Sara Crovitz

Sara Crovitz, most recently Deputy Chief Counsel and Associate Director of the U.S. Securities and Exchange Commission’s Division of Investment Management, provides counsel on all aspects of investment company and investment adviser regulation. She worked at the SEC for 21 years, including 17 years in the Division of Investment Management focusing on issues under the Investment Company and Investment Advisers Acts of 1940. While in the Division, Sara supervised the provision of significant legal guidance to the investment management industry through no-action and interpretive letters, exemptive applications, IM guidance updates and other written and oral means.

OCIE issues Risk Alert on Form CRS

OCIE issued a Risk Alert to provide broker-dealers and investment adviser with information about the scope and content of initial examinations after the compliance date for Form CRS. The Risk Alert indicates that initial examinations will focus on assessing whether firms have made a good faith effort to implement Form CRS and highlights the following areas:

  • Delivery and filing – OCIE may review whether a firm has appropriately filed and delivered its Form CRS. In particular, OCIE may review records of the dates that each relationship summary was provided to retail investors to validate whether the firm has complied with the delivery obligations.
  • Content – OCIE may review content, including the areas prescribed in the instructions to Form CRS.
  • Recordkeeping – OCIE may review the firm’s records related to delivery of the relationship summary, and the policies and procedures regarding such records.

The Risk Alert also highlights that OCIE may, over time, review whether a firm appropriately updates its Form CRS.

COVID-19 Coverage: Part 5 of 1940 Act Issues to Consider During the Pandemic

Stradley’s Coronavirus Task Force will be updating this high-level overview of coronavirus disease 2019 (COVID-19) related issues for registered investment companies and fund managers as developments warrant.

NEW ISSUES:

  • Affiliated Purchases of Debt Securities: The SEC staff has issued no-action relief to affiliates of open-end funds, other than exchange-traded funds and money market funds, to allow them to purchase debt securities from the funds.1 The relief is subject to conditions, including that the price must be the security’s fair market value per Section 2(a)(41) of the Investment Company Act of 1940, provided that this price is not materially different from the value indicated by a reliable third-party pricing service, and that the fund must publicly disclose the purchase on its website and inform the staff. In addition, if the purchaser thereafter sells the security for a higher price, it must promptly pay the difference to the fund, unless the purchaser is a bank or bank affiliate and this condition would conflict with Sections 23A and 23B of the Federal Reserve Act. The relief will be in effect until further notice from the staff. (New 3/31/20)

UPDATED ISSUES:

  • Market Closures and Market Restrictions: A list of securities market closures and market restrictions is available here. (Updated 3/31/2020)
  • Money Market Mutual Funds:
    • Form N-CR: Several money market funds have filed on Form N-CR to report financial support, and one money market fund has filed on Form N-CR to report a downward deviation of its shadow price by more than ¼ of 1 percent. An amended report is required to be filed within four business days of the provision of financial support or downward deviation that describes the reason for the support and terms of the support or the reason for the deviation, as applicable. (Updated 3/23/2020)
    • Purchases by Affiliated Banks: The Federal Reserve Board has issued a template exemptive letter allowing banks to purchase assets from affiliated money market funds, subject to certain conditions, including that the assets must be investment grade and purchased at fair market value.2 In addition, the SEC staff has granted no-action relief to permit certain bank affiliates of money market funds to purchase securities from the funds in accordance with the Federal Reserve Board guidance, but otherwise pursuant to rule 17a-9, subject to certain conditions.3 The SEC no-action letter does not affect the ability of other money market fund affiliates to purchase assets from the fund in accordance with rule 17a-9. (Updated 3/23/2020)
    • Liquidity Facility: The Federal Reserve Board has announced a Money Market Mutual Fund Liquidity Facility (MMLF) that is intended to assist money market funds in meeting demands for redemptions.Under the MMLF, the Federal Reserve Bank of Boston will lend to depository institutions and bank holding companies, taking as collateral assets purchased by the borrower from prime money market funds (i) concurrently with the borrowing or (ii) or on or after March 18, but before the opening of the facility. The facility is similar to the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility that operated from late 2008 to early 2010 but will purchase a broader range of assets. The Federal Reserve Board expanded the facility to cover certain assets purchased from tax-exempt municipal money market funds.5  The Federal Reserve Board has announced that the facility opened March 23, and full documentation and additional guidance are available.6 (Updated 3/23/2020)
    • Guaranty: The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which was enacted into law on March 27, suspends the existing prohibition on the use of the Exchange Stabilization Fund for the establishment of any guaranty programs for the money market fund industry.7 Any such guarantee shall be limited to a guarantee of the total value of a shareholder’s account in a participating fund as of the close of business on the day before the announcement of the guarantee and terminate not later than December 31, 2020. This provision allows the Department of the Treasury to establish a Money Market Funds Guaranty Program, but does not require it to do so. (Updated 3/31/2020)

ISSUES:

