Two New Commissioners on Tap for the SEC

With one current vacancy and a second upcoming vacancy, the Securities and Exchange Commission needs some new blood. President Biden nominated two new commissioners to help the agency regain its full population.

Jaime Lizárraga has been nominated to fill a Democratic seat currently occupied by commissioner Allison Lee. She has stated that she is resigning, but will serve until her successor is in place. Lizárraga has worked for Speaker Pelosi for 14 years, and spent eight years before that on the House Financial Services Committee. He was the deputy director of legislative affairs at the SEC, briefly in the 1990s.

Mark Uyeda has been tapped to replace the vacancy created by former Republican commissioner Elad Roisman. Mr. Uyeda is a career attorney with the Securities and Exchange Commission. He is currently on detail from the SEC to the U.S. Senate Committee on Banking, Housing, and Urban Affairs, where he serves as Securities Counsel on the Committee’s Minority Staff.

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SEC Offers Up a Buffet of Private Fund Regulations

At its open meeting on February 9, the Securities and Exchange Commission offered up a buffet of proposed regulations of private funds. It’s really an all-you-can eat buffet with six proposed changes across a variety of areas.

The SEC wants private funds to send out quarterly statements to private fund investors. It doesn’t seem that the SEC would require them to be audited. It would have to provide a detailed accounting of all fees and expenses. It sounds like it would some form of standardized reporting. The quarterly reports would have to provide information on fund performance. For “liquid funds, the quarterly statement would provide annual net total returns since inception, average annual net total returns over prescribed time periods, and quarterly net total returns for the current calendar year. For “illiquid funds,” the statement would provide the gross and net internal rate of return and gross and net multiple of invested capital for the illiquid fund to capture performance from the fund’s inception through the end of the current calendar quarter. Not sure what is going to draw lines between “liquid” and “illiquid” funds.

The SEC is proposing that private funds have an annual audit. This seems odd to me. Private funds largely have to do this already under the Custody Rule. Not sure what this regulation would do beyond the Custody Rule, unless it will replace the Custody Rule for private funds.

Adviser-Led Secondaries Rule would require a fairness opinion in connection with an adviser led secondary transaction. This requirement would provide a check against an adviser’s conflicts of interest in structuring and leading a transaction from which it may stand to profit at the expense of private fund investors. Not sure how much this rule would help in already complex transactions

The preferential treatment rule would prohibit private fund advisers from providing preferential terms for redemptions and providing additional information about fund holdings.  The proposed rule would go further and prohibit private fund advisers from providing “other preferential treatment” unless disclosed to current and prospective investors. This proposed rule is designed to protect investors by prohibiting specific types of preferential treatment that have a material, negative effect on other investors. Is the SEC trying to kill side letters? This proposal could be a mess.

The prohibited activities rule is side table full of dishes cooked up by the SEC under the umbrella  that these practices are contrary to the public interest and the protection of investors

  • Charging certain fees and expenses to a private fund or its portfolio investments, such as fees for unperformed services (e.g., accelerated monitoring fees) and fees associated with an examination or investigation of the adviser;
  • Seeking reimbursement, indemnification, exculpation, or limitation of its liability for certain activity;
  • Reducing the amount of an adviser clawback by the amount of certain taxes;
  • Charging fees or expenses related to a portfolio investment on a non-pro rata basis; and
  • Borrowing or receiving an extension of credit from a private fund client.

The desert is that all registered investment advisers, not just private funds, have to document their annual review in writing.

Commissioner Peirce, as expected, was against the rule. She sees it as a diversion of resources by the SEC away from retail investor protection. Further she says that maybe the SEC needs to re-think whether there is any reason to keep private placements away from retail investors if the SEC is going to impose retail-like requirements on private investments.

Chair Gensler along with Commissioner Lee and Crenshaw were all in favor of the proposed rule. They all piled on the idea that private funds are a large and growing segment of the investment industry. Of course if investors were unhappy with private funds they would not be investing in private funds and they would not be a large and growing segment of the investment industry.

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More Compliance Changes for Private Fund Managers

On Wednesday February 9 the SEC has a full agenda for its meeting and fund managers should pay attention. Here are the matters to be considered:

  1. The Commission will consider whether to propose rules and amendments under the Investment Advisers Act of 1940 (“Advisers Act”) for private fund advisers and whether to propose amendments to the compliance rule under the Advisers Act.
  2. The Commission will consider whether to propose new rules to address cybersecurity risk management for investment advisers and investment companies as well as related amendments to certain rules regarding adviser and fund disclosures under the Investment Advisers Act of 1940 and the Investment Company Act of 1940.
  3. The Commission will consider whether to propose rules and rule amendments under the Securities Exchange Act of 1934 to shorten the standard settlement cycle for most securities transactions.  The proposed rules and rule amendments would be applicable to broker-dealers and certain clearing agencies.  The Commission also will consider whether to propose rule amendments under the Investment Advisers Act of 1940 to require investment advisers to maintain certain related records.
  4. The Commission will consider whether to propose amendments to its whistleblower rules.

