or particular short form accreditation questionnaire that can be relied upon solely to create such a relationship.”

This Citizen VC no-action letter emphasizes the need for issuers relying on Rule 506(b) to perform a substantive evaluation of the status of prospective investors as “accredited investors” and their financial sophistication.  Guidance.

 

Personal Securities Transactions Reports By Registered Investment Advisers: Securities Held In Accounts Over Which Reporting Persons Had No Influence Or Control

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In a recent Guidance Update, the Staff of the Division of Investment Management of the Securities and Exchange Commission addressed certain issues arising under Section 204A of the Investment Advisers Act of 1940 which requires registered investment advisers to maintain and enforce written policies and procedures reasonably designed to prevent the firm or its employees from misusing material nonpublic information.

In particular, Rule 204A-1 thereunder provides that an adviser’s Code of Ethics must include requirements that certain advisory personnel report personal securities trading to provide a mechanism for the adviser and examiners to identify improper trades or patterns of trading.  The Rule was designed, in part, to prevent the misuse of material nonpublic information, including the misuse of material nonpublic information about a registered adviser’s securities recommendations, and client securities holdings and transactions.

Among the issues addressed in the Guidance Update is whether certain arrangements satisfactorily establish that an access person’s securities are held in an account over which he or she had “no direct or indirect influence or control” and, accordingly, under the Rule are not required to be reported.  The Guidance provides that if an access person provides a trustee with management authority over a trust for which he or she is grantor or beneficiary, or provides a third-party manager discretionary investment authority over his or her personal account, that, by itself, is insufficient for an adviser to reasonably believe that the access person had no direct or indirect influence or control over the trust or account.  The Guidance then addresses certain arrangements that the adviser may be able to implement that could establish a reasonable belief that an access person had no direct or indirect influence or control over the trust or account and could, accordingly, rely upon the exception.

Responses to Frequently Asked Questions Regarding the Commission’s Rule under Section 13 of the Bank Holding Company Act (the “Volcker Rule”)

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The Staff of the SEC Division of Trading and Markets, Investment Management, and Corporate Finance provided updated guidance on June 12, 2015 in response to frequently asked questions (“FAQs”) regarding the SEC’s final rule implementing section 13 of the Bank Holding Company Act of 1956, commonly referred to as the “Volcker Rule.”  The responses to these FAQ’s address a broad range of issues arising under the restrictions imposed by the Volcker Rule on banking entities proprietary trading activities and the ownership, sponsorship and management of “covered funds.”  FAQ Responses.

CFTC Staff Issues No-Action Relief from Introducing Broker and Commodity Trading Advisor Registration to Persons Located Outside the United States Engaged in Activities on behalf of Customers that are International Financial Institutions

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On June 4, the Commodity Futures Trading Commission’s (“CFTC”) Division of Swap Dealer and Intermediary Oversight (“DSIO”) issued a No-Action Letter stating that it will not recommend that the CFTC take action for failure to register as an introducing broker or commodity trading advisor against persons located outside the United States that facilitate swap transactions for International Financial Institutions (“IFIs”) that have offices in the United States.

The DSIO took the position that the relief is appropriate in light of the unique attributes and status of IFIs, and in consideration of international comity. In addition, the relief granted is consistent with the CFTC’s prior treatment of IFIs for purposes of foreign futures and options transactions, the swap dealer definition, and mandatory clearing.

DSIO has defined IFIs, for purposes of the no-action letter, in accordance with prior CFTC policy to be the following institutions and organizations: International Monetary Fund, International Bank for Reconstruction and Development, European Bank for Reconstruction and Development, International Development Association, International Finance Corp., Multilateral Investment Guarantee Agency, African Development Bank, African Development Fund, Asian Development Bank, Inter-American Development Bank, Bank for Economic Cooperation and Development in the Middle East and North Africa, Inter-American Investment Corp., Council of Europe Development Bank, Nordic Investment Bank, Caribbean Development Bank, European Investment Bank and European Investment Fund (International Bank for Reconstruction and Development, International Finance Corp. and Multilateral Investment Guarantee Agency are parts of the World Bank Group).

 

SEC Approves Pilot to Assess Tick Size Impact for Smaller Companies

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On May 6, 2015, the Securities and Exchange Commission approved a proposal by the national securities exchanges and the Financial Industry Regulatory Authority (FINRA) for a two-year pilot program that would widen the minimum quoting and trading increments–or tick sizes–for stocks of some smaller companies.  The SEC plans to use the pilot program to assess whether wider tick sizes enhance the market quality of these stocks for the benefit of issuers and investors.

The tick size pilot will begin by May 6, 2016.  It will include stocks of companies with $3 billion or less in market capitalization, an average daily trading volume of one million shares or less, and a volume weighted average price of at least $2.00 for every trading day.

The pilot will consist of a control group of approximately 1,400 securities and three test groups with 400 securities in each selected by a stratified sampling.  During the pilot:

  • Pilot securities in the control group will be quoted at the current tick size increment of $0.01 per share and will trade at the currently permitted increments.
  • Pilot securities in the first test group will be quoted in $0.05 minimum increments but will continue to trade at any price increment that is currently permitted.
  • Pilot securities in the second test group will be quoted in $0.05 minimum increments and will trade at $0.05 minimum increments subject to a midpoint exception, a retail investor exception, and a negotiated trade exception.
  • Pilot securities in the third test group will be subject to the same terms as the second test group and also will be subject to the “trade-at” requirement to prevent price matching by a person not displaying at a price of a trading center’s best “protected” bid or offer, unless an enumerated exception applies. In addition to the exceptions provided under the second test group, an exception for block size orders and exceptions that mirror those under Rule 611 of Regulation NMS will apply.

A variety of data generated during the tick size pilot will be released publicly on an aggregated basis to assist in analyzing the impact of wider tick sizes on smaller capitalization stocks.  The exchanges and FINRA will submit their initial assessments on the tick size pilot’s impact 18 months after the pilot begins.  Order.

SEC Staff Issues Update Guidance Regarding Cybersecurity

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Recently, the Staff of the Division of Investment Management of the Securities and Exchange Commission (the “Staff”) issued updated Guidance that highlights the importance of cybersecurity of registered investment funds and registered investment advisers.  The Guidance discusses a number of measures that funds and advisers may wish to consider when addressing cybersecurity risks.  In particular, the Staff identified a number of measures that funds and advisers may with to consider in addressing cybersecurity risk.  It further advised that funds and advisers should identify their respective compliance obligations when assessing their ability to prevent, detect and respond to cyber attacks.  Fund managers and advisers should anticipate that cybersecurity will be a focal point of the Staff’s examination program.  Guidance Update.