  • SEC Lending and Borrowing Relief: The SEC has issued an order providing additional flexibility for open-end funds (other than money market funds) and insurance company separate accounts registered as unit investment trusts to obtain short-term funding.8 The relief is available until a notice terminating it is issued, which will be at least two weeks from the date of the notice and no earlier than June 30, 2020. Prior to relying on any of the relief, the fund would have to notify SEC staff. In addition, interfund lending requires notification on a fund’s public website.
    • Fund affiliates may lend money to the fund on a collateralized basis, provided the board makes determinations that the borrowing is in the best interest of the fund and its shareholders and that it will be for the purposes of satisfying shareholder redemptions.
    • For fund families with an SEC order permitting an interfund lending and borrowing facility, a lending fund may lend up to 25% of its current net assets and the term may be for any period that does not extend beyond the expiration of the relief, notwithstanding the terms of the order, provided, among other conditions, that the board reasonably determines that the maximum term for interfund loans is appropriate. (Recent orders typically limit lending funds to 15% of current net assets and the term to seven days.)
    • For fund families without an interfund lending order, funds may lend and borrow in accordance with the terms of any such order issued within the past twelve months, with the same modifications.9
    • Funds are not required to seek shareholder approval if lending under the relief would violate a fundamental policy, provided that the board reasonably determines that the lending or borrowing is in the best interests of the fund and its shareholders. (New 3/27/2020)
  • OCIE Statement: The SEC’s Office of Compliance Inspections and Examinations has issued a statement that it has moved to conducting examinations off-site through correspondence, unless it is absolutely necessary to be on-site, and that it will work with registrants to ensure that its work can be conducted in a manner consistent with maintaining normal operations and with necessary or appropriate health and safety measures.10 OCIE also stated that reliance on regulatory relief will not be a risk factor utilized in determining whether OCIE commences an examination, and it encourages registrants to utilize available regulatory relief as needed. (New 3/27/2020)
  • Signatures on EDGAR Filings: The SEC staff has issued a statement on the manual signature and record requirements for documents filed electronically with the SEC.11 The staff will not recommend enforcement action if a signatory retains a document adopting the signature and provides the document to the filer for retention, with the time and date executed, and the filer establishes and maintains policies and procedures governing this process. (New 3/27/2020)
  • FINRA Guidance: FINRA has issued guidance that provides temporary relief and guidance with respect to a number of requirements, including filings that would otherwise be required for temporary relocations and the timing of FOCUS reports and certain other filings.12 The guidance will be available until FINRA publishes a Regulatory Notice announcing a termination date. (New 3/27/2020)
  • Blue Sky Guidance: A number of state and provincial securities regulators have published guidance that provides relief or other COVID-19-related updates. The North American Securities Administrators Association has established a resource page to collect these updates.13 (New 3/27/2020)
  • Exchange-Traded Funds:
    • For an ETF that invests in foreign markets that close, the ETF may wish to consider whether to invest in alternative instruments, such as ADRs, in order to achieve the desired exposure to the foreign securities. In circumstances where there is no ability to make additional investments in appropriate alternative instruments, an ETF may wish to stop accepting creation unit purchases. The Commission previously has noted that ETFs generally may suspend the issuance of creation units only for a limited time and only due to extraordinary circumstances, such as when the markets on which the ETF’s portfolio holdings are traded are closed for a limited period of time.14 ETF issuers should be aware that any decision to suspend creations could have an impact on the arbitrage efficiency of the ETF and could lead to greater deviations between the market price of the ETF shares and the NAV of the shares. Like other open-end funds, ETFs cannot suspend redemptions unless the New York Stock Exchange is closed or there is appropriate guidance from the SEC. ETFs are permitted to charge transaction fees of up to 2% on redemptions. Such fees are designed to offset the costs of redemptions to the ETF. Some fixed-income ETFs that deliver cash redemptions instead of in-kind redemptions reportedly have increased their transaction fees on redemptions in light of increased transaction costs in the bond market. (Updated 3/23/2020)
    • On March 23, 2020, the Federal Reserve Bank of New York established the Secondary Market Corporate Credit Facility (SMCCF), which will purchase in the secondary market corporate bonds issued by investment grade U.S. companies and U.S.-listed ETFs whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds.15 The SMCCF would not be permitted to purchase more than 20% of the assets of any ETF as of March 22, 2020. The SMCCF will cease making such purchases no later than September 30, 2020, unless extended. (Updated 3/27/2020)
  • SEC Filings: The SEC has updated its previous orders under both the 1940 Act and the Investment Advisers Act of 1940 to extend the time periods of the relief.16 Entities must notify the SEC staff and/or investors, as applicable, of the intent to rely on the relief, but generally no longer need to describe why they are relying on the order or estimate a date by which the required action will occur. The 1940 Act Orders provide relief from the timeliness requirements of Form N-CEN, Form N-PORT, and Form N-23C-2 when a fund is unable to meet a deadline due to circumstances related to current or potential effects of COVID-19. The relief for Forms N-CEN and N-PORT applies to filing obligations for which the original due date is on or after March 13 but on or prior to June 30, 2020, while the relief for Form N-23C-2 extends to August 15, 2020. The Advisers Act Orders provide timeliness relief for Form ADV and Form PF filings and for Form ADV Part 2 client delivery obligations for 45 days from the original due date, when the original due date is on or after March 13 but on or prior to June 30, 2020. The SEC previously posted staff guidance that Form ADV does not have to be updated to reflect temporary teleworking locations.17 The SEC has also provided relief from timeliness requirements for certain filings under the Securities Exchange Act of 1934.18 Note that filings not covered by the orders continue to be required on a timely basis, including filings on Form N-LIQUID, Form N-CR, and Form N-MFP, although it is possible that the SEC will consider issues with these forms on an individualized basis. The SEC provided information on contacting the staff with issues, including issues with these filings, in press releases announcing the actions.19 (Updated 3/27/2020)
  • In-Person Board Meetings: The 1940 Act Orders allow fund boards to meet telephonically or by video conference to consider and vote on matters that would otherwise require an in-person vote. The relief applies whenever reliance upon it is necessary or appropriate due to circumstances related to current or potential effects of COVID-19 and is available until August 15, 2020. The SEC’s Division of Investment Management previously provided no-action relief for the period from March 4 to June 15.20 (Updated 3/27/2020)
  • Delivery of Prospectuses and Shareholder Reports: The 1940 Act Orders also provide relief from the obligations to timely transmit annual and semiannual reports to shareholders and to file them with the SEC. The relief applies when the original due date is on or after March 13 but on or prior to June 30, 2020, and the fund is unable to prepare or transmit the report due to circumstances related to current or potential effects of COVID-19. In addition, the SEC announced that it would not provide a basis for an SEC enforcement action if a fund does not timely deliver a current prospectus because of circumstances related to COVID-19 when delivery was originally required during this period. The position is not available to an initial purchase by the investor of the fund’s shares. (Updated 3/27/2020)
  • Annual Meetings: The SEC staff has provided guidance to both operating companies and funds that is intended to provide regulatory flexibility to companies seeking to change the date and location of the meetings and use new technologies, such as “virtual” shareholder meetings that avoid the need for in-person shareholder attendance, while at the same time ensuring that shareholders and other market participants are informed of any changes.21 The guidance notes that the ability to conduct a “virtual” meeting is governed by state law, where permitted, and the issuer’s governing documents. Note that companies seeking to conduct a virtual meeting may, under state law, need to have an appropriate process for shareholders to vote at the meeting. (Updated 3/27/2020)
  • State and Local Closures: Several states, counties and cities (e.g., California, Pennsylvania, New York and Illinois) have announced business closures in connection with “shelter-in-place” public health efforts to slow the spread of COVID-19. Some of the orders may contain broad exceptions for the financial services industry, while others may not. Beyond the direct impact on firms in those localities, review the location of service providers and the terms of these orders carefully to determine whether necessary support functions will remain available. FINRA has posted a resource page with links to state “shelter-in-place” and “stay-at-home” orders.22 (Updated 3/27/2020)
  • Transfer Agents: The SEC has provided a broad exemption for the period from March 16 to May 30 from requirements applicable to transfer agents except for the safeguarding requirement.23 Transfer agents relying on the relief must provide notice to the SEC by May 30. The SEC encourages transfer agents and the issuers for whom they act to inform affected security holders. (New 3/23/2020)
  • Tax Implications for Funds with Institutional Shareholders: For institutional funds with few shareholders, beware that the fund could fall into personal holding company status if at any time during the last half of the taxable year more than 50 percent in value of the fund’s shares are owned, directly or indirectly, by or for not more than 5 “individuals.” For purposes of this rule, employee pension trusts, private foundations, trusts forming part of a plan providing for the payment of supplemental unemployment compensation benefits, and a trust, a portion of which is permanently set aside or to be used exclusively for charitable purposes, are considered individuals. (New 3/23/2020)
  • CPO NFA Filings: The CFTC staff has provided no-action relief to commodity pool operators that extends certain filing deadlines.24 With respect to Form CPO-PQR filings under CFTC Regulation 4.27, Small and Mid-Sized CPOs have until May 15, 2020 to submit their annual filings for 2019, while Large CPOs have until July 15, 2020 to submit their filings for Q1 2020. For pool annual reports under CFTC Regulations 4.7(b)(3) or 4.22(c) that are due on or before April 30, 2020, the deadline for filing and distributing the report, which must include certified financial statements, has been extended until 45 days after the due date specified in the regulations. For monthly or quarterly reports to pool participants under CFTC Regulation 4.7(b)(2) or 4.22(b) for all reporting periods ending on or before April 30, 2020, the deadline for distribution to participants has been extended to 45 days after the end of the reporting period (instead of 30 days as stated in the regulations). The National Futures Association has issued similar relief for CPO Members and has provided Commodity Trading Advisor Members with similar relief for NFA Form PR filings.25 (Updated 3/23/2020)
  • Liquidity Risk Management: Current developments raise a number of issues for the management of funds’ liquidity risk:
    • Assessment, management, and periodic review of liquidity risk: Funds should review fund liquidity risk in light of current and reasonably expected market events and redemption patterns and may need to consider appropriate mitigating steps for strengthening the fund’s ability to meet redemptions, including readying borrowing and other liquidity facilities. Some fund managers may wish to consider use of the relief provided by the SEC and its staff for affiliated transactions.
    • Classification of portfolio investments: Rule 22e-4 requires funds to review their portfolio investments’ liquidity classifications more frequently than monthly if changes in relevant market, trading, and investment-specific considerations are reasonably expected to materially affect classifications. Such reviews should focus especially on holdings that could be considered illiquid investments as a result of these developments or that could fall out of highly liquid investment status. An important consideration will be a review of the reasonably anticipated trading sizes in light of redemption expectations. Funds should be alert to the possibility that vendor classifications may be based on historical rather than current data.
    • Highly liquid investment minimum: For funds that currently hold primarily highly liquid assets, and therefore are not required to have an HLIM, the program administrator may need to examine whether the fund can still qualify for that status. For HLIM funds, the HLIM may need to be reviewed under the required factors in light of current market and redemption developments and, if a shortfall is reasonably anticipated, a shortfall response plan should be developed, which must include a plan for reporting shortfalls to the fund’s board.
    • Illiquid investments: During this period of extreme market volatility, the fund should monitor closely whether there is a need to reclassify holdings as illiquid investments. Funds should be prepared to file Form N-LIQUID if the fund’s illiquid assets exceed 15% of its net assets. The program administrator should have guidance designed to prevent purchases that would violate the prohibition on acquiring illiquid investments when over the 15% limit. We do not yet know if the SEC will provide guidance relieving funds from filing Form N-LIQUID in the event of foreign or other market closings that are beyond the scope of existing guidance on extended foreign holidays.
    • Redemptions in kind: Funds may wish to consider whether redemptions in kind would be an appropriate tool for large redemption requests, including whether operational logistics are in place to accommodate any such redemption requests. (Updated 3/19/2020)
  • Form CRS: We understand that the SEC staff is considering whether brokers and advisers should be given relief from the Form CRS deadline. Unless such relief is given, compliance with the Form CRS requirement will be required as of June 30, 2020. (New 3/19/2020)
  • SEC Comment Periods: The SEC has issued a statement noting that the Commission and staff have historically considered comments submitted after a comment period closes but before adoption of a final rule or order.26 For certain pending rule proposals, including proposals concerning auditor independence, the accredited investor definition, and fund investments in derivatives, the SEC stated that it will not take final action before April 24 in order to allow commenters additional time if needed. (New 3/19/2020)
  • MiFID II Reporting: Under the MiFID II delegated regulation, investment firms providing the service of portfolio management and subject to MiFID II must inform the client where the overall value of the portfolio, as evaluated at the beginning of each reporting period, depreciates by 10% and thereafter at multiples of 10%, no later than the end of the business day in which the threshold is exceeded or, in a case where the threshold is exceeded on a non-business day, the close of the next business day.27 (New 3/19/2020)
  • Fund Boards: Fund directors should stay up to speed on current market events so they can properly apply their business judgment as necessary from a governance standpoint. In many cases, fund boards are receiving periodic status reports or attending status updates from fund advisers. Examples of areas for directors to consider include, for funds, fund flows, liquidity levels, valuation, and performance; and for fund advisers, status of operations under business continuity plans, market assessments, and the assessment of critical fund service providers. Board reporting from fund advisers is particularly important during times of market stress. To strike an appropriate balance between staying apprised and being efficient and respectful of fund advisory personnel time, boards may seek to channel questions or communications through independent counsel or the board chair/lead independent director. (New 3/19/2020)
  • Business Continuity Plans: Business continuity at the current time is key. In most cases, those plans already are in effect. Consideration should be given to contingency planning in the event that fund managers, transfer agents, pricing services, or other service providers are unable to provide services because of employee absences. Funds and fund managers should make and communicate revisions to their plans as they adjust to the developing environment.
  • Valuation: Funds should examine whether they are able to obtain valid prices for their investments, especially in markets that may be closed or have limited availability. Experience from the 2008 financial crisis shows that vendor reassurances as to the quality of their pricing information may provide false comfort, so vendor prices should be checked for reliability. At this time, we do not expect the SEC to provide relief from the daily pricing requirement.
  • Redemptions: Under Section 22(e) of the 1940 Act, open-end funds generally may not suspend the right of redemption unless the New York Stock Exchange is closed, or the SEC provides guidance that daily redemptions are not required because trading is restricted or an emergency exists. At this point, funds should assume that they must continue to provide daily redemptions. Funds should review any borrowing arrangements that may need to be utilized. We are closely monitoring for any relevant guidance from the SEC or its staff on this topic.
  • Cybersecurity: Firms are at increased risk of cyberattacks, particularly with the use of remote offices and telework. Anxious employees may be more vulnerable to email phishing attacks. Employees should be reminded of the continued need for vigilance.
  • Prospectus Disclosures: Funds should review their prospectus disclosures, and particularly their risk disclosures. It may be appropriate to add a pandemic risk factor if this risk is not already addressed. However, funds have different risk profiles, and there is no one-size-fits-all solution for the necessary disclosures.

Please do not hesitate to reach out to your Stradley Ronon contact, or to any member of Stradley’s Coronavirus Task Force, with any questions and concerns you may have during this period. You can reach Crovitz Sara at 202.507.6414 or scrovitz@stradley.com, or John Baker at 202.419.8413 or jbaker@stradley.com.

