Table of Contents:
Securities and Exchange Commission Division of Examinations Announces 2024 Priorities
Treasury Revisits Past Rulemaking to Bring Investment Advisers Under AML Oversight
Table of Contents:
Securities and Exchange Commission Division of Examinations Announces 2024 Priorities
Treasury Revisits Past Rulemaking to Bring Investment Advisers Under AML Oversight
SECURITIES AND EXCHANGE COMMISSION DIVISION OF EXAMINATIONS ANNOUNCES 2024 PRIORITIES
On October 16, 2023, the Securities and Exchange Commission’s (the “SEC” or the “Commission”) Division of Examinations (the “Division”) released its 2024 examination priorities (the “Priorities”). As noted in the Priorities, the Division will prioritize areas that “pose emerging risks to investors or the markets, as well as examinations of core and perennial risk areas.” This analysis focuses on the Division’s examination priorities with respect to investment advisers, registered investment companies, and broker-dealers, but the Priorities also include discussions of the Division’s priorities with respect to self-regulatory organizations, clearing agencies, and certain other market participants.
Examinations of Investment Advisers
Noting the Division’s priority to examine for advisers’ adherence to their duties of care and loyalty, the Division indicated that it would continue to focus on:
Additionally, the Priorities discuss the examination focus on adviser compliance policies and procedures, noting that such examinations will include:
Examinations of Investment Advisers to Private Funds
As noted in the Priorities, the Division will continue to focus on private fund advisers and prioritize specific topics, including:
Registered Investment Companies
Citing their importance to retail investors and retail investors saving for retirement, the Priorities note that the Division continues to prioritize examinations of registered investment companies, including mutual funds and ETFs. The Priorities include that examinations of investment companies may include the following examination focus areas:
Broker Dealers
With respect to broker-dealers and Regulation Best Interest, the Priorities include that in reviewing whether broker-dealer recommendations are in customers’ best interest, the following will be areas of particular importance (i) recommendations with regard to products, investment strategies, and account types; (ii) disclosures made to investors regarding conflicts of interest; (iii) conflict mitigation practices; (iv) processes for reviewing reasonably available alternatives; and (v) factors considered in light of the investor’s investment profile, including investment goals and account characteristics.
The Priorities also include that the Division’s examinations will review the content of the broker-dealers’ relationship summary on Form CRS, compliance with the Net Capital Rule and Customer Protections Rule and related internal processes, procedures and controls, and broker-dealer trading practices.
SEC ADOPTS RULE TO INCREASE TRANSPARENCY INTO SHORT SELLING AND AMENDMENT TO CAT NMS PLAN FOR PURPOSES OF SHORT SALE DATA COLLECTION
On October 13, the Commission adopted new Rule 13f-2 and related Form SHO under the Securities Exchange Act of 1934 (the “Exchange Act”) to require certain institutional investment managers (“Managers”) to report, on a monthly basis on Form SHO, certain short position data and short activity data for certain equity securities required by Rule 13f-2. Additionally, the Commission adopted an amendment to the national market system plan (“NMS Plan”) governing the consolidated audit trail (“CAT”) to require the reporting of reliance on the bona fide market making exception in the Commission’s short sale rules.
Rule 13f-2 will require a Manager to file a Form SHO report via the Commission’s EDGAR system within fourteen (14) calendar days after the end of each calendar month with regard to:
For each reported equity security, a Manager will be required to report on Form SHO certain information, including:
The Commission will then publish, through EDGAR, and on a slightly delayed basis (expected to be within one (1) month after the end of the reporting calendar month), certain aggregated short sale related information regarding each equity security reported by Managers on Form SHO, including, for example:
The amendment to the CAT NMS Plan will require CAT reporting firms to report to the CAT, for the original receipt or origination of an order to sell an equity security, whether the order is a short sale effected by a market maker in connection with bona fide market making activities in the equity security for which the bona fide market making exception in Rule 203(b)(2)(iii) of Regulation SHO is claimed.
Rule 13f-2, Form SHO, and the amendment to the CAT NMS Plan became effective January 2, 2024. The compliance date for Rule 13f-2 and Form SHO is twelve (12) months after the effective date, with public aggregated reporting to follow three (3) months later. The compliance date for the amendment to the CAT NMS Plan is July 1, 2025.
TREASURY REVISITS PAST RULEMAKING TO BRING INVESTMENT ADVISERS UNDER AML OVERSIGHT
On December 11, the U.S. Department of the Treasury (“Treasury”) announced in a Fact Sheet its renewed focus on the perceived money laundering risks associated with investment advisers.
