Upcoming Regulatory Initiatives Impacting Private Fund Managers - U.S. Regulatory Initiatives

Dechert LLP

SEC Publishes Annual Rule Making Agenda

The SEC published its annual Rule Making Agenda on June 11, 2021 (the Agenda). The Agenda indicates a number of upcoming regulatory reviews and changes that will affect private funds and their managers.

Proposed Rule Stage:

Custody Rule. The SEC has noted it will propose amendments to the Custody Rule (Rule 206(4)-2 under the Investment Advisers Act of 1940 (the Advisers Act)) that will seek to improve and modernize the regulations around the custody of funds or investments of clients by Investment Advisers. While it is not known exactly what will be included, it may address certain issues raised by the SEC in a comment solicitation in March 2019 that sought information on digital assets and non-delivery-versus-payment transactions.

Form PF. The SEC has indicated it may add additional disclosures on the Form PF. These may cover additional risk disclosures such as counterparty risk information.

Short Sale Disclosures. The Division of Trading and Markets has indicated it is considering recommending that the SEC propose rules to implement section 929X(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) in relation to public disclosure of short sales positions.

ESG. The Division of Investment Management has indicated it is considering recommending that the SEC propose requirements for investment companies and investment advisers related to environmental, social and governance (ESG) factors, including ESG claims and related disclosures. What such disclosures might entail and their conflicts or alignments with EU rules will be of significant importance to managers selling funds on a global basis.

Incentive Based Compensation. The Division of Markets and Trading is considering recommending that the SEC and the Board of Governors of the Federal Reserve, and various other agencies (the Agencies), re-propose rules regarding incentive-based compensation practices at certain financial institutions (including investment advisers and broker-dealers) that have US$1 billion or more in total assets as required by the Dodd-Frank Act. The specified section of the Act, 956, seeks to help prevent practices that might encourage inappropriate risks by financial institutions that could lead to a material financial loss or that are providing excessive compensation. The prior proposal in 2011 noted the SEC’s proposed rules would:

  • require reports related to incentive-based compensation that institutions would file annually with the SEC
  • prohibit incentive-based compensation arrangements that encourage inappropriate risk-taking by providing excessive compensation or could lead to material financial loss to the firm
  • provide additional requirements for financial institutions with US$50 billion or more in assets, including deferral of incentive-based compensation of executive officers and approval of compensation for people whose job functions give them the ability to expose the firm to a substantial amount of risk, and
  • require institutions to develop policies and procedures that ensure and monitor compliance with requirements related to incentive-based compensation.

Pre-Rule stage:

Exempt Offerings. The Division of Corporation Finance is considering recommending that the SEC seek public comment on ways to further update the SEC’s rules related to exempt offerings. The particular focus appears to lie with ways to more effectively promote investor protection and might include updating the financial thresholds in the accredited investor definition, ensuring appropriate access to and enhancing the information available regarding Regulation D offerings, and amendments related to the integration framework for registered and exempt offerings.

Further information: as updates in relation to any of the above actions on the Agenda move forward, Dechert will provide further updates.

Substantial Overhaul of the SEC Advertising and Solicitation Rules

The SEC has finalized its amendments to Rule 206(4)-1 – Advertisements by Investment Advisers (Old Advertising Rule) and Rule 206(4)-3 – Cash Payments for Client Solicitations (Old Solicitation Rule) under the Advisers Act, as well as technical amendments to Rule 204-2 (the Recordkeeping Rule) and Form ADV, Part 1A (separately, Updated Advertising Rule and Updated Solicitation Rule, and collectively, New Rules). The New Rules took effect on 4 May 2021 and all advertisements by advisers that are registered or required to be registered with the SEC are required to be in compliance by 4 November 2022.

These changes, while mainly of concern to SEC-registered investment advisers, will also be relevant to managers that are not registered with the SEC, as the Advertising Rules are generally considered largely applicable to all advisers via the “Anti-Fraud” provisions of the Advisers Act.