______________

1 Investment Company Institute, SEC No-Action Letter (Mar. 26, 2020), https://www.sec.gov/investment/investment-company-institute-032620-17a.
2 Money Market Mutual Funds Template Letter (Mar. 17, 2020), https://www.federalreserve.gov/supervisionreg/legalinterpretations/fedreserseactint20200317.pdf.
3 Investment Company Institute, SEC No-Action Letter (Mar. 19, 2020), https://www.sec.gov/investment/investment-company-institute-031920-17a.
4 Press Release, Federal Reserve Board broadens program of support for the flow of credit to households and businesses by establishing a Money Market Mutual Fund Liquidity Facility (MMLF) (Mar. 18, 2020), https://www.federalreserve.gov/newsevents/pressreleases/monetary20200318a.htm.
5 Press Release, Federal Reserve Board expands its program of support for flow of credit to the economy by taking steps to enhance liquidity and functioning of crucial state and municipal money markets (Mar. 20, 2020) https://www.federalreserve.gov/newsevents/pressreleases/monetary20200320b.htm.
6 Policy Tools: Money Market Mutual Fund Liquidity Facility, https://www.federalreserve.gov/monetarypolicy/mmlf.htm.
7 H.R. 748, § 4015, 116th Cong. (2020), https://www.congress.gov/116/bills/hr748/BILLS-116hr748enr.pdf.
8 Release No. IC-33821 (Mar. 23, 2020), https://www.sec.gov/rules/other/2020/ic-33821.pdf.
9 Recent interfund lending orders are available at https://www.sec.gov/rules/icreleases.shtml#interfundlending.
10 OCIE Statement on Operations and Exams – Health, Safety, Investor Protection and Continued Operations are our Priorities (Mar. 20, 2020), https://www.sec.gov/ocie/announcement/ocie-statement-operations-health-safety-investor-protection-and-continued.
11 Staff Statement Regarding Rule 302(b) of Regulation S-T in Light of COVID-19 Concerns (Mar. 24, 2020), https://www.sec.gov/corpfin/announcement/staff-statement-regarding-rule-302b-regulation-s-t-light-covid-19-concerns.
12 Frequently Asked Questions Related to Regulatory Relief Due to the Coronavirus Pandemic (Mar. 24, 2020), https://www.finra.org/rules-guidance/guidance/faqs/coronavirus. FINRA guidance, updates, and other information on COVID-19 are available at https://www.finra.org/rules-guidance/key-topics/covid-19. Other self-regulatory organizations are also providing relief and guidance. See, e.g., Cboe Regulatory Circular 20-021 (Mar. 25, 2020), http://cdn.cboe.com/resources/regulation/circulars/regulatory/RC20-021-Filing-Extensions-for-Annual-Reports-and-FOCUS-Reports.pdf; Cboe Regulatory Circular 20-022 (Mar. 25, 2020), http://cdn.cboe.com/resources/regulation/circulars/regulatory/RC20-022-Extension-of-Time-for-Certain-Filings-Currently-Due-April-1-2020.pdf.
13 Novel Coronavirus COVID-19 Updates, https://www.nasaa.org/industry-resources/covid-19-updates/.
14 Release Nos. 33-10695, IC-33646 (Sept. 25, 2019), 84 Fed. Reg. 57162, 57178 (Oct. 24, 2019), https://www.federalregister.gov/d/2019-21250.
15 Policy Tools: Secondary Market Corporate Credit Facility, https://www.federalreserve.gov/monetarypolicy/smccf.htm.
16 For the 1940 Act Orders, see Release No. IC-33824 (Mar. 25, 2020), https://www.sec.gov/rules/other/2020/ic-33824.pdf; Release No. IC-33817 (Mar. 13, 2020), https://www.sec.gov/rules/other/2020/ic-33817.pdf. For the Advisers Act Orders, see IA-5469 (Mar. 25, 2020), https://www.sec.gov/rules/other/2020/ia-5469.pdf; Release No. IA-5463 (Mar. 13, 2020), https://www.sec.gov/rules/other/2020/ia-5463.pdf. The various forms of relief provided by the SEC are subject to conditions that are set out in the respective orders, such as subsequent ratification of votes, notice to the SEC of filing delays, and website disclosure of issues with the delivery of shareholder reports, prospectuses, and Form ADV client brochures.
17 Using IARD, Form ADV: Item 1.F, https://www.sec.gov/divisions/investment/iard/iardfaq.shtml#item1f.
18 Release No. 34-88465(Mar. 25, 2020), https://www.sec.gov/rules/exorders/2020/34-88465.pdf; Release No. 34-88318 (Mar. 4, 2020), https://www.sec.gov/rules/other/2020/34-88318.pdf.
19 Press Release 2020-73, SEC Extends Conditional Exemptions from Reporting and Proxy Delivery Requirements for Public Companies, Funds, and Investment Advisers Affected by Coronavirus Disease 2019 (COVID-19) (Mar. 25, 2020), https://www.sec.gov/news/press-release/2020-73; Press Release 2020-63, SEC Takes Targeted Action to Assist Funds and Advisers, Permits Virtual Board Meetings and Provides Conditional Relief from Certain Filing Procedures (Mar. 13, 2020), https://www.sec.gov/news/press-release/2020-63.
20 SEC Division of Investment Management, Staff Statement on Fund Board Meetings and Unforeseen or Emergency Circumstances Related to Coronavirus Disease 2019 (COVID-19) (Mar. 4, 2020), https://www.sec.gov/investment/staff-statement-im-covid-19.
21 Staff Guidance for Conducting Annual Meetings in Light of COVID-19 Concerns (Mar. 13, 2020), https://www.sec.gov/ocr/staff-guidance-conducting-annual-meetings-light-covid-19-concerns.
22 State “Shelter-in-Place” and “Stay-at-Home” Orders, https://www.finra.org/rules-guidance/key-topics/covid-19/shelter-in-place.
23 Release No. 34-8844 (Mar. 20, 2020), https://www.sec.gov/rules/exorders/2020/34-88448.pdf.
24 Press Release No. 8136-20, CFTC Issues Third Wave of Relief to Market Participants in Response to COVID-19 (Mar. 20, 2020), https://www.cftc.gov/PressRoom/PressReleases/8136-20.
25 Notice to Members I-20-15 (Mar. 23, 2020), https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=5218.
26 Comment Periods for Certain Pending Actions, https://www.sec.gov/rules/proposed.shtml.
27 European Commission Delegated Regulation art. 62, https://ec.europa.eu/transparency/regdoc/rep/3/2016/EN/3-2016-2398-EN-F1-1.PDF.

COVID-19 Coverage: Part 4 of 1940 Act Issues to Consider During the Pandemic

Stradley’s Coronavirus Task Force will be updating this high-level overview of coronavirus disease 2019 (COVID-19) related issues for registered investment companies and fund managers as developments warrant.

NEW ISSUES:

  • SEC Lending and Borrowing Relief: The SEC has issued an order providing additional flexibility for open-end funds (other than money market funds) and insurance company separate accounts registered as unit investment trusts to obtain short-term funding.1 The relief is available until a notice terminating it is issued, which will be at least two weeks from the date of the notice and no earlier than June 30, 2020. Prior to relying on any of the relief, the fund would have to notify SEC staff. In addition, interfund lending requires notification on a fund’s public website.
  • Fund affiliates may lend money to the fund on a collateralized basis, provided the board makes determinations that the borrowing is in the best interest of the fund and its shareholders and that it will be for the purposes of satisfying shareholder redemptions.
  • For fund families with an SEC order permitting an interfund lending and borrowing facility, a lending fund may lend up to 25% of its current net assets and the term may be for any period that does not extend beyond the expiration of the relief, notwithstanding the terms of the order, provided, among other conditions, that the board reasonably determines that the maximum term for interfund loans is appropriate. (Recent orders typically limit lending funds to 15% of current net assets and the term to seven days.)
  • For fund families without an interfund lending order, funds may lend and borrow in accordance with the terms of any such order issued within the past twelve months, with the same modifications.2
  • Funds are not required to seek shareholder approval if lending under the relief would violate a fundamental policy, provided that the board reasonably determines that the lending or borrowing is in the best interests of the fund and its shareholders. (New 3/27/2020)
  • OCIE Statement: The SEC’s Office of Compliance Inspections and Examinations has issued a statement that it has moved to conducting examinations off-site through correspondence, unless it is absolutely necessary to be on-site, and that it will work with registrants to ensure that its work can be conducted in a manner consistent with maintaining normal operations and with necessary or appropriate health and safety measures.3 OCIE also stated that reliance on regulatory relief will not be a risk factor utilized in determining whether OCIE commences an examination, and it encourages registrants to utilize available regulatory relief as needed. (New 3/27/2020)
  • Signatures on EDGAR Filings: The SEC staff has issued a statement on the manual signature and record requirements for documents filed electronically with the SEC.4 The staff will not recommend enforcement action if a signatory retains a document adopting the signature and provides the document to the filer for retention, with the time and date executed, and the filer establishes and maintains policies and procedures governing this process. (New 3/27/2020)
  • FINRA Guidance: FINRA has issued guidance that provides temporary relief and guidance with respect to a number of requirements, including filings that would otherwise be required for temporary relocations and the timing of FOCUS reports and certain other filings.5 The guidance will be available until FINRA publishes a Regulatory Notice announcing a termination date. (New 3/27/2020)
  • Blue Sky Guidance: A number of state and provincial securities regulators have published guidance that provides relief or other COVID-19-related updates.6 The North American Securities Administrators Association has established a resource page to collect these updates. (New 3/27/2020)

UPDATED ISSUES:

  • Market closures and market restrictions: A list of securities market closures and market restrictions is available here(Updated 3/27/2020)
  • Money Market Mutual Funds:
    • Form N-CR: Several money market funds have filed on Form N-CR to report financial support, and one money market fund has filed on Form N-CR to report a downward deviation of its shadow price by more than ¼ of 1 percent. An amended report is required to be filed within four business days of the provision of financial support or downward deviation that describes the reason for the support and terms of the support or the reason for the deviation, as applicable. (Updated 3/23/2020)
    • Purchases by Affiliated Banks: The Federal Reserve Board has issued a template exemptive letter allowing banks to purchase assets from affiliated money market funds, subject to certain conditions, including that the assets must be investment grade and purchased at fair market value.7 In addition, the SEC staff has granted no-action relief to permit certain bank affiliates of money market funds to purchase securities from the funds in accordance with the Federal Reserve Board guidance, but otherwise pursuant to rule 17a-9, subject to certain conditions.8 The SEC no-action letter does not affect the ability of other money market fund affiliates to purchase assets from the fund in accordance with rule 17a-9. (Updated 3/23/2020)
    • Liquidity Facility: The Federal Reserve Board has announced a Money Market Mutual Fund Liquidity Facility (MMLF) that is intended to assist money market funds in meeting demands for redemptions.9 Under the MMLF, the Federal Reserve Bank of Boston will lend to depository institutions and bank holding companies, taking as collateral assets purchased by the borrower from prime money market funds (i) concurrently with the borrowing or (ii) or on or after March 18, but before the opening of the facility. The facility is similar to the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility that operated from late 2008 to early 2010 but will purchase a broader range of assets. The Federal Reserve Board expanded the facility to cover certain assets purchased from tax-exempt municipal money market funds.10 The Federal Reserve Board has announced that the facility opened March 23, and full documentation and additional guidance are available.11 (Updated 3/23/2020)
    • Guaranty: The proposed Coronavirus Aid, Relief, and Economic Security Act (CARES Act), as approved by the Senate on March 25, would suspend the existing prohibition on the use of the Exchange Stabilization Fund for the establishment of any guaranty programs for the money market fund industry.12 Any such guarantee shall be limited to a guarantee of the total value of a shareholder’s account in a participating fund as of the close of business on the day before the announcement of the guarantee and terminate not later than December 31, 2020. This provision, if passed, would still require action by the Department of the Treasury to establish a Money Market Funds Guaranty Program. (Updated 3/27/2020)
  • Exchange-traded funds:
    • For an ETF that invests in foreign markets that close, the ETF may wish to consider whether to invest in alternative instruments, such as ADRs, in order to achieve the desired exposure to the foreign securities. In circumstances where there is no ability to make additional investments in appropriate alternative instruments, an ETF may wish to stop accepting creation unit purchases. The Commission previously has noted that ETFs generally may suspend the issuance of creation units only for a limited time and only due to extraordinary circumstances, such as when the markets on which the ETF’s portfolio holdings are traded are closed for a limited period of time.13 ETF issuers should be aware that any decision to suspend creations could have an impact on the arbitrage efficiency of the ETF and could lead to greater deviations between the market price of the ETF shares and the NAV of the shares. Like other open-end funds, ETFs cannot suspend redemptions unless the New York Stock Exchange is closed or there is appropriate guidance from the SEC. ETFs are permitted to charge transaction fees of up to 2% on redemptions. Such fees are designed to offset the costs of redemptions to the ETF. Some fixed-income ETFs that deliver cash redemptions instead of in-kind redemptions reportedly have increased their transaction fees on redemptions in light of increased transaction costs in the bond market. (Updated 3/23/2020)
    • On March 23, 2020, the Federal Reserve Bank of New York established the Secondary Market Corporate Credit Facility (SMCCF), which will purchase in the secondary market corporate bonds issued by investment grade U.S. companies and U.S.-listed ETFs whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds.14 The SMCCF would not be permitted to purchase more than 20% of the assets of any ETF as of March 22, 2020. The SMCCF will cease making such purchases no later than September 30, 2020, unless extended. (Updated 3/27/2020)
  • SEC Filings: The SEC updated its previous orders under both the 1940 Act and the Advisers Act to extend the time periods of the relief.15 Entities must notify the SEC staff and/or investors, as applicable, of the intent to rely on the relief, but generally no longer need to describe why they are relying on the order or estimate a date by which the required action will occur. The 1940 Act Orders provide relief from the timeliness requirements of Form N-CEN, Form N-PORT, and Form N-23C-2 when a fund is unable to meet a deadline due to circumstances related to current or potential effects of COVID-19. The relief for Forms N-CEN and N-PORT applies to filing obligations for which the original due date is on or after March 13 but on or prior to June 30, 2020, while the relief for Form N-23C-2 extends to August 15, 2020. The Advisers Act Orders provide timeliness relief for Form ADV and Form PF filings and for Form ADV Part 2 client delivery obligations for 45 days from the original due date, when the original due date is on or after March 13 but on or prior to June 30, 2020. The SEC previously posted staff guidance that Form ADV does not have to be updated to reflect temporary teleworking locations.16 The SEC has also provided relief from timeliness requirements for certain filings under the Securities Exchange Act of 1934.17 Note that filings not covered by the orders continue to be required on a timely basis, including filings on Form N-LIQUID, Form N-CR, and Form N-MFP, although it is possible that the SEC will consider issues with these forms on an individualized basis. The SEC provided information on contacting the staff with issues, including issues with these filings, in press releases announcing the actions.18 (Updated 3/27/2020)
  • In-person board meetings: The 1940 Act Orders allow fund boards to meet telephonically or by video conference to consider and vote on matters that would otherwise require an in-person vote. The relief applies whenever reliance upon it is necessary or appropriate due to circumstances related to current or potential effects of COVID-19 and is available until August 15, 2020. The SEC’s Division of Investment Management previously provided no-action relief for the period from March 4 to June 15.19 (Updated 3/27/2020)
  • Delivery of prospectuses and shareholder reports: The 1940 Act Orders also provide relief from the obligations to timely transmit annual and semiannual reports to shareholders and to file them with the SEC. The relief applies when the original due date is on or after March 13 but on or prior to June 30, 2020, and the fund is unable to prepare or transmit the report due to circumstances related to current or potential effects of COVID-19. In addition, the SEC announced that it would not provide a basis for an SEC enforcement action if a fund does not timely deliver a current prospectus because of circumstances related to COVID-19 when delivery was originally required during this period. The position is not available to an initial purchase by the investor of the fund’s shares. (Updated 3/27/2020)
  • Annual meetings: The SEC staff has provided guidance to both operating companies and funds that is intended to provide regulatory flexibility to companies seeking to change the date and location of the meetings and use new technologies, such as “virtual” shareholder meetings that avoid the need for in-person shareholder attendance, while at the same time ensuring that shareholders and other market participants are informed of any changes.20 The guidance notes that the ability to conduct a “virtual” meeting is governed by state law, where permitted, and the issuer’s governing documents. Note that companies seeking to conduct a virtual meeting may, under state law, need to have an appropriate process for shareholders to vote at the meeting. (Updated 3/27/2020)
  • State and Local Closures: Several states, counties and cities (e.g., California, Pennsylvania, New York and Illinois) have announced business closures in connection with “shelter-in-place” public health efforts to slow the spread of COVID-19. Some of the orders may contain broad exceptions for the financial services industry, while others may not. Beyond the direct impact on firms in those localities, review the location of service providers and the terms of these orders carefully to determine whether necessary support functions will remain available. FINRA has posted a resource page with links to state “shelter-in-place” and “stay-at-home” orders.21 (Updated 3/27/2020)

ISSUES:

