SEC Agrees to Broaden Exemptions to New Issue and Spinning Rules; Comment Now on SEC Advertising and Cash Solicitation Rule Changes; CFTC Simplifies CPO/CTA Registration Exemptions; Actively-Managed ETFs Clear Regulatory Barrier: Regulatory Update for January 2020


For Investment Advisers and Broker-Dealers: SEC and FINRA Actions

SEC Approves Amendments to FINRA New Issue and Anti-Spinning Rules. See also: FINRA Amends Rules Regarding Initial Public Offerings. Effective January 1, 2020, FINRA Rules 5130 and 5131 have been amended to promote capital formation, aid firm compliance efforts and maintain the integrity of the public offering process. FINRA Rule 5130 prohibits securities industry insiders, including broker-dealers, registered representatives, owners of broker-dealers, and portfolio managers (defined under Rule 5130 as “restricted persons”), from buying shares from initial public offerings (IPOs) through any account in which they have a “beneficial interest”. FINRA Rule 5131 prohibits allocating IPOs to accounts in which executive officers or directors of a public company or a “covered non-public company” have a beneficial interest. The rule is meant to stop “spinning”, where broker-dealers allocate new issues to executive officers and directors of current and potential clients in exchange for investment banking business. The amendments:

  • Provide alternative conditions for satisfying the foreign investment company exemption;
  • Exempt employee retirement benefits plans provided they meet specified conditions;
  • Align and clarify the provisions relating to issuer-directed allocations;
  • Amend the definition of “new issue” to exclude special-purpose acquisition companies and foreign offerings made under Regulation S or otherwise made outside of the US, provided that the Regulation S securities are not concurrently registered for sale in the US;
  • Amend the definition of “family investment vehicle” so that key investment professionals employed by a family office will be able to invest together with immediate family members without jeopardizing the vehicle’s exemption from Rule 5130;
  • Exclude sovereign entities that own broker-dealers from the categories of restricted persons under Rule 5130;
  • Exclude certain transfers to immediate family members from Rule 5131’s public announcement requirement relating to lock-up agreements and codify FINRA’s existing guidance regarding the disclosure of a lock-up agreement release or waiver in a publicly-filed registration statement;
  • Exclude unaffiliated charitable organizations from the definition of “covered non-public company” in Rule 5131; and
  • Add an anti-dilution provision to Rule 5131, similar to the provision in Rule 5130.

While significant changes to systems and processes will not likely be necessary as a result of these amendments, firms that invest in new issues should consider whether to update their procedures for determining and monitoring “restricted person” or “exempted entity” status. Contributed by Rochelle A. Truzzi, Senior Compliance Consultant.

For Investment Advisers: SEC Actions

The Clock is Ticking: Comment Period on Proposed Amendments to Advertising Rule Ends February 10, 2020. The comment period for the proposed amendments to the Advertising and Solicitors Rules started on December 10, 2019, and ends on February 10, 2020. The SEC is asking “everyday investors” for their thoughts about investment adviser advertising by providing a questionnaire as Appendix B. The SEC also included an 18-page questionnaire for smaller advisers to provide their feedback.

The proposal includes some positive changes, including scrapping the four specific prohibitions on advertisements in favor of a principles-based approach. The proposal allows advisers to use testimonials, endorsements, and third-party ratings, hypothetical performance, and extracted and related performance in marketing materials, provided that certain disclosures are included. The SEC also finally acknowledges that there is a difference between retail and non-retail investors, giving more latitude for ads aimed at more sophisticated audiences.

There are some negative implications, however, such as the expansion of the definition of advertisement to include “any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes the investment adviser’s investment advisory services or that seeks to obtain or retain one or more investment advisory clients or investors in any pooled investment vehicle advised by the investment adviser” (emphasis added). Advisers will carry a more significant record-keeping burden since the current rule only requires keeping records of ads sent to 10 or more persons. The amended rule also requires keeping recordings of live broadcasts and communications to single recipients, even though these communications are exempt from the new review and approval requirements.

The proposal also defines “non-retail” persons to include only persons who are one or both of “qualified purchasers” (as defined in Section 2(a)(51) of the Investment Company Act of 1940) or “knowledgeable employees” (as defined in Rule 3c-5 under the Investment Company Act). This definition conflicts with the definition of “retail” in Form CRS, which refers to “a natural person or legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes”. “Qualified client”, as defined in Section 205-3 of the Advisers Act, would make more sense since advisers are already counting these types of clients for Form ADV Item 5.D. Unfortunately for advisers, the proposal as currently written adds yet another nuanced iteration for defining sophisticated investors to complicate their advertising policies and procedures. Contributed by Jaqueline M. Hummel, Partner and Managing Director.