For the first item, I don’t have any insight into what is cooking in the SEC’s regulatory kitchen. Whatever is in the oven is coming out hot and for private fund managers. I’m going to guess its related to fees and fee disclosure. I think the Chair Gensler’s November 10 speech at the Institutional Limited Partners Association Summit may give us some insight.

I wonder whether fund investors have enough transparency with respect to these fees. I wonder whether limited partners have the consistent, comparable information they need to make informed investment decisions.

That’s why I have asked the staff to consider what recommendations they could make to bring greater transparency to fee arrangements.

I’m going to guess that the SEC is going to propose some kind of standard fee disclosure table for private funds like there is in registered funds.

As for item 2 on cybersecurity, I think we can look at Chair Gensler’s January 24 speech at the Northwestern Pritzker School of Law’s Annual Securities Regulation Institute.

Next, I’d like to discuss the broader group of financial sector registrants, like investment companies, investment advisers, and broker-dealers, beyond those covered by Reg SCI.

As I mentioned earlier, this group has to comply with various rules that may implicate their cybersecurity practices, such as books-and-records, compliance, and business continuity regulations. Building upon that, I’ve asked staff to make recommendations for the Commission’s consideration around how to strengthen financial sector registrants’ cybersecurity hygiene and incident reporting, taking into consideration guidance issued by CISA [Cybersecurity and Infrastructure Security Agency] and others.

I’m guessing we will see an expansion of cybersecurity requirements and reporting of cyber incidents to clients and investors.

We’ll have to tune it find out.

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Changes to Form PF

It’s been a decade since the SEC and FSOC pushed Form PF on to private funds. The SEC has decided it wants more data and has proposed an amendment to Form PF.  

The big change is next day reporting for key events by Large Hedge Fund Advisers and Private Equity Funds 

For large Hedge Funds: 

  • certain extraordinary investment losses 
  • significant margin and counterparty default events,  
  • material changes in prime broker relationships,  
  • changes in unencumbered cash,  
  • operations events, and  
  • events associated with withdrawals and redemptions 

For Private Equity Funds: 

  • execution of adviser-led secondary transactions,  
  • implementation of general partner or limited partner clawbacks,  
  • removal of a fund’s general partner,  
  • termination of a fund’s investment period, or  
  • termination of a fund. 

The purpose is provide more timely information to the SEC and FSOC and presumably signal distress in the markets quicker than the current delayed reporting. 

Commissioner Pierce opposed the changes. She does not think it will actually provide useful information for FSOC. She thinks it’s just a grab by the SEC to enhance enforcement activity and twist the form into micro-management by the SEC. In particular, the one-day period is an incredibly short term for a firm that will likely be focused on trying to resolve issues rather than regulatory reporting.  

Chair Gensler raised the specter of Long Term Capital Management in 1998. He used this as the boogeyman for why the SEC needs such intensive and quick reporting. 

Net assets managed by private funds rose to $11.7 trillion in the first quarter of last year from $5.3 trillion in 2013, SEC data show. There were 6,910 private equity funds with $1.60 trillion in gross assets in first quarter of 2013 and 15,584 funds with $4.71 trillion in gross assets in the fourth quarter of 2020. 

The proposal would reduce the threshold that triggers reporting as a large private-equity adviser to $1.5 billion from $2 billion in assets under management. That would pull approximately 75% of private equity funds into the reporting regime. 

The Form PF still has that clunky definition of a “hedge fund” that leaves fund managers with subscription credit facilities wondering if they might considered a hedge fund.

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The SEC Spat Over Its Regulatory Agenda

The Securities and Exchange Commission publishes its Unified Agenda of Regulatory and Deregulatory Action List annually, setting up items that the SEC is working on or thinking about working on. Occasionally, we learn of something new. Usually, it’s a fairly boring exercise to meet the requirements under the Administrative Procedure Act.

There was one surprise for private funds on the list: Exempt Offerings

“The Division is considering recommending that the Commission seek public comment on ways to further update the Commission’s rules related to exempt offerings to more effectively promote investor protection, including 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.”

A surprise, but not really. Exempt offerings are right in the middle of the cross purposes of protecting investors and creating efficient capital markets.

The big surprise was that two of the SEC Commissioners published a criticism of the agenda. Commissioners Peirce and Roisman take issue with the agenda revisiting the recently adopted changes to the accredited investor definition. They also note the inclusion of the Proxy Rules, Resource Extraction Payments and the whistleblower rules.

“As far as we can tell, the agency has received no new information which would warrant opening up any of these rules for further changes at this time. We are disappointed that the Commission would dedicate our scarce resources to rehashing newly completed rules.”