The Fact Sheet covered a broad range of topics, focusing on the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) increased efforts to address the illicit finance and national security threats posed by corruption across various industries and sectors, including asset management. Per the Fact Sheet, investment advisers are not subject to consistent or comprehensive anti-money laundering (“AML”) and countering the financing of terrorism (“CFT”) obligations in the United States. Accordingly, the Treasury is re-examining and updating its September 1, 2015, Notice of Proposed Rule Making (the “2015 Proposal”). Generally, private funds are subject to the AML requirements of the USA PATRIOT Act and similar regulations in other jurisdictions.
The 2015 Proposal proposed to include investment advisers in the definition of “financial institution” in the regulations implementing the Bank Secrecy Act (the “BSA”), which, among other things, would require advisers to comply with suspicious activity reporting requirements, including filing Currency Transaction Reports (“CTRs”) and keeping records relating to the transmittal of funds. The 2015 Proposed Rule stalled following a 2017 moratorium on in-process rules.
Since that time, in January 2021, Congress enacted the Anti-Money Laundering Act of 2020 (the “AMLA”), which made sweeping reforms to the Bank Secrecy Act. Part of the AMLA is the Corporate Transparency Act (the “CTA”). Additionally, in September 2022, under the CTA, FinCEN issued a beneficial ownership reporting rule (the “BOI Rule”), which establishes a beneficial ownership information reporting requirement for certain “reporting companies.” The BOI, which became effective January 1, 2024, is intended to help prevent and combat money laundering, terrorist financing, tax fraud, and other illicit activity. Although there are exemptions to the definition of a “reporting company” under the BOI Rule, the BOI Rule is expected to impact private funds and their advisers and sponsors significantly.
In light of Tresuary’s renewed focus, investment advisers may want to pay particular attention to their compliance programs and consider implementing or enhancing existing procedures to attempt to ensure they are prepared for enacted and potential AML laws and regulations.
SECURITIES LENDING TRANSPARENCY RULES
On October 13, 2023, the Commission voted to adopt new Rule 10c-1a under the Exchange Act, which is intended to increase the transparency and efficiency of the securities lending market. Generally speaking, Rule 10c-1a will require “covered persons” who agree to a “covered securities loan” to provide specified Rule 10c-1a information comprised of certain “data elements” to a registered national securities association (“RNSA”) by the end of the day on which the loan is effected or modified. Rule 10c-1a will also require a RNSA to make publicly available most of the Rule 10c-1a information it receives, by the morning of the next business day, except for the loan amount, which must be made public after 20 business days. The RNSA must keep the “confidential data elements” it receives confidential, in accordance with applicable law and the rule’s requirements regarding data retention and availability. Currently, the Financial Industry Regulatory Authority (“FINRA”) is the only RNSA. Rule 10c-1a became effective on January 2, 2024. Covered persons will have to start reporting information to FINRA by the compliance date, January 2, 2026, which is 24 months after the effective date. However, FINRA will not publicly report information regarding Rule 10c-1a until 90 calendar days after the compliance date.
Covered Persons
Rule 10c-1a requires “covered persons” to report to FINRA by the end of the day. Rule 10c-1a defines the term “covered person” to mean (i) any person that agrees to a covered securities loan on behalf of a lender (an “intermediary”) other than a clearing agency when providing only the functions of a central counterparty or central securities depository; (ii) any person that agrees to a covered securities loan as a lender when an intermediary is not used, unless the borrower is a broker or dealer borrowing fully paid or excess margin securities; or (iii) a broker or dealer when borrowing fully paid or excess margin securities. Rule 10c-1a does not provide any sort of de minimis exemption from the definition of covered person.
Covered Securities Loans
Rule 10c-1a requires the reporting of all “covered securities loans” agreed to by any covered person. A covered securities loan is defined as “a transaction in which any person on behalf of itself or one or more other persons, lends a reportable security to another person.” In turn, a “reportable security” is defined in Rule 10c-1a(j)(3) as any security or class of an issuer’s securities for which information is reported or required to be reported to the consolidated audit trail (“CAT”) as required by Rule 613 and the CAT National Market System Plan, FINRA’s Trade Reporting and Compliance Engine (“TRACE”), the Municipal Securities Rulemaking Board Real-Time Transaction Reporting System, or any reporting system that replaces one of these systems.
Rule 10c-1a Data Elements
Rule 10c-1a prescribes three types of data elements that must be reported. The first set of data elements are public facing and concerns the material terms of the covered securities loan, requiring covered persons to provide in their initial report information regarding the:
The second set of data elements concerns information related to modifications of a covered securities loan if the modification impacts any previously reported “data element” submitted to FINRA. In this instance, covered persons are required to provide:
The third set of data elements concerns confidential information about the loan not intended to ever become publicly available (though FINRA may share such data with the SEC and such “other persons as the Commission may designate by order upon a demonstrated regulatory need”), and requires covered persons to include in their report:
Timing of Reporting
Covered persons must report the required data elements by the end of the day on which the covered securities loan is effected or modified; the reporting obligation does not depend on when the securities loan is actually settled. Importantly, Rule 10c-1a uses the term “day” rather than “business day” when discussing the reporting requirements applicable to covered persons and reporting agents under sections (c) and (d) of the rule, which indicates that loans entered into on non-business days may still be subject to end of day reporting.