  • Transfer Agents: The SEC provided a broad exemption for the period from March 16 to May 30 from requirements applicable to transfer agents except for the safeguarding requirement.22 Transfer agents relying on the relief must provide notice to the SEC by May 30. The SEC encourages transfer agents and the issuers for whom they act to inform affected security holders. (New 3/23/2020)
  • Tax implications for funds with institutional shareholders: For institutional funds with few shareholders, beware that the fund could fall into personal holding company status if at any time during the last half of the taxable year more than 50 percent in value of the fund’s shares are owned, directly or indirectly, by or for not more than 5 “individuals.” For purposes of this rule, employee pension trusts, private foundations, trusts forming part of a plan providing for the payment of supplemental unemployment compensation benefits, and a trust, a portion of which is permanently set aside or to be used exclusively for charitable purposes, are considered individuals. (New 3/23/2020)
  • CPO NFA Filings: The CFTC staff has provided no-action relief to commodity pool operators that extends certain filing deadlines.23 With respect to Form CPO-PQR filings under CFTC Regulation 4.27, Small and Mid-Sized CPOs have until May 15, 2020 to submit their annual filings for 2019, while Large CPOs have until July 15, 2020 to submit their filings for Q1 2020. For pool annual reports under CFTC Regulations 4.7(b)(3) or 4.22(c) that are due on or before April 30, 2020, the deadline for filing and distributing the report, which must include certified financial statements, has been extended until 45 days after the due date specified in the regulations. For monthly or quarterly reports to pool participants under CFTC Regulation 4.7(b)(2) or 4.22(b) for all reporting periods ending on or before April 30, 2020, the deadline for distribution to participants has been extended to 45 days after the end of the reporting period (instead of 30 days as stated in the regulations). The National Futures Association has issued similar relief for CPO Members and has provided commodity trading advisor Members with similar relief for NFA Form PR filings.24 (Updated 3/23/2020)
  • Liquidity risk management: Current developments raise a number of issues for the management of funds’ liquidity risk:
  • Assessment, management, and periodic review of liquidity risk: Funds should review fund liquidity risk in light of current and reasonably expected market events and redemption patterns and may need to consider appropriate mitigating steps for strengthening the fund’s ability to meet redemptions, including readying borrowing and other liquidity facilities.
  • Classification of portfolio investments: Rule 22e-4 requires funds to review their portfolio investments’ liquidity classifications more frequently than monthly if changes in relevant market, trading, and investment-specific considerations are reasonably expected to materially affect classifications. Such reviews should focus especially on holdings that could be considered illiquid investments as a result of these developments or that could fall out of highly liquid investment status. An important consideration will be a review of the reasonably anticipated trading sizes in light of redemption expectations. Funds should be alert to the possibility that vendor classifications may be based on historical rather than current data.
  • Highly liquid investment minimum: For funds that currently hold primarily highly liquid assets, and therefore are not required to have an HLIM, the program administrator may need to examine whether the fund can still qualify for that status. For HLIM funds, the HLIM may need to be reviewed under the required factors in light of current market and redemption developments and, if a shortfall is reasonably anticipated, a shortfall response plan should be developed, which must include a plan for reporting shortfalls to the fund’s board.
  • Illiquid investments: During this period of extreme market volatility, the fund should monitor closely whether there is a need to reclassify holdings as illiquid investments. Funds should be prepared to file Form N-LIQUID if the fund’s illiquid assets exceed 15% of its net assets. The program administrator should have guidance designed to prevent purchases that would violate the prohibition on acquiring illiquid investments when over the 15% limit. We do not yet know if the SEC will provide guidance relieving funds from filing Form N-LIQUID in the event of foreign or other market closings that are beyond the scope of existing guidance on extended foreign holidays.
  • Redemptions in kind: Funds may wish to consider whether redemptions in kind would be an appropriate tool for large redemption requests, including whether operational logistics are in place to accommodate any such redemption requests. (Updated 3/19/2020)
  • Form CRS: We understand that the SEC staff is considering whether brokers and advisers should be given relief from the Form CRS deadline. Unless such relief is given, compliance with the Form CRS requirement will be required as of June 30, 2020. (New 3/19/2020)
  • SEC Comment Periods: The SEC has issued a statement noting that the Commission and staff have historically considered comments submitted after a comment period closes but before adoption of a final rule or order.25 For certain pending rule proposals, including proposals concerning auditor independence, the accredited investor definition, and fund investments in derivatives, the SEC stated that it will not take final action before April 24 in order to allow commenters additional time if needed. (New 3/19/2020)
  • MiFID II Reporting: Under the MiFID II delegated regulation, investment firms providing the service of portfolio management and subject to MiFID II must inform the client where the overall value of the portfolio, as evaluated at the beginning of each reporting period, depreciates by 10% and thereafter at multiples of 10%, no later than the end of the business day in which the threshold is exceeded or, in a case where the threshold is exceeded on a non-business day, the close of the next business day.26 (New 3/19/2020)
  • Fund Boards: Fund directors should stay up to speed on current market events so they can properly apply their business judgment as necessary from a governance standpoint. In many cases, fund boards are receiving periodic status reports or attending status updates from fund advisers. Examples of areas for directors to consider include, for funds, fund flows, liquidity levels, valuation, and performance; and for fund advisers, status of operations under business continuity plans, market assessments, and the assessment of critical fund service providers. Board reporting from fund advisers is particularly important during times of market stress. To strike an appropriate balance between staying apprised and being efficient and respectful of fund advisory personnel time, boards may seek to channel questions or communications through independent counsel or the board chair/lead independent director. (New 3/19/2020)
  • Business continuity plans: Business continuity at the current time is key. In most cases, those plans already are in effect. Consideration should be given to contingency planning in the event that fund managers, transfer agents, pricing services, or other service providers are unable to provide services because of employee absences. Funds and fund managers should make and communicate revisions to their plans as they adjust to the developing environment.
  • Valuation: Funds should examine whether they are able to obtain valid prices for their investments, especially in markets that may be closed or have limited availability. Experience from the 2008 financial crisis shows that vendor reassurances as to the quality of their pricing information may provide false comfort, so vendor prices should be checked for reliability. At this time, we do not expect the SEC to provide relief from the daily pricing requirement.
  • Redemptions: Under Section 22(e) of the 1940 Act, open-end funds generally may not suspend the right of redemption unless the New York Stock Exchange is closed, or the SEC provides guidance that daily redemptions are not required because trading is restricted or an emergency exists. At this point, funds should assume that they must continue to provide daily redemptions. Funds should review any borrowing arrangements that may need to be utilized. We are closely monitoring for any relevant guidance from the SEC or its staff on this topic.
  • Cybersecurity: Firms are at increased risk of cyberattacks, particularly with the use of remote offices and telework. Anxious employees may be more vulnerable to email phishing attacks. Employees should be reminded of the continued need for vigilance.
  • Prospectus disclosures: Funds should review their prospectus disclosures, and particularly their risk disclosures. It may be appropriate to add a pandemic risk factor if this risk is not already addressed. However, funds have different risk profiles, and there is no one-size-fits-all solution for the necessary disclosures.

Please do not hesitate to reach out to your Stradley Ronon contact, or to any member of Stradley’s Coronavirus Task Force, with any questions and concerns you may have during this period. You can reach Sara Crovitz at 202.507.6414 or scrovitz@stradley.com, or John Baker at 202.419.8413 or jbaker@stradley.com.
________________

1 Release No. IC-33821 (Mar. 23, 2020), https://www.sec.gov/rules/other/2020/ic-33821.pdf.
2 Recent interfund lending orders are available at https://www.sec.gov/rules/icreleases.shtml#interfundlending.
3 OCIE Statement on Operations and Exams – Health, Safety, Investor Protection and Continued Operations are our Priorities (Mar. 20, 2020), https://www.sec.gov/ocie/announcement/ocie-statement-operations-health-safety-investor-protection-and-continued.
4 Staff Statement Regarding Rule 302(b) of Regulation S-T in Light of COVID-19 Concerns (Mar. 24, 2020), https://www.sec.gov/corpfin/announcement/staff-statement-regarding-rule-302b-regulation-s-t-light-covid-19-concerns.
5 Frequently Asked Questions Related to Regulatory Relief Due to the Coronavirus Pandemic (Mar. 24, 2020), https://www.finra.org/rules-guidance/guidance/faqs/coronavirus. FINRA guidance, updates, and other information on COVID-19 are available at https://www.finra.org/rules-guidance/key-topics/covid-19. Other self-regulatory organizations are also providing relief and guidance. See, e.g., Cboe Regulatory Circular 20-021 (Mar. 25, 2020), http://cdn.cboe.com/resources/regulation/circulars/regulatory/RC20-021-Filing-Extensions-for-Annual-Reports-and-FOCUS-Reports.pdf; Cboe Regulatory Circular 20-022 (Mar. 25, 2020), http://cdn.cboe.com/resources/regulation/circulars/regulatory/RC20-022-Extension-of-Time-for-Certain-Filings-Currently-Due-April-1-2020.pdf.
6 Novel Coronavirus COVID-19 Updates, https://www.nasaa.org/industry-resources/covid-19-updates/.
7 Money Market Mutual Funds Template Letter (Mar. 17, 2020), https://www.federalreserve.gov/supervisionreg/legalinterpretations/fedreserseactint20200317.pdf.
8 Investment Company Institute, SEC No-Action Letter (Mar. 19, 2020), https://www.sec.gov/investment/investment-company-institute-031920-17a.
9 Press Release, Federal Reserve Board broadens program of support for the flow of credit to households and businesses by establishing a Money Market Mutual Fund Liquidity Facility (MMLF) (Mar. 18, 2020), https://www.federalreserve.gov/newsevents/pressreleases/monetary20200318a.htm.
10 Press Release, Federal Reserve Board expands its program of support for flow of credit to the economy by taking steps to enhance liquidity and functioning of crucial state and municipal money markets (Mar. 20, 2020) https://www.federalreserve.gov/newsevents/pressreleases/monetary20200320b.htm.
11 Policy Tools: Money Market Mutual Fund Liquidity Facility, https://www.federalreserve.gov/monetarypolicy/mmlf.htm.
12 H.R. 748, § 4015, 116th Cong. (2020), https://www.appropriations.senate.gov/imo/media/doc/FINAL%20FINAL%20CARES%20ACT.pdf.
13 Release Nos. 33-10695, IC-33646 (Sept. 25, 2019), 84 Fed. Reg. 57162, 57178 (Oct. 24, 2019), https://www.federalregister.gov/d/2019-21250.
14 Policy Tools: Secondary Market Corporate Credit Facility, https://www.federalreserve.gov/monetarypolicy/smccf.htm.
15 For the 1940 Act Orders, see Release No. IC-33824 (Mar. 25, 2020), https://www.sec.gov/rules/other/2020/ic-33824.pdf; Release No. IC-33817 (Mar. 13, 2020), https://www.sec.gov/rules/other/2020/ic-33817.pdf. For the Advisers Act Orders, see IA-5469 (Mar. 25, 2020), https://www.sec.gov/rules/other/2020/ia-5469.pdf; Release No. IA-5463 (Mar. 13, 2020), https://www.sec.gov/rules/other/2020/ia-5463.pdf. The various forms of relief provided by the SEC are subject to conditions that are set out in the respective orders, such as subsequent ratification of votes, notice to the SEC of filing delays, and website disclosure of issues with the delivery of shareholder reports, prospectuses, and Form ADV client brochures.
16 Using IARD, Form ADV: Item 1.F, https://www.sec.gov/divisions/investment/iard/iardfaq.shtml#item1f.
17 Release No. 34-88465(Mar. 25, 2020), https://www.sec.gov/rules/exorders/2020/34-88465.pdf; Release No. 34-88318 (Mar. 4, 2020), https://www.sec.gov/rules/other/2020/34-88318.pdf.
18  Press Release 2020-73, SEC Extends Conditional Exemptions from Reporting and Proxy Delivery Requirements for Public Companies, Funds, and Investment Advisers Affected by Coronavirus Disease 2019 (COVID-19) (Mar. 25, 2020), https://www.sec.gov/news/press-release/2020-73; Press Release 2020-63, SEC Takes Targeted Action to Assist Funds and Advisers, Permits Virtual Board Meetings and Provides Conditional Relief from Certain Filing Procedures (Mar. 13, 2020), https://www.sec.gov/news/press-release/2020-63.
19 SEC Division of Investment Management, Staff Statement on Fund Board Meetings and Unforeseen or Emergency Circumstances Related to Coronavirus Disease 2019 (COVID-19) (Mar. 4, 2020), https://www.sec.gov/investment/staff-statement-im-covid-19.
20 Staff Guidance for Conducting Annual Meetings in Light of COVID-19 Concerns (Mar. 13, 2020), https://www.sec.gov/ocr/staff-guidance-conducting-annual-meetings-light-covid-19-concerns.
21 State “Shelter-in-Place” and “Stay-at-Home” Orders, https://www.finra.org/rules-guidance/key-topics/covid-19/shelter-in-place.
22 Release No. 34-8844 (Mar. 20, 2020), https://www.sec.gov/rules/exorders/2020/34-88448.pdf.
23  Press Release No. 8136-20, CFTC Issues Third Wave of Relief to Market Participants in Response to COVID-19 (Mar. 20, 2020), https://www.cftc.gov/PressRoom/PressReleases/8136-20.
24  Notice to Members I-20-15 (Mar. 23, 2020), https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=5218.
25 Comment Periods for Certain Pending Actions, https://www.sec.gov/rules/proposed.shtml.
26 European Commission Delegated Regulation art. 62, https://ec.europa.eu/transparency/regdoc/rep/3/2016/EN/3-2016-2398-EN-F1-1.PDF.

