Should the rule making process continue for regulations that are not related to COVID-19? At least 21 state attorneys general say “no.”
In a letter to the Acting Director of the federal Office of Management and Budget, the attorneys general want the federal bureaucracy to prioritize regulations that are responsive to the pandemic while generally freezing all new and pending regulations.
Against that backdrop, the letter urges the federal government to halt most non-COVID-related rulemaking processes. It also asks the Administration to consider reopening certain already-closed rule comment periods.
I think the request is likely to fall on deaf ears. The 21 states behind the request are more blue than red.
The halt to new rule-making is not unprecedented. The letter points out that President Trump put an nearly identical freeze in place when he took office.
The SEC’s Office of Compliance Inspections and Examinations issued a statement on operations and exams during the pandemic. OCIE is still operational and can still run exams. They will be off-site through correspondence, unless necessary to be on site. I assume this means that OCIE is focusing on firms suspected of fraud and is limiting routine exams.
I’ve also heard that OCIE is asking firms about their pandemic response as part of their business continuity plans. For many firms this pandemic is a test of their BCPs.
Some of the SEC questions:
Does the firm have: (i) a written Business Continuity Plan; (ii) a Pandemic Continuity of Operations Plan; and/or (iii) equivalent informal plans or guidance (collectively, “BCP”)?
If so: Briefly describe some of the aspects of the BCP that are particularly applicable to maintaining continuity of business operations when dealing with the COVID-19 pandemic (e.g., personnel working remotely).
Are there any business operations that cannot be performed remotely?
Is the firm prepared to have all of its personnel operate remotely for several weeks (e.g., 3+) or months, if required or appropriate? Are any personnel unable to operate remotely or unable to do so for several weeks or months?
Has the COVID-19 pandemic created hardships for the firm (e.g., financial, human resources, or otherwise)?
We are in extraordinary times. To me it feels like a combination of the days after 9-11 and the 2008 Lehman collapse. We are sheltered in place, fearful for our lives and the economy is grinding to a halt.
Our government came up short in its response to pandemic. (I try to keep this blog out of the political debate. This is not one of those times.) The administration was ill-equipped to handle the pandemic, ignored the problem, failed to take early action, and has consistently gotten the facts wrong. It’s initial response was tax cuts, which did not address the pandemic and was a poor tool to help those in economic distress. Things will stabilize, eventually.
The next problem will be be figuring out when to end things. We will need to release people from their isolation and tell everyone it’s okay to start meeting again. I fear that we will lack the leadership and trust in government to hit the restart button. Who will honestly tell us that it’s okay to go out?
That leaves us where we are now. Trying to keep our businesses running in this time of crisis. Holding thing together. Waiting for normal to return.
For registered investment advisers, the Securities and Exchange Commission has offered some relief. You can have some extra time to file your Form ADV. It requires notifying the SEC and posting information on your website. Similar extensions are available for filing Form PF. I hope things are better a month from now and firms won’t need that extension.
In September 2019, the U.S. Department of the Treasury issued proposed regulations to implement the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). Part of those proposed real estate transactions passing ownership to a foreign person near critical locations. The final regulations came out and are largely unchanged.
The regulations extend CFIUS jurisdiction to cover the purchase or lease by, or a concession to, a foreign person of real estate in and/or around specific airports, maritime ports and military installations. The restricted areas depending on the type of critical real estate.
The specific restricted areas are:
Within one mile of any of the 100 identified military installations
Within 99 miles of any of 32 identified military installations
Any county or other geographic area identified in connection with certain Air Force bases located in Colorado, Montana, Nebraska, North Dakota, and Wyoming;
Any part of 23 identified military installations and located within 12 nautical miles of the U.S. coast
Located within or will function as part of an airport or maritime port
That’s a lot of real estate covered by this rule assuming its accurate. The rule talks about the creation of tool to make this more certain.
One of the exceptions is urbanized areas. Unless the real estate is in “close proximity” of an identified military installation or is part of a covered port, the rule provide an exception for transactions that involve real estate located within an “urbanized area” or “urban cluster.” Those two terms: “urbanized area” or “urban cluster” are defined by the Census Bureau based on population density. Hopefully, most major cities inside all of those problematic areas in the map will fall under this exception. The question will be how far does the urbanized area extend outside the CBD.
Another exception is if your foreign investor is from Australia, Canada or the United Kingdom. Apparently, the Trump administration likes these countries and investors from those three get a pass from CFIUS on real estate transaction. The rules do allow for other countries to be added to the list.
Leases are also excluded from CFIUS as long as the lease is for less than 10% of the building and there are at least 9 other tenants.
Real estate transactions are not subject to mandatory CFIUS filings. Of course you risk having the transaction fall apart if CFIUS comes in later to undo the transaction.
The new rules give you the option of filing a short-form “declaration” rather than the longer, traditional form of “notice.” That also means a shorter 30-day review period.
The standard in 950 CMR 12.207 will apply to any broker-dealer or agent in Massachusetts. The original proposal included investment advisers and investment adviser representatives. But according to the Adopting Release, the final regulation excluded them because they are already subject to a fiduciary standard.
For broker-dealers, the fiduciary standard extends past the recommendation requirement standard if the broker-dealer has discretionary authority over the account, has an agreement to monitor the account or receives ongoing compensation.
For private funds to comply with the Custody Rule, they usually rely on the annual, independent audit prong for compliance. That rule requires an audit from an auditor that is subject to audit as defined in Regulation S-X. The SEC has proposed some changes to Regulation S-X that affect the auditor independent framework.
