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The BD/IA Regulator

Providing securities regulatory, enforcement and litigation trends for broker-dealers, investment advisers and investment funds

SEC Postpones Date for Filing Form N-PORT

Posted in Fund Regulation

On December 8, 2017, citing the “importance of sound data security practices and protocols for sensitive, nonpublic information,” the Securities and Exchange Commission (SEC) adopted a temporary final rule postponing the filing of Form N-PORT on EDGAR until April 30, 2019 (originally July 30, 2018) for larger fund groups (those with net assets of $1 billion or more) and until April 30, 2020 for smaller fund groups (originally June 1, 2019).  The SEC also delayed the rescission of Form N-Q.

Form N-PORT requires registered investment companies (other than money market funds, small business investment companies, and unit investment trusts that operate as ETFs) to report information about their complete monthly portfolio holdings, in addition to other information, to the SEC in  extensible markup language (XML) structured data format no later than 30 days after the close of each month.

According to the SEC, the EDGAR system receives over 1.7 million electronic filings per year.  In an effort to strengthen the SEC’s (and EDGAR’s) cybersecurity risk profile going forward, and to protect nonpublic information filed, the SEC “initiated a focused review and, as necessary or appropriate, uplift of the EDGAR system.”  Certain enhancements, the SEC said, “which will be designed to improve EDGAR’s functionality and security, could negatively affect EDGAR’s ability to validate and accept Form N-PORT filings in a timely manner, in particular during peak filing periods.”

The new Rule (30b1-9(T)), however, which has the effect of delaying the filing of the Form, still requires larger fund groups that are subject to the June 1, 2018 compliance date to satisfy their reporting obligation by that date and maintain in their records the information required to be included in Form N-PORT; they just do not have to file that information via EDGAR.  These records are treated as records under Section 31 of the Investment Company Act of 1940 and Rule 31a-1, and are subject to the requirements of Rule 31a-2 (generally, preservation of records for no less than six years, the first two of which in an easily accessible place).  These records must be made available to the SEC upon request.  Smaller fund groups are not subject to the requirement to maintain Form N-PORT information in their records during the postponement.

In other words, funds have only been relieved of their filing obligations and must still comply with the June 1, 2018 compliance date.

Our Take

While at first glance the postponement appears to relieve fund groups of certain requirements, its practical effect may be to create additional administrative burdens.  Not only are fund groups responsible for maintaining records that meet the requirements of Form N-PORT, they must still file Form N-Q.

FINRA Issues Report on Its Examination Findings

Posted in Anti-Money Laundering, Broker-Dealer Regulation, FINRA Enforcement

In December 2017, FINRA issued a report highlighting several key findings from its recent examinations of broker-dealer members.  The report is available here.

The report focuses on several observations from recent examinations that FINRA believed would be worth highlighting to members.  Of course, the report cannot list all of FINRA’s concerns; however, FINRA selected these issues based on their “potential impact on investors and markets or the frequency with which they occur.”  The report also describes a number of practices that FINRA has observed to be helpful for some members in carrying out their duties.

The report covers a fairly wide variety of regulatory and compliance areas, which are summarized below.

  • Cybersecurity: While broker-dealers have substantially enhanced their attention to these issues, FINRA lists a variety of areas where it believed broker-dealers of various sizes could improve their cybersecurity programs.
  • Outside Business Activities: FINRA noted a variety of ways in which some firms did not fully comply with their obligations under Rules 3270 and 3280 as to associated persons’ outside business activities and securities transactions.
  • Anti-Money Laundering: FINRA determined that some firms did not establish and implement an AML program reasonably designed to detect and cause the reporting of suspicious activities.
  • Product Suitability: FINRA identified a number of issues that were not necessarily linked to the size of the broker-dealers, including:
    • Customers were advised to roll UIT investments early, generating additional fees, but these broker-dealers did not have appropriate mechanisms to identify and review these recommendations.
    • Brokers recommended higher-fee share classes of mutual funds and complex products without making an appropriate suitability determination and, in some cases, did not attempt to obtain key pieces of investor profile information.
    • Some firms did not establish adequate supervisory systems and written supervisory procedures as to funds with multiple share classes and complex products.
    • Some firms did not adequately train their representatives as to suitability issues.
  • Best Execution: FINRA determined that some firms did not conduct an adequate regular review of the quality of the executions of customer orders.
  • Market Access Controls (SEC Rule 15c3-5): FINRA determined that some firms did not satisfy their obligations under the rule, particularly as to the establishment of pre-traded financial thresholds, implementing and monitoring aggregate capital or credit exposures, and tailoring erroneous trade controls.
  • Order Capacity: Some broker-dealers sometimes failed to comply with the requirement to enter the correct capacity code, such as agency, principal and risk-less principal) when reporting off-exchange trades. (As we have previously indicated, a number of firms have changed their trading practices in light of, for example, the DOL’s fiduciary rules.)
  • TRACE Reporting: FINRA identified a variety of issues in the TRACE reporting of debt securities, including late reporting of transactions.

The report also identified a number of deficiencies in broker-dealers’ maintenance of alternative investments in IRAs, net capital and credit risk assessment requirements, and Regulation SHO compliance.