COVID-19 Coverage: Part 3 of 1940 Act Issues to Consider During the Pandemic

Stradley’s Coronavirus Task Force will be updating this high-level overview of coronavirus disease 2019 (COVID-19) related issues for registered investment companies and fund managers as developments warrant.

NEW ISSUES:

  • State and Local Closures: Several states, counties and cities (e.g., California, Pennsylvania, New York and Illinois) have announced business closures in connection with “shelter-in-place” public health efforts to slow the spread of COVID-19. Some of the orders may contain broad exceptions for the financial services industry, while others may not. Beyond the direct impact on firms in those localities, review the location of service providers and the terms of these orders carefully to determine whether necessary support functions will remain available. (New 3/23/2020)
  • Transfer Agents: The SEC provided a broad exemption for the period from March 16 to May 30 from requirements applicable to transfer agents except for the safeguarding requirement. Transfer agents relying on the relief must provide notice to the SEC by May 30. The SEC encourages transfer agents and the issuers for whom they act to inform affected security holders. (New 3/23/2020)
  • Tax implications for funds with institutional shareholders: For institutional funds with few shareholders, beware that the fund could fall into personal holding company status if at any time during the last half of the taxable year more than 50 percent in value of the fund’s shares are owned, directly or indirectly, by or for not more than 5 “individuals.” For purposes of this rule, employee pension trusts, private foundations, trusts forming part of a plan providing for the payment of supplemental unemployment compensation benefits, and a trust, a portion of which is permanently set aside or to be used exclusively for charitable purposes, are considered individuals. (New 3/23/2020)

UPDATED ISSUES:

  • Market closures and market restrictions: A list of securities market closures and market restrictions is available here(Updated 3/23/2020)
  • Money Market Mutual Funds:
    • Form N-CR: Several money market funds have filed on Form N-CR to report financial support, and one money market fund has filed on Form N-CR to report a downward deviation of its shadow price by more than ¼ of 1 percent. An amended report is required to be filed within four business days of the provision of financial support or downward deviation that describes the reason for the support and terms of the support or the reason for the deviation, as applicable.
    • Purchases by Affiliated BanksThe Federal Reserve Board has issued a template exemptive letter allowing banks to purchase assets from affiliated money market funds, subject to certain conditions, including that the assets must be investment grade and purchased at fair market value.1 In addition, the SEC staff has granted no-action relief to permit certain bank affiliates of money market funds to purchase securities from the funds in accordance with the Federal Reserve Board guidance, but otherwise pursuant to rule 17a-9, subject to certain conditions.2 The SEC no-action letter does not affect the ability of other money market fund affiliates to purchase assets from the fund in accordance with rule 17a-9.
    • Liquidity Facility: The Federal Reserve Board has announced a Money Market Mutual Fund Liquidity Facility (MMLF) that is intended to assist money market funds in meeting demands for redemptions.Under the MMLF, the Federal Reserve Bank of Boston will lend to depository institutions and bank holding companies, taking as collateral assets purchased by the borrower from prime money market funds (i) concurrently with the borrowing or (ii) or on or after March 18, but before the opening of the facility. The facility is similar to the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility that operated from late 2008 to early 2010 but will purchase a broader range of assets. The Federal Reserve Board expanded the facility to cover certain assets purchased from tax-exempt municipal money market funds.4 The Federal Reserve Board has announced that the facility will open today, March 23, and full documentation and additional guidance are now available.5
    • Guaranty: In addition, there are proposed congressional actions that would temporarily permit the use of the Exchange Stabilization Fund to guarantee money market funds. The Exchange Stabilization Fund was used for this purpose in 2008, but current law prohibits its use for the establishment of any future guaranty programs for the United States money market fund industry, so this would require legislation. See 12 U.S.C. § 5236. (Updated 3/23/2020)
  • Exchange-traded funds: For an ETF that invests in foreign markets that close, the ETF may wish to consider whether to invest in alternative instruments, such as ADRs, in order to achieve the desired exposure to the foreign securities. In circumstances where there is no ability to make additional investments in appropriate alternative instruments, an ETF may wish to stop accepting creation unit purchases. The Commission previously has noted that ETFs generally may suspend the issuance of creation units only for a limited time and only due to extraordinary circumstances, such as when the markets on which the ETF’s portfolio holdings are traded are closed for a limited period of time.ETF issuers should be aware that any decision to suspend creations could have an impact on the arbitrage efficiency of the ETF and could lead to greater deviations between the market price of the ETF shares and the NAV of the shares. Like other open-end funds, ETFs cannot suspend redemptions unless the New York Stock Exchange is closed or there is appropriate guidance from the SEC. ETFs are permitted to charge transaction fees of up to 2% on redemptions. Such fees are designed to offset the costs of redemptions to the ETF. Some fixed-income ETFs that deliver cash redemptions instead of in-kind redemptions reportedly have increased their transaction fees on redemptions in light of increased transaction costs in the bond market. (Updated 3/23/2020)
  • CPO NFA Filings: The CFTC staff has provided no-action relief to commodity pool operators that extends certain filing deadlines.7 With respect to Form CPO-PQR filings under CFTC Regulation 4.27, Small and Mid-Sized CPOs have until May 15, 2020 to submit their annual filings for 2019, while Large CPOs have until July 15, 2020 to submit their filings for Q1 2020. For pool annual reports under CFTC Regulations 4.7(b)(3) or 4.22(c) that are due on or before April 30, 2020, the deadline for filing and distributing the report, which must include certified financial statements, has been extended until 45 days after the due date specified in the regulations. For monthly or quarterly reports to pool participants under CFTC Regulation 4.7(b)(2) or 4.22(b) for all reporting periods ending on or before April 30, 2020, the deadline for distribution to participants has been extended to 45 days after the end of the reporting period (instead of 30 days as stated in the regulations). The National Futures Association has issued similar relief for CPO Members and has provided commodity trading advisor Members with similar relief for NFA Form PR filings.8 (Updated 3/23/2020)

ISSUES:

  • Liquidity risk management: Current developments raise a number of issues for the management of funds’ liquidity risk:
    • Assessment, management, and periodic review of liquidity risk: Funds should review fund liquidity risk in light of current and reasonably expected market events and redemption patterns and may need to consider appropriate mitigating steps for strengthening the fund’s ability to meet redemptions, including readying borrowing and other liquidity facilities.
    • Classification of portfolio investments: Rule 22e-4 requires funds to review their portfolio investments’ liquidity classifications more frequently than monthly if changes in relevant market, trading, and investment-specific considerations are reasonably expected to materially affect classifications. Such reviews should focus especially on holdings that could be considered illiquid investments as a result of these developments or that could fall out of highly liquid investment status. An important consideration will be a review of the reasonably anticipated trading sizes in light of redemption expectations. Funds should be alert to the possibility that vendor classifications may be based on historical rather than current data.
    • Highly liquid investment minimum: For funds that currently hold primarily highly liquid assets, and therefore are not required to have an HLIM, the program administrator may need to examine whether the fund can still qualify for that status. For HLIM funds, the HLIM may need to be reviewed under the required factors in light of current market and redemption developments and, if a shortfall is reasonably anticipated, a shortfall response plan should be developed, which must include a plan for reporting shortfalls to the fund’s board.
    • Illiquid investments: During this period of extreme market volatility, the fund should monitor closely whether there is a need to reclassify holdings as illiquid investments. Funds should be prepared to file Form N-LIQUID if the fund’s illiquid assets exceed 15% of its net assets. The program administrator should have guidance designed to prevent purchases that would violate the prohibition on acquiring illiquid investments when over the 15% limit. We do not yet know if the SEC will provide guidance relieving funds from filing Form N-LIQUID in the event of foreign or other market closings that are beyond the scope of existing guidance on extended foreign holidays.
    • Redemptions in kind: Funds may wish to consider whether redemptions in kind would be an appropriate tool for large redemption requests, including whether operational logistics are in place to accommodate any such redemption requests. (Updated 3/19/2020)
  • SEC Filings: The SEC’s 1940 Act Order (cited below) provides relief from the timeliness requirements of Form N-CEN, Form N-PORT, and Form N-23C-2 when a fund is unable to meet a deadline due to circumstances related to current or potential effects of COVID-19. The relief for Forms N-CEN and N-PORT applies to filing obligations for which the original due date is on or after March 13 but on or prior to April 30, 2020, while the relief for Form N-23C-2 extends to June 15, 2020. A separate order under the Investment Advisers Act of 1940 provides timeliness relief for Form ADV and Form PF filings and for Form ADV Part 2 client delivery obligations, when the original due date is on or after March 13 but on or prior to April 30, 2020,9 and the SEC has posted staff guidance that Form ADV does not have to be updated to reflect temporary teleworking locations.10 The SEC previously provided relief from timeliness requirements for certain filings under the Securities Exchange Act of 1934.11 Note that filings not covered by the orders continue to be required on a timely basis, including filings on Form N-LIQUID, Form N-CR, and Form N-MFP, although it is possible that the SEC will consider issues with these forms on an individualized basis. The SEC provided information on contacting the staff with issues, including issues with these filings, in a press release announcing the actions.12 (Updated 3/19/2020)
  • Form CRS: We understand that the SEC staff is considering whether brokers and advisers should be given relief from the Form CRS deadline. Unless such relief is given, compliance with the Form CRS requirement will be required as of June 30, 2020. (New 3/19/2020)
  • SEC Comment Periods: The SEC has issued a statement noting that the Commission and staff have historically considered comments submitted after a comment period closes but before adoption of a final rule or order.13 For certain pending rule proposals, including proposals concerning auditor independence, the accredited investor definition, and fund investments in derivatives, the SEC stated that it will not take final action before April 24 in order to allow commenters additional time if needed. (New 3/19/2020)
  • MiFID II Reporting: Under the MiFID II delegated regulation, investment firms providing the service of portfolio management and subject to MiFID II must inform the client where the overall value of the portfolio, as evaluated at the beginning of each reporting period, depreciates by 10% and thereafter at multiples of 10%, no later than the end of the business day in which the threshold is exceeded or, in a case where the threshold is exceeded on a non-business day, the close of the next business day.14 (New 3/19/2020)
  • Fund Boards: Fund directors should stay up to speed on current market events so they can properly apply their business judgment as necessary from a governance standpoint. In many cases, fund boards are receiving periodic status reports or attending status updates from fund advisers. Examples of areas for directors to consider include, for funds, fund flows, liquidity levels, valuation, and performance; and for fund advisers, status of operations under business continuity plans, market assessments, and the assessment of critical fund service providers. Board reporting from fund advisers is particularly important during times of market stress. To strike an appropriate balance between staying apprised and being efficient and respectful of fund advisory personnel time, boards may seek to channel questions or communications through independent counsel or the board chair/lead independent director. (New 3/19/2020)
  • In-person board meetings: On March 13, the SEC issued an order under the Investment Company Act of 1940 (“1940 Act Order”), allowing fund boards to meet telephonically or by video conference to consider and vote on matters that would otherwise require an in-person vote.15 The relief applies whenever reliance upon it is necessary or appropriate due to circumstances related to current or potential effects of COVID-19 and is available until June 15, 2020. The SEC’s Division of Investment Management previously provided no-action relief for the period from March 4 to June 15.16
  • Delivery of prospectuses and shareholder reports: The 1940 Act Order also provides relief from the obligations to timely transmit annual and semiannual reports to shareholders and to file them with the SEC. The relief applies when the original due date is on or after March 13 but on or prior to April 30, 2020, and the fund is unable to prepare or transmit the report due to circumstances related to current or potential effects of COVID-19. In addition, the SEC announced that it would not provide a basis for an SEC enforcement action if a fund does not timely deliver a current prospectus because of circumstances related to COVID-19 when delivery was originally required during this period. The position is not available to an initial purchase by the investor of the fund’s shares.
  • Business continuity plans: Business continuity at the current time is key. In most cases, those plans already are in effect. Consideration should be given to contingency planning in the event that fund managers, transfer agents, pricing services, or other service providers are unable to provide services because of employee absences. Funds and fund managers should make and communicate revisions to their plans as they adjust to the developing environment.
  • Valuation: Funds should examine whether they are able to obtain valid prices for their investments, especially in markets that may be closed or have limited availability. Experience from the 2008 financial crisis shows that vendor reassurances as to the quality of their pricing information may provide false comfort, so vendor prices should be checked for reliability. At this time, we do not expect the SEC to provide relief from the daily pricing requirement.
  • Redemptions: Under Section 22(e) of the 1940 Act, open-end funds generally may not suspend the right of redemption unless the New York Stock Exchange is closed, or the SEC provides guidance that daily redemptions are not required because trading is restricted or an emergency exists. At this point, funds should assume that they must continue to provide daily redemptions. Funds should review any borrowing arrangements that may need to be utilized. We are closely monitoring for any relevant guidance from the SEC or its staff on this topic.
  • Cybersecurity: Firms are at increased risk of cyberattacks, particularly with the use of remote offices and telework. Anxious employees may be more vulnerable to email phishing attacks. Employees should be reminded of the continued need for vigilance.
  • Prospectus disclosures: Funds should review their prospectus disclosures, and particularly their risk disclosures. It may be appropriate to add a pandemic risk factor if this risk is not already addressed. However, funds have different risk profiles, and there is no one-size-fits-all solution for the necessary disclosures.
  • Annual meetings: The SEC staff has provided guidance to both operating companies and funds that are intended to provide regulatory flexibility to companies seeking to change the date and location of the meetings and use new technologies, such as “virtual” shareholder meetings that avoid the need for in-person shareholder attendance, while at the same time ensuring that shareholders and other market participants are informed of any changes.17 The guidance notes that the ability to conduct a “virtual” meeting is governed by state law, where permitted, and the issuer’s governing documents.

Please do not hesitate to reach out to your Stradley Ronon contact, or to any member of Stradley’s Coronavirus Task Force, with any questions and concerns you may have during this period. You can reach Sara Crovitz at 202.507.6414 or scrovitz@stradley.com, or John Baker at 202.419.8413 or jbaker@stradley.com.

________________

1 Money Market Mutual Funds Template Letter (Mar. 17, 2020), https://www.federalreserve.gov/supervisionreg/legalinterpretations/fedreserseactint20200317.pdf.

2 Investment Company Institute, SEC No-Action Letter (Mar. 19, 2020), https://www.sec.gov/investment/investment-company-institute-031920-17a.

3 Press Release, Federal Reserve Board broadens program of support for the flow of credit to households and businesses by establishing a Money Market Mutual Fund Liquidity Facility (MMLF) (Mar. 18, 2020), https://www.federalreserve.gov/newsevents/pressreleases/monetary20200318a.htm.

4 Press Release, Federal Reserve Board expands its program of support for flow of credit to the economy by taking steps to enhance liquidity and functioning of crucial state and municipal money markets (Mar. 20, 2020) https://www.federalreserve.gov/newsevents/pressreleases/monetary20200320b.htm.

5 Policy Tools: Money Market Mutual Fund Liquidity Facility, https://www.federalreserve.gov/monetarypolicy/mmlf.htm.

6 Exchange-Traded Funds, Release Nos. 33-10695, IC-33646 (Sept. 25, 2019), 84 Fed. Reg. 57162, 57178 (Oct. 24, 2019).

7 Press Release No. 8136-20, CFTC Issues Third Wave of Relief to Market Participants in Response to COVID-19 (Mar. 20, 2020), https://www.cftc.gov/PressRoom/PressReleases/8136-20.

8 Notice to Members I-20-15 (Mar. 23, 2020), https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=5218.

9 Release No. IA-5463 (Mar. 13, 2020), https://www.sec.gov/rules/other/2020/ia-5463.pdf.

10 Using IARD, Form ADV: Item 1.F, https://www.sec.gov/divisions/investment/iard/iardfaq.shtml#item1f.

11 Release No. 34-88318 (Mar. 4, 2020), https://www.sec.gov/rules/other/2020/34-88318.pdf.

12 Press Release 2020-63, SEC Takes Targeted Action to Assist Funds and Advisers, Permits Virtual Board Meetings and Provides Conditional Relief from Certain Filing Procedures (Mar. 13, 2020), https://www.sec.gov/news/press-release/2020-63.

13 Comment Periods for Certain Pending Actions, https://www.sec.gov/rules/proposed.shtml.

14 European Commission Delegated Regulation art. 62, https://ec.europa.eu/transparency/regdoc/rep/3/2016/EN/3-2016-2398-EN-F1-1.PDF.

15 Release No. IC-33817 (Mar. 13, 2020), https://www.sec.gov/rules/other/2020/ic-33817.pdf. The various forms of relief provided by the SEC are subject to conditions that are set out in the respective orders, such as subsequent ratification of votes, notice to the SEC of filing delays, and website disclosure of issues with the delivery of shareholder reports, prospectuses, and Form ADV client brochures.

16 SEC Division of Investment Management, Staff Statement on Fund Board Meetings and Unforeseen or Emergency Circumstances Related to Coronavirus Disease 2019 (COVID-19) (Mar. 4, 2020), https://www.sec.gov/investment/staff-statement-im-covid-19.

17 Staff Guidance for Conducting Annual Meetings in Light of COVID-19 Concerns (Mar. 13, 2020), https://www.sec.gov/ocr/staff-guidance-conducting-annual-meetings-light-covid-19-concerns.

COVID-19 Coverage: Part 2 of 1940 Act Issues to Consider During the Pandemic

Stradley’s Coronavirus Task Force will be updating this high-level overview of coronavirus disease 2019 (COVID-19) related issues for registered investment companies and fund managers as developments warrant.