The Updated Advertising Rule dramatically revises and modernizes the regulatory framework for investment adviser and private fund marketing materials. It replaces the current set of rigid prohibitions (particularly those relating to testimonials and past specific recommendations) with a more flexible, principles-based approach, and codifies and rationalizes the patchwork of guidance provided through SEC enforcement actions and Staff no-action letters (particularly as these apply to performance advertising) over prior years. Among other things, the Updated Advertising Rule:

a) brings the regulatory scheme into the 21st century and adapts it from primarily paper-based premises to a more technology-neutral basis that recognizes the realities of the Internet, social media and mobile applications

b) updates the definition of “advertisement” to include communications by third parties such as placement agents or other promoters

c) permits the use of third-party testimonials and endorsements within the framework of the Updated Solicitation Rule

d) increases flexibility in presenting certain types of information by introducing a general principles-based framework highlighting “fair and balanced” disclosure

e) introduces specific guidance on how certain non-standard performance information must be presented, and

f) relies more expressly on compliance policies and procedures, as well as additional reviews by advisers, than under the Old Advertising Rule.

While the changes in the Updated Solicitation Rule are less fundamental, they also reflect a significant modernization of the Old Solicitation Rule (which is now subsumed in the New Advertising Rule) with a more streamlined structure.

Certain deviations from the proposal issued in 2019 include:

a) the proposals regarding distinguishing between retail and non-retail investors was not adopted

b) the definition of advertisement was not expanded to one-on-one communications

c) internal review and written approval of advertisements by certain adviser personnel is not required prior to dissemination, and

d) the requirements surrounding advertisements that display predecessor performance are less onerous than was proposed.

Further information: as the SEC releases further guidance on the interpretation of the New Rules, Dechert will provide further updates.

Proposed amendment to Rule 13f-1 and Form 13F

In July 2020, the SEC proposed amendments to Rule 13f-1 of the Securities Exchange Act of 1934 and the corresponding Form 13F that would dramatically raise the reporting threshold for institutional investment managers, from US$100 million to US$3.5 billion, to reflect the change in size and structure of the U.S. equities market since 1975, when Rule13f-1 was adopted. Rule 13f-1 and the corresponding Form 13F relate to required reporting by institutional investment managers of positions meeting the reporting thresholds of specified publicly traded equity securities. The proposed amendments would also amend Form 13F to increase the information provided by institutional investment managers by eliminating the omission threshold for individual securities and requiring managers to provide additional identifying information. There are also additional proposed amendments to modernize the structure of data reporting and to take account of confidential treatment requests per recent U.S. Supreme Court jurisprudence.

The comment period for the proposal has closed, and it is notable that the New York Stock Exchange was amongst the overwhelming majority of comment letters that were issued a commentary submission against the proposal on the basis that it would decrease transparency in the markets. Further updates will be made when available. The SEC confirmed to Bloomberg that it remains clear to them that the threshold is outdated and that Form 13F is being utilized in ways that were not anticipated when it was adopted. In light of this, they are focused on examining the issues further. Additional updates, if any, will be provided when available.

SEC Registration of UK Managers

Following the implementation of the European Union’s (EU) General Data Protection Regulation (GDPR), non-U.S. firms have been unable to register with the SEC as investment advisers pursuant to the Advisers Act because of concerns held by the SEC’s Staff regarding the impact of GDPR on the cross-border transfer of data.

Specifically, the Staff’s fears were based on the fact that provisions of GDPR seemed to prevent the Staff from obtaining prompt, direct access to the books and records of EU firms.

A number of industry groups have been involved in lobbying the SEC on behalf of their members to resolve this issue and find ways to address the SEC’s concerns. The industry groups have actively encouraged a direct dialogue between the SEC and UK Information Commissioner’s Office (ICO), which has met with success.

The ICO has provided comfort to the SEC, in the form of a letter to the SEC staff dated 11 September 2020 and made publicly available on 19 January 2021, that UK firms can, according to the ICO’s interpretation of GDPR, share any necessary data with the SEC without breaching the provisions of GDPR.

SEC Acting Chairman Elad Roisman has published a Public Statement on 19 January 2021 confirming this.

The SEC’s position only covers UK firms at this time, but we understand that other jurisdictions have been in discussions with the SEC and are hopeful that relief will be forthcoming.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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