“Many of the current independence requirements have not been updated since their initial adoption in 2000 and amendments in 2003. Since that time, the Commission and our staff have, through several consultations per year, continued to learn about the application of our independence rule set and the efficiency and effectiveness of our independence requirements as market conditions and industry practices have changed. The proposed amendments to Rule 2-01 are designed to respond to these changes, reflect the SEC staff’s experience administering the independence requirements, and incorporate consideration of the recent and longer term feedback received from the public. “
The changes look like they will mostly be at the edges of compliance and not have a significant impact on auditor independence for fund managers.
I had some questions about auditor independence a few years ago and found the decision-making about independence to be very opaque with almost no public guidance. This modernization may help improve this process.
As part of Regulation BI package of regulatory changes, the Securities and Exchange Commission created a new Form CRS that needs to be delivered to “retail investors.” Of course there are questions from the industry. The SEC’s Division of Investment Management and Division of Trading and Markets created a website that answers Frequently Asked Questions on Form CRS. The question for pooled funds whether whether the rule would look through to retail investors in a fund.
Pursuant to new rules adopted by the SEC under the Securities Exchange Act of 1934 and the 1940 Act in connection with Regulation BI, registered broker-dealers and registered investment advisers will be required to deliver a relationship summary to retail investors. This summary is Form CRS.
Form CRS will require a firm to provide information about the relationships and services the firm offers to retail investors, fees and costs that retail investors will pay, specified conflicts of interest and standards of conduct, and disciplinary history.
One FAQ addresses a question I had regarding pooled funds:
Q: My firm is an investment adviser to pooled investment vehicles, such as a hedge funds, private equity funds and venture capital funds. The investors in these funds include natural persons who may be “retail investors” as defined in Form CRS. Am I required to deliver a relationship summary to these funds?
A: An investment adviser must initially deliver a relationship summary to each retail investor before or at the time the adviser enters into an investment advisory contract with the retail investor. “Retail investor” is defined as “a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family or household purposes.” In the staff’s view, the types of pooled investment vehicles described above would not meet this definition and a relationship summary would not be required to be delivered.
So, the manager doesn’t have to deliver a Form CRS to the fund itself. It’s less clear if you have to deliver it to the “retail investors” in the fund. Does Rule 206(4)-8 pass the Form CRS requirement through the pooled investment vehicle?
“[T]o satisfy their duty of loyalty, directors must make a good faith effort to implement an oversight system and then monitor it.”
Marchand v. Barnhill, 212 A.3d 805 (Del. 2019)
Clovis Oncology’s stock dropped sharply in 2015 when it disclosed poor clinical trial results for Rociletinib a promising experimental drug for the treatment of lung cancer. That meant the FDA was unlikely to approve Rociletinib to enter the market. Shareholder lawsuits ensued. The claim was that board breached its fiduciary duties by disregarding red flags that reports of the drug’s performance in clinical trials were inflated.
Delaware’s Caremark line of cases impose a responsibility on corporate boards to have a compliance program, but with a great deal of discretion to design it for the corporation’s context, industry, and resources. However, that compliance obligation is heightened when the corporation operates in an area of mission-critical regulatory compliance risk.
In the recent decision of In re Clovis Oncology, Inc. Derivative Litigation, the court highlighted the two components required of corporate compliance. First, you have to have an oversight system in place. Second, you have to monitor the oversight system. In area of mission-critical regulatory compliance, board oversight responsibility is heightened.
If you fail to do either, the corporation risks fiduciary litigation when bad news comes out.
The SEC’s Office of Compliance Inspections and Examinations issued a Risk Alert describing failures by investment advisers to comply with regulatory requirements when engaging in principal and agency-cross transactions. OCIE found that many advisers did not even recognize that they were engaging in (1) a principal transaction by buying or selling to a client or (2) an agency cross transaction when the adviser is acting as a broker for other than the client.
Advisers Act Section 206(3) makes it unlawful for any investment adviser, directly or indirectly, acting as principal for his own account knowingly to (a) sell any security to a client or (b) purchase any security from a client (“principal trades”), without disclosing to such client in writing before the completion of such transaction the capacity in which the adviser is acting and obtaining the consent of the client to such transaction. Section 206(3) requires an adviser entering into a principal trade with a client to satisfy these disclosure and consent requirements on a transaction-by-transaction basis. Blanket disclosure and consent are not permitted.
Two of the items mentioned related to private funds. Advisers that effected trades between advisory clients and an affiliated pooled investment vehicle, but failed to recognize that the advisers’ significant ownership interests in the pooled investment vehicle would cause the transaction to be subject to Section 206(3).
Staff in the Division of Investment Management has stated its view that Section 206(3) does not apply to a transaction between a client account and a pooled investment vehicle of which the investment adviser and/or its controlling persons, in the aggregate, own 25% or less. If the adviser owns more than 25% of the fund, it’s likely considered to a “principal” of the adviser under 206(3)
Second, OCIE noted advisers that effected principal trades between themselves and pooled investment vehicle clients, but did not obtain effective consent from the pooled investment vehicle prior to completing the transactions. The SEC has brought charges against an adviser to a pooled investment vehicle failed to obtain effective consent to principal trades because the review committee established by the adviser to approve the pricing of the trades in an attempt to satisfy the requirements of Section 206(3) was itself conflicted.
