Regulatory Developments
SEC Issues Order Approving Inflation Adjustments to “Qualified Client” Dollar Thresholds for Investment Adviser Performance Fee Rule
On June 14, the SEC issued an order approving inflation-related adjustments to the two dollar amount tests in Rule 205-3 under the Investment Advisers Act of 1940, as amended (the Advisers Act) and as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Rule 205-3 of the Advisers Act permits SEC-registered investment advisers to charge performance-based compensation to “qualified clients.” Under the current rule, an investment adviser can charge performance fees if the client has $1.0 million under management with the investment adviser immediately after entering into the advisory contract (assets-under-management test) or if the investment adviser reasonably believes, immediately prior to entering into the contract, that the client had a net worth of more than $2.0 million (net worth test). Effective as of August 15, 2016, the dollar amount of the “qualified client” net worth test will increase from $2.0 million to $2.1 million and the dollar amount for the assets-under-management test will remain the same at $1.0 million.
SEC Approves Investors’ Exchange LLC as a National Securities Exchange with Built-in “Speed Bump”
On June 17, the SEC announced its approval of the application by Investors’ Exchange, LLC (IEX) to register as a national securities exchange pursuant to the Securities Exchange Act of 1934, subject to satisfaction of certain conditions outlined in the SEC’s order. In addition, the SEC issued updated revised interpretation of the Order Protection Rule under Regulation NMS that now permits an automated quotation to be considered “immediate” if it is subject to no more than a de minimis delay, and requires trading centers to honor automated securities prices subject to de minimis time delays when being accessed. The SEC staff also issued guidance concerning the duration of such de minimis intentional access delays stating that delays of less than one millisecond are at a de minimis level and thus in compliance with Regulation NMS.
SEC Chair Testifies Before U.S. Senate Committee on Banking, Housing, and Urban Affairs
On June 14, SEC Chair Mary Jo White testified before the U.S. Senate Committee on Banking, Housing, and Urban Affairs during a full committee hearing entitled “Oversight of the U.S. Securities and Exchange Commission.” Her testimony focused on SEC staff accomplishments, the status of current rulemaking and future goals relating to: (1) SEC governance and oversight, (2) money market fund reforms and the asset management regulatory regime, (3) broker-dealer financial responsibility, (4) the status of the Volcker Rule, (5) enhanced risk monitoring and regulatory safeguard for the asset management industry, (6) a uniform fiduciary standard of conduct, (7) cybersecurity and (8) strengthening compliance with risk-based examinations. A full transcript can be found here.
House Committee Approves IAA-Supported Investment Advisers Modernization
On June 16, the House Financial Services Committee approved the Investment Advisers Modernization Act of 2016 (H.R. 5424). The bill, adopted by a 47-12 bipartisan vote, amends the Investment Advisers Act of 1940 by relieving advisers of certain duties. While some changes are applicable to all advisers, others are more narrowly focused to certain types of advisers. A relaxation of the custody rule, amendments to the proxy voting rule, amendments to the definition of assignment and “pre-consent” by qualified clients to future assignments would apply to all advisers. For advisers with sophisticated or high net worth clients, the rules on advertising would be relaxed to permit usage of testimonials and past specific recommendations in advertisements that are restricted to qualified clients, knowledgeable employees, qualified purchasers and accredited investors. For all private fund advisers, the custody rules and the requirement to deliver Form ADV Part 2A or 2B to certain clients would be relaxed further and the SEC would be prohibited from extending the sales literature rules of the Securities Act (Rule 156) to private fund offerings (private fund advisers would continue to be subject to anti-fraud provisions of the Advisers Act and the funds would remain subject to Securities and Exchange Act anti-fraud provisions). For private equity fund advisers, the requirement that they report detailed information relating to each fund’s portfolio companies on their Form PF would be eliminated. The Investment Adviser Association strongly supports the bill, and claims that it “will relieve advisers of unnecessary burdens without affecting the paramount investor protections provided by the Investment Advisers Act.”
FSOC Identifies Marketplace Lending and Adoption of the Blockchain as Emerging Threats to Financial Stability
In its 2016 Annual Report, the Financial Stability Oversight Council (FSOC) identified financial innovation in general, and the growth of marketplace lending and the adoption of blockchain technology by financial firms in particular, as emerging threats to financial stability. According to the Annual Report, while new financial products, delivery mechanisms, and business practices, such as marketplace lending and distributed ledger systems, offer opportunities to lower transaction costs and improve the efficiency of financial intermediation, innovations may also embed risks, such as credit risk associated with the use of new and untested underwriting models. In other instances, risks embedded in new products and practices may be difficult to foresee. The FSOC concluded that “Precisely because innovations are new and potentially disruptive, they merit special attention from financial regulators who must be vigilant to ensure that new products and practices do not blunt the effectiveness of existing regulations or pose unanticipated risks to markets or institutions.”
Client Alert: SEC Non-GAAP Guidance: Impact on Earnings Releases, SEC Reports and Other Disclosures
The compliance and disclosure interpretations, or C&DIs, published by the staff of the SEC’s Division of Corporation Finance in May 2016 will require many companies to make changes in how they present non-GAAP financial measures in their upcoming SEC reports, earnings releases and other public disclosure materials. For more information, please see the client alert prepared by Goodwin’s Public Company Practice.
Enforcement Litigation
SEC No-Action Letter to Investment Management Company: Auditor Independence
On June 20, the SEC’s Division of Investment Management (IM Division) issued a No-Action Letter to Fidelity Management & Research Company regarding violations of auditor independence requirements under Rule 2-01(c)(1)(ii)(A) of Regulation S-X (the Loan Rule). Under the Loan Rule, an accounting firm is not considered independent if it has a lending relationship with any entities having a record or beneficial ownership of more than 10% of any entity within the investment company complex of an audit client, regardless of whether those entities in the investment company complex are audited by the accounting firm. The IM Division stated that the staff would not recommend enforcement action against Fidelity for continuing to use an audit firm that was not in compliance with the Loan Rule so long as the following conditions were met: 1) the audit firm has complied with PCAOB Rule 3526(b)(1) and (2) or, with respect to an entity to which Rule 3526 does not apply, has provided substantially equivalent communications; (2) the non-compliance of the audit firm is with respect to the Lending Relationships; and (3) notwithstanding any non-compliance, the audit firm has concluded that it is objective and impartial with respect to the issues encompassed within its engagement and there has not been a contrary determination by a party responsible for overseeing the engagement of the audit firm. In addition, the IM Division clarified that, in the staff's view, the Loan Rule also encompasses an institution that controls the record or beneficial owner of more than 10% of the shares of an entity in the investment company complex, but does not encompass an institution controlled by or under common control with the record or beneficial owner of such shares. The IM Division’s assurances are temporary and expire 18 months from issuance of the No-Action Letter.