CFTC Approves CPO & CTA Exemptions from Registration for Qualifying Family Offices and BDCs, Simplifies Reporting Obligations. The CFTC approved final amendments to the CPO and CTA registration exemptions and exclusions in Part 4 of its regulations (here and here) on November 25, 2019. The amendments are effective on January 9, 2020, and have various compliance dates. Highlights include:

  1. Forms CPO-PQR and CTA-PR have been required by all “Reporting Persons,” even if they were only operating exempt or excluded pools. Over time, the CFTC offered no-action relief from these filing requirements to CPOs and CTAs only operating such exempt or excluded pools through two no-action letters (see CFTC No-Action Letters 14-115 and 15-47). The amendments codify this no-action relief in the regulations and will replace the no-action letters.
  2. For registered investment companies, CFTC Rule 4.5 now clarifies that the entity required to claim an applicable exemption under Rule 4.5 is “the entity most commonly understood to solicit for or ‘‘operate’’ the RIC, i.e., the RIC’s investment adviser”. Advisers to investment companies where another party has previously filed to claim the exemption will have until March 1, 2021 to make the appropriate new filing.
  3. Family offices relying on the “family office exemption” from investment adviser registration requirements under the Adviser’s Act will now find similar CFTC rulemaking for a family office exemption from CPO/CTA registration. These amendments formalize the exemptive relief from CPO/CTA registration that was previously available to qualifying family offices under two no-action letters (see CFTC No Action Letters No 12-37 and 14-143).
  4. Finally, the amendments to CFTC Rule 4.5 codify an exclusion from CFTC registration that has been available to advisers of Business Development Companies (“BDCs”) through CFTC No Action Letter No 12-40 amendments do not contain new requirements, so BDCs that comply with the no action relief now will also comply with the new rules. However, BDC advisers must file with the NFA to rely on the exclusion “as soon as practicable after these amendments go into effect” on January 9, 2020. Going forward, advisers to BDCs will be required to submit a filing to confirm their continued reliance on this exclusion within 60 days after each calendar year end.

The CFTC’s rationale for these amendments is “to simplify the regulatory landscape for CPOs and CTAs without reducing the protections or benefits provided by those regulations, to increase public awareness about available relief by incorporating commonly relied upon no-action or exemptive relief in Commission Regulations, and to generally reduce the regulatory burden without sacrificing the Commission’s customer protection and other regulatory interests”.

Affected advisers should review their current CFTC exemptions, update their filings as needed according to the new rules and incorporate any new, ongoing filings into their annual compliance calendar going forward. Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

For Mutual Fund Managers: SEC Actions

Regulatory Baby Steps: SEC Approves Four New Semi-Transparent Active ETFs. In a regulatory trend underscored earlier this year with the SEC’s approval of a semi-transparent active ETF by Precidian Investments, the SEC recently approved four new types of actively-managed ETFs. These approvals signal that the regulatory door is opening further to managers previously reticent to launch an ETF due to the daily holdings’ transparency required. The following articles provide details about each of the four newly-approved approaches and how each ETF will satisfy the holdings disclosure requirements, such as disclosing a representative portfolio or basket that is either based on current holdings with some of the portfolio weights disguised or based on current holdings reported with a specified lag time:

  1.’s “Coming Soon: New Twist to ETFs
  2. Thompson Hine LLP’s “The ETF Evolution Continues: SEC Approves Four New ‘Proxy Basket’ Active Semi Transparent ETFs”.

As Thompson Hine notes, although the regulatory landscape seems to be warming up to these approaches to semi-transparent active ETFs, they are not yet market-ready. “None of the exchanges that would list these products have received the necessary relief under Rule 19b-4 under the Securities Exchange Act of 1934 to list them. Once the SEC’s Division of Trading and Markets issues the orders, it will take a reasonable period of time to implement the plumbing (e.g., NSCC protocol for creating portfolio composition files of the various types of active semi-transparent ETFs) that supports the ETF product. Advisory firms electing to use one of the approved models discussed above will have to enter a licensing agreement with the product’s sponsor. In addition to the four new approved platforms and the ActiveShares platform, other semi-transparent ETF exemptive applications will be filed.” Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

SEC Publishes Small Entity Compliance Guide on New ETF Rule. The SEC recently published guidance to assist small entities in their compliance with Rule 6c-11, also known as the new “ETF Rule”. The crux of the new ETF Rule is that certain exchange-traded funds (“ETFs”) will no longer need to apply for and obtain an exemptive order provided certain conditions are satisfied. The guidance addresses topics that include: which ETFs are impacted by the ETF Rule, the exemptive relief provided by the ETF rule and the corresponding conditions, and what disclosure and recordkeeping requirements will apply. The guidance also addresses related amendments adopted by the SEC regarding Forms N-1A, N-8B-2, and N-CEN. Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

For Hedge Fund Managers: NFA Actions

Advisers Relying on Exemptions from CPO or CTA Registration Should Mark their Calendars for February 29. The CFTC requires any person claiming an exemption from CPO registration under CFTC Regulation 4.13(a)(1), 4.13(a)(2), 4.13(a)(3), 4.13(a)(5), an exclusion from CPO registration under CFTC Regulation 4.5, or an exemption from CTA registration under 4.14(a)(8) (collectively, exemption) to annually affirm the applicable notice of exemption within 60 days of the calendar year end, which is February 29, 2020. Failure to affirm an active exemption from CPO or CTA registration will result in the exemption being withdrawn on March 1, 2020. For registered CPOs or CTAs, withdrawal of the exemption will result in the entity being subject to Part 4 Requirements regardless of whether the entity otherwise remains eligible for the exemption. For non-registrants, the withdrawal of the exemption may subject the person or entity to enforcement action by the CFTC. Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

Photo Credits: Photo by J A N U P R A S A D on Unsplash

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