Looks like the new SEC is off to a rock start under the Chair Gensler.

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Withdrawal of No Action Letters

In connection with Securities and Exchange Commission’s new Marketing Rule, I’m expecting the SEC to withdraw a bunch of the no-action letters that address advertising by registered investment advisers. For example, the Clover no-action letter doesn’t seem to fit with the new Marketing Rule and will likely have to be withdrawn to avoid confusion.

The release for the Marketing Rule stated so.

Additionally, pursuant to the staff’s review, the staff will be withdrawing the staff’s remaining no-action letters and other staff guidance, or portions thereof, as of the compliance date of the final rules. [832]

https://www.federalregister.gov/d/2020-28868/p-1389

That footnote 832 said: “A list of the letters to be withdrawn will be available on the Commission’s website.

That website now exists: https://www.sec.gov/divisions/investment/im-modified-withdrawn-staff-statements

Or maybe it already existed and I never noticed that page on the SEC’s website before before. It looks new to me and the vast majority of the withdrawal dates are from the past year and moving forward.

However, there are no withdrawal notices for investment adviser marketing yet. I assume there will be a bigger announcement when it happens.

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Got Thoughts on Form PF or Private Fund Registration Requirements?

The Securities and Exchange Commission published a list of rules to be reviewed pursuant to the Regulatory Flexibility Act. The publication invites comments on whether the rules should be amended or continued without change. Two items caught my attention.

The first is Form PF. It was adopted in October 2011. The second is the registration requirement imposed on private funds and other Dodd-Frank requirement. That rule and rule amendments was adopted in June 2011.

Does this mean changes are coming?

The Regulatory Flexibility Act (5 U.S.C. 601-612) requires an agency to review its rules that have a significant economic impact upon a substantial number of small entities within ten years of the publication of such rules as final rules. 5 U.S.C. 610(a). The purpose of the review is “to determine whether such rules should be continued without change, or should be amended or rescinded . . . to minimize any significant economic impact of the rules upon a substantial number of such small entities.”

The SEC notes that there were no comments on its initial Regulatory Flexibility Analysis for either rule.

The publication of these opening for comments seems like a pro forma step by the SEC to comply with the Regulatory Flexibility Act and not movement to make regulatory changes. But if the SEC gets comments, maybe it will think about making changes. The link to leave comments is on this page: https://www.sec.gov/rules/other.htm.

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SEC’s ESG Task Force


The Securities and Exchange Commission announced the creation of a Climate and ESG Task Force in the Division of Enforcement. The Division of Corporate Finance announced an enhanced focus on climate-related disclosures in public filings. The Division of Examinations announced a focus on climate-related risks as part its 2021 examination priorities. Sounds like all of the SEC has turned to ESG and climate issues over the last two weeks.

Or not.

Commissioner Hester M. Peirce and Commissioner Elad L. Roisman issued a joint public statement calling into question these climate/ESG initiatives.

“What does this ‘enhanced focus’ on climate-related matters mean?  The short answer is: it’s not yet clear.  Do these announcements represent a change from current Commission practices or a continuation of the status quo with a new public relations twist?  Time will tell.”

As the two commissioners point out, the Commission has not voted on any new standards or expectations relating to climate-related disclosure. They also point (as I did) although there is a big headline for climate issues in the press release for the 2021 examination priorities, there is little mention of it in the actual publication. As for the Enforcement Task Force, its clear these two commissioners are not on board.

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Increased SEC Enforcement?

The annual number of enforcement actions by the Securities and Exchange Commission decreased each year during the Trump administration. Starting at the high of 1,063 in 2016 and dropping to 827 in 2019, according to a tabulation in the Wall Street Journal. Now there is a new President and new Acting Chair of the Securities and Exchange Commission. Are enforcement actions going to increase?

Acting Chair Allison Herren Lee broadened the delegation of authority to senior officers in the Division of Enforcement. Under former Chair Clayton during the Trump administration, only the two co-heads of the Enforcement Division could approve the issuance of a Formal Order of Investigation. Now a broader group of officials in the Enforcement Division can do so.

Will this result in more enforcement actions? My guess would be “no.” I think the number of enforcement actions is correlated more to the size of the enforcement staff. It was reduced by about 8% during the Trump administration. Enforcement staff can only handle so many cases per person.

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Division of Examination

Goodbye Office of Compliance Inspections and Examinations.
Hello Division of Examination.

The Securities and Exchange Commission decided that OCIE, with 23% of the SEC employees, is probably more than an office and elevated it to the level of “Division” by naming it the Division of of Examinations. That puts it on equal name status with Corporate Finance, Investment Management, Trading and Markets, Economic and Risk Analysis and Enforcement.

I’m not sure I ever felt that OCIE was somehow less important because it was an “Office” and not a “Division.” Names do matter and its good to see that the examination staff can now carry around a more prestigious division name.

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