FINRA indicated that it expects to update the report over time, with a view to assisting broker-dealers with their various compliance obligations.  However, even for now, the report is a useful read for broker-dealer compliance departments, providing a useful guide to some of FINRA’s current key concerns, and a variety of observations of useful practices to follow.

Complimentary Teleconference – Financing Fintech: State Regulation of Marketplace Lenders as Loan Brokers or Arrangers of Credit

Posted in Events

Thursday, January 25, 2018
5:00 p.m. – 5:45 p.m. EDT

Join us for one of our upcoming monthly telephone briefings led by members of our Fintech team.

Topic: State Regulation of Marketplace Lenders as Loan Brokers or Arrangers of Credit

This call will be an operator-assisted call of approximately 45 minutes in duration, and will be followed by a brief Q&A opportunity. We also invite you to submit questions before the start of the call. A replay will be available upon request.

In order to RSVP for the December call, and to submit questions, please click here.


2017 IIA Compliance Workshop – Denver

Posted in Events

Thursday, November 30, 2017
9:15 a.m. – 2:00 p.m. MST

Investment Advisor Association Seminar

Westin Denver Downtown
672 Lawrence Street
Denver, CO 80202

The IAA Compliance Workshops are an excellent opportunity to gain practical insights into challenging legal and regulatory issues facing SEC-registered investment advisers, and to meet compliance and legal professionals at other IAA member firms.

Of Counsel Kelley A. Howes will participate in a panel discussion addressing current regulatory and examination priorities.

For more information, or to register, please click here.

Open-End Fund Converts to Closed-End Fund

Posted in Fund Regulation

In what has been reported as a market first, the independent directors and shareholders of an open-end fund (mutual fund) agreed to convert an approximately $1 billion open-end fund to an exchange-listed, closed-end fund.

While open-end funds issue shares continuously, closed-end funds typically raise money through issuing a fixed amount of shares in an initial public offering.  In a more common type of conversion, closed-end fund shareholders pressure the fund (for example, if its share price is trading at a substantial discount to its asset value) to convert to an open-end fund to increase the net asset value (NAV) of its shares and reduce the market discount to NAV.

The impetus for this transaction was the uncertainty surrounding a 2015 court case currently on appeal.  The lower court decision ordered a large financial institution to pay $287.5 million (minus attorney fees) to the fund for certain allegations—a large gain for the fund (approximately 30 percent).  However, since the appeals process has not yet been exhausted, the fund may not include the payment in the fund’s calculation of its NAV since the payment is still contingent.  As a result, speculative investors could buy shares of the fund, in anticipation of the fund’s receipt of payment, diluting existing shareholders realization of gains from the proceeds.  In addition, significant inflows between the time of a final judgment confirming the payment order and the time the fund actually collects the money could create a potential liquidity mismatch.

By converting the fund to a closed-end fund, open-end sales of the shares of the fund were immediately stopped, preventing shareholder dilution in the event the judgment is upheld.  Instead of issuing additional, dilutive shares on purchase demand, which is what an open-end fund would be required to do, the closed-end fund’s price per share would simply rise with more demand.  Moreover, the liquidity mismatch could be managed better since closed-end funds do not have the same redemption requirements as open-end funds.

Our Take

The facts underlying the decision to convert the fund, and the underlying lawsuit itself, are unusual, but not altogether impossible to repeat.  This transaction creates another tool for funds to better protect shareholder interests.

ThinkingCapMarkets Podcast: Bad Actor Disqualification Provisions

Posted in Podcast

There are very similar disqualification provisions in Regulation A, Regulation CF (Crowdfunding) and Regulation D. These rules make these exemptions from registration unavailable for an offering if the issuer or certain “covered persons” is or has been subject to a relevant criminal conviction, regulatory or court order or other disqualifying event.  If a covered person is subject to a disqualification event, then the offering participants must rely on a different exemption from registration, if one is available.

In response to these disqualification provisions, issuers and placement agents have put in place diligence procedures to identify offering participants who may cause the issuer to lose the benefit of the exemption.  These diligence procedures must be followed prior to the commencement of the offering; they should not be an afterthought considered only after the offering has begun.

Morrison & Foerster’s Bradley Berman gives an overview of the bad actor disqualification provisions in this ThinkingCapMarkets podcast.

Our recently updated FAQs can be accessed here: Frequently Asked Questions relating to the Bad Actor Disqualification Provisions.

Treasury Urges Principles-Based Regulation of Money Managers

Posted in Fund Regulation, Investment Adviser Regulation

The U.S. Department of the Treasury’s report on asset management and insurance recommends, among other things, a delay in implementation of the SEC’s liquidity risk management rule and the Department of Labor’s fiduciary rule.

The October 2017 report is the third of four that address the president’s Core Principles to regulate the U.S. financial system, signed by executive order in February 2017. The report recommends that the Financial Stability Oversight Counsel (FSOC), which broadly oversees systemic risks to the U.S. financial system, back off on entity-based systemic risk evaluations of asset managers, and that the SEC focus on potential risks that arise from asset management and on strengthening the asset management industry as a whole.

Read our client alert.

Morrison & Foerster’s Jay G. Baris summarizes the provisions of the report that directly affect regulation of investment companies and investment managers in this ThinkingCapMarkets podcast.