FINRA Publication of Data
The final rule requires FINRA to make publicly available the data elements (except for the loan amount), the unique identifier assigned to the loan by FINRA, and the LEI, ISIN, CUSIP, FIGI, or other security identifier(s) that FINRA determines is appropriate to identify the relevant reportable security, as well as information pertaining to the aggregate transaction activity and distribution of loan rates for each reportable security and those security identifier(s), not later than the morning of the business day after the covered securities loan is effected. On the 20th business day after the covered securities loan is effected, FINRA will publicize the loan amount. Likewise, the modification of any data element will be made public by FINRA on the day after the modification and any modification to the loan amount will be disclosed on the 20th business day after the covered securities loan is modified.
SEC RELEASES FORM ADV FAQS
On October 26, the SEC’s Division of Investment Management staff updated the “Frequently Asked Questions on Form ADV and IARD” (the “FAQs”) for investment advisers that submit Form ADV to the SEC pursuant to the Investment Advisers Act of 1940, as amended (the “Advisers Act”), either as “exempt reporting advisers” (“ERAs”) or registrants (“RIAs”). By way of background, Form ADV is the uniform form used by investment advisers to register with both the SEC and state securities authorities. ERAs must also file a Form ADV, although the specific requirements and deadlines may vary. The form consists of three parts. Parts 1 and 2 are used by the SEC and the states. Part 3 is used by the SEC and some states.
The FAQs provide additional guidance from the staff concerning specific questions concerning Form ADV and the Investment Adviser Registration Depository (“IARD”) system, which filers submit Form ADV and amendments thereto. The FAQs include both technical updates to previously existing FAQs as well as new FAQs on a variety of topics.
A summary of some of the more significant new and amended the FAQs are set forth below.
New FAQ on Audits for Newly Created Private Funds
Item 7.B.(1) requires RIAs to complete a separate Section 7.B.(1) of Schedule D for each private fund it advises. Section 7.B.(2) of Schedule D requires RIAs to report information about each private fund, including information about the fund’s service providers, such as its auditor, prime broker, custodian, administrators, and marketers. In a new FAQ on question 23(a) of Schedule D, Section 7.B.(1) related to auditors, the staff stated that an adviser to a newly created private fund should not report that a private fund’s financial statements are subject to an annual audit if an auditing firm has not been engaged to conduct an audit for the applicable fiscal year.
Modified FAQ on Delivery of Private Fund Audits
Question 23(g) of Schedule D, Section 7.B.(1) asks whether the private fund’s audited financial statements for the most recently completed fiscal year were distributed to the private fund’s investors. For RIAs relying on the “audit approach” for their compliance with the Custody Rule (Rule 206(4)-2), audited financial statements must be delivered to investors within 120 days of the pool’s fiscal year-end and within 180 days of the fiscal year end of a fund-of-funds. Due to the timing of the annual update (within 90 days after the end of your fiscal year), some RIAs to private funds may have neither received the audit reports nor distributed them at the time of filing the Form ADV annual update. As a result, these RIAs may not have distributed the audit reports by the Form ADV filing deadline.
In a modified FAQ, the staff clarified that if the applicable deadline for distributing the private fund’s audited financial statement has not yet passed, an adviser may answer “Yes” if it has engaged an auditor, and the audited financial statements will be distributed as required. Otherwise, an adviser should answer “No” if the applicable deadline for distribution has passed and audited financial statements were not delivered to clients for the most recently completed fiscal year.
New FAQ on Material Changes to ADV Part 2A
The instructions to Item 2 of Part 2A require prompt disclosure of any material changes to Part 2 that an RIA may make a part of its annual update for Form ADV. A new FAQ clarifies the staff’s expectations that providing a list of material changes is not a sufficient discussion; instead, an adviser must identify and discuss material changes.
New FAQ on Typos and Mistakes in an Annual Updating Amendment
In a new series of FAQs on Filing an annual Updating Amendment, the staff addressed the mistaken submission of an “other-than-annual amendment” instead of an Annual Updating Amendment and the occurrence of typos in an adviser’s annual amendment filing. The staff noted that it cannot change the date (or any information filed) on Form ADV filing. Accordingly, filing an other-than-annual amendment is not a substitute for filing an annual updating amendment. In both scenarios, an adviser must file another Form ADV annual updating amendment with the correct year. The adviser may wish to consider entering a note in the Miscellaneous section of Schedule D explaining the reason for filing an amended annual updating amendment.
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