  • Market closures and market restrictions: A list of securities market closures and market restrictions is available here. (New 3/19/2020)
  • Money Market Mutual Fund Liquidity Facility: The Federal Reserve Board has announced a Money Market Mutual Fund Liquidity Facility (MMLF) that is intended to assist money market funds in meeting demands for redemptions.1 Under the MMLF, the Federal Reserve Bank of Boston will lend to depository institutions and bank holding companies, taking as collateral assets purchased by the borrower from prime money market funds (i) concurrently with the borrowing or (ii) or on or after March 18, but before the opening of the facility. The facility is similar to the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility that operated from late 2008 to early 2010, but will purchase a broader range of assets. In addition, the Department of the Treasury reportedly is seeking congressional action that would temporarily permit the use of the Exchange Stabilization Fund to guarantee money market funds. The Exchange Stabilization Fund was used for this purpose in 2008, but current law prohibits its use for the establishment of any future guaranty programs for the United States money market fund industry, so this would require legislation. See 12 U.S.C. § 5236. (New 3/19/2020)
  • Liquidity risk management: Current developments raise a number of issues for the management of funds’ liquidity risk:
    • Assessment, management, and periodic review of liquidity risk: Funds should review fund liquidity risk in light of current and reasonably expected market events and redemption patterns, and may need to consider appropriate mitigating steps for strengthening the fund’s ability to meet redemptions, including readying borrowing and other liquidity facilities.
    • Classification of portfolio investments: Rule 22e-4 requires funds to review their portfolio investments’ liquidity classifications more frequently than monthly if changes in relevant market, trading, and investment-specific considerations are reasonably expected to materially affect classifications. Such reviews should focus especially on holdings that could be considered illiquid investments as a result of these developments or that could fall out of highly liquid investment status. An important consideration will be a review of the reasonably anticipated trading sizes in light of redemption expectations. Funds should be alert to the possibility that vendor classifications may be based on historical rather than current data.
    • Highly liquid investment minimum: For funds that currently hold primarily highly liquid assets, and therefore are not required to have an HLIM, the program administrator may need to examine whether the fund can still qualify for that status. For HLIM funds, the HLIM may need to be reviewed under the required factors in light of current market and redemption developments and, if a shortfall is reasonably anticipated, a shortfall remediation plan should be developed.
    • Illiquid investments: During this period of extreme market volatility, the fund should monitor closely whether there is a need to reclassify holdings as illiquid investments. Funds should be prepared to file Form N-LIQUID if the fund’s illiquid assets exceed 15% of its net assets. The program administrator should have guidance designed to prevent purchases that would violate the prohibition on acquiring illiquid investments when over the 15% limit. We do not yet know if the SEC will provide guidance relieving funds from filing Form N-LIQUID in the event of foreign or other market closings that are beyond the scope of existing guidance on extended foreign holidays.
    • Redemptions in kind: Funds may wish to consider whether redemptions in kind would be an appropriate tool for large redemption requests, including whether operational logistics are in place to accommodate any such redemption requests. (Updated 3/19/2020)
  • Exchange-traded funds: For an ETF that invests in foreign markets that close, the ETF may wish to consider whether to invest in alternative instruments, such as ADRs, in order to achieve the desired exposure to the foreign securities. In circumstances where there is no ability to make additional investments in appropriate alternative instruments, an ETF may wish to stop accepting creation unit purchases. The Commission previously has noted that ETFs generally may suspend the issuance of creation units only for a limited time and only due to extraordinary circumstances, such as when the markets on which the ETF’s portfolio holdings are traded are closed for a limited period of time.2 ETF issuers should be aware that any decision to suspend creations could have an impact on the arbitrage efficiency of the ETF and could lead to greater deviations between the market price of the ETF shares and the NAV of the shares. Like other open-end funds, ETFs cannot suspend redemptions unless the New York Stock Exchange is closed or there is appropriate guidance from the SEC. (Updated 3/19/2020)
  • SEC Filings: The SEC’s 1940 Act Order (cited below) provides relief from the timeliness requirements of Form N-CEN, Form N-PORT, and Form N-23C-2 when a fund is unable to meet a deadline due to circumstances related to current or potential effects of COVID-19. The relief for Forms N-CEN and N-PORT applies to filing obligations for which the original due date is on or after March 13 but on or prior to April 30, 2020, while the relief for Form N-23C-2 extends to June 15, 2020. A separate order under the Investment Advisers Act of 1940 provides timeliness relief for Form ADV and Form PF filings and for Form ADV Part 2 client delivery obligations, when the original due date is on or after March 13 but on or prior to April 30, 2020,3 and the SEC has posted staff guidance that Form ADV does not have to be updated to reflect temporary teleworking locations.4 The SEC previously provided relief from timeliness requirements for certain filings under the Securities Exchange Act of 1934.Note that filings not covered by the orders continue to be required on a timely basis, including filings on Form N-LIQUID, Form N-CR, and Form N-MFP, although it is possible that the SEC will consider issues with these forms on an individualized basis. The SEC provided information on contacting the staff with issues, including issues with these filings, in a press release announcing the actions.6 (Updated 3/19/2020)
  • Form CRS: We understand that the SEC staff is considering whether brokers and advisers should be given relief from the Form CRS deadline. Unless such relief is given, compliance with the Form CRS requirement will be required as of June 30, 2020. (New 3/19/2020)
  • CPO NFA Filings: We understand that the CFTC staff is considering extending relief to commodity pool operators to postpone the deadline for filing annual audited financial statements and extending the requirement to furnish monthly or quarterly reports to pool participants under CFTC Regulations 4.7 and 4.22 and related regulations. Unless and until such relief is provided, CPOs continue to be subject to existing deadlines. We also understand that firms seeking an extension to file pool financial statements with the National Futures Association must individually file extension requests using NFA’s EasyFile system.7 NFA can only grant a Rule 4.22(f) extension if the firm files the request before the statement’s due date. Otherwise, the firm must obtain relief from the CFTC. (New 3/19/2020)
  • SEC Comment Periods: The SEC has issued a statement noting that the Commission and staff have historically considered comments submitted after a comment period closes but before adoption of a final rule or order.8 For certain pending rule proposals, including proposals concerning auditor independence, the accredited investor definition, and fund investments in derivatives, the SEC stated that it will not take final action before April 24 in order to allow commenters additional time if needed. (New 3/19/2020)
  • MiFID II Reporting: Under the MiFID II delegated regulation, investment firms providing the service of portfolio management and subject to MiFID II must inform the client where the overall value of the portfolio, as evaluated at the beginning of each reporting period, depreciates by 10% and thereafter at multiples of 10%, no later than the end of the business day in which the threshold is exceeded or, in a case where the threshold is exceeded on a non-business day, the close of the next business day.9 (New 3/19/2020)
  • Fund Boards: Fund directors should stay up to speed on current market events so they can properly apply their business judgment as necessary from a governance standpoint.  In many cases, fund boards are receiving periodic status reports or attending status updates from fund advisers. Examples of areas for directors to consider include, for funds, fund flows, liquidity levels, valuation, and performance; and for fund advisers, status of operations under business continuity plans, market assessments, and the assessment of critical fund service providers.  Board reporting from fund advisers is particularly important during times of market stress. To strike an appropriate balance between staying apprised and being efficient and respectful of fund advisory personnel time, boards may seek to channel questions or communications through independent counsel or the board chair/lead independent director. (New 3/19/2020)
  • In-person board meetings: On March 13, the SEC issued an order under the Investment Company Act of 1940 (“1940 Act Order”), allowing fund boards to meet telephonically or by video conference to consider and vote on matters that would otherwise require an in-person vote.10 The relief applies whenever reliance upon it is necessary or appropriate due to circumstances related to current or potential effects of COVID-19 and is available until June 15, 2020. The SEC’s Division of Investment Management previously provided no-action relief for the period from March 4 to June 15.11
  • Delivery of prospectuses and shareholder reports: The 1940 Act Order also provides relief from the obligations to timely transmit annual and semiannual reports to shareholders and to file them with the SEC. The relief applies when the original due date is on or after March 13 but on or prior to April 30, 2020, and the fund is unable to prepare or transmit the report due to circumstances related to current or potential effects of COVID-19. In addition, the SEC announced that it would not provide a basis for an SEC enforcement action if a fund does not timely deliver a current prospectus because of circumstances related to COVID-19, when delivery was originally required during this period. The position is not available to an initial purchase by the investor of the fund’s shares.
  • Business continuity plans: Business continuity at the current time is key. In most cases, those plans already are in effect. Consideration should be given to contingency planning in the event that fund managers, transfer agents, pricing services, or other service providers are unable to provide services because of employee absences. Funds and fund managers should make and communicate revisions to their plans as they adjust to the developing environment.
  • Valuation: Funds should examine whether they are able to obtain valid prices for their investments, especially in markets that may be closed or have limited availability. Experience from the 2008 financial crisis shows that vendor reassurances as to the quality of their pricing information may provide false comfort, so vendor prices should be checked for reliability. At this time, we do not expect the SEC to provide relief from the daily pricing requirement.
  • Redemptions: Under Section 22(e) of the 1940 Act, open-end funds generally may not suspend the right of redemption unless the New York Stock Exchange is closed, or the SEC provides guidance that daily redemptions are not required because trading is restricted or an emergency exists. At this point, funds should assume that they must continue to provide daily redemptions. Funds should review any borrowing arrangements that may need to be utilized. We are closely monitoring for any relevant guidance from the SEC or its staff on this topic.
  • Cybersecurity: Firms are at increased risk of cyberattacks, particularly with the use of remote offices and telework. Anxious employees may be more vulnerable to email phishing attacks. Employees should be reminded of the continued need for vigilance.
  • Prospectus disclosures: Funds should review their prospectus disclosures, and particularly their risk disclosures. It may be appropriate to add a pandemic risk factor if this risk is not already addressed. However, funds have different risk profiles, and there is no one-size-fits-all solution for the necessary disclosures.
  • Annual meetings: The SEC staff has provided guidance to both operating companies and funds that is intended to provide regulatory flexibility to companies seeking to change the date and location of the meetings and use new technologies, such as “virtual” shareholder meetings that avoid the need for in-person shareholder attendance, while at the same time ensuring that shareholders and other market participants are informed of any changes.12 The guidance notes that the ability to conduct a “virtual” meeting is governed by state law, where permitted, and the issuer’s governing documents.

Please do not hesitate to reach out to your Stradley Ronon contact, or to any member of Stradley’s Coronavirus Task Force, with any questions and concerns you may have during this period. You can reach Sara Crovitz at 202.507.6414 or scrovitz@stradley.com, or John Baker at 202.419.8413 or jbaker@stradley.com.

____________________

1 Press Release, Federal Reserve Board broadens program of support for the flow of credit to households and businesses by establishing a Money Market Mutual Fund Liquidity Facility (MMLF) (Mar. 18, 2020), https://www.federalreserve.gov/newsevents/.
2 Exchange-Traded Funds, Release Nos. 33-10695, IC-33646 (Sept. 25, 2019), 84 Fed. Reg. 57162, 57178 (Oct. 24, 2019).
3 Release No. IA-5463 (Mar. 13, 2020), https://www.sec.gov/rules/other/2020/ia-5463.pdf.
4 Using IARD, Form ADV: Item 1.F, https://www.sec.gov/divisions/investment/iard/.
5 Release No. 34-88318 (Mar. 4, 2020), https://www.sec.gov/rules/other/2020/34-88318.pdf.
6 Press Release 2020-63, SEC Takes Targeted Action to Assist Funds and Advisers, Permits Virtual Board Meetings and Provides Conditional Relief from Certain Filing Procedures (Mar. 13, 2020), https://www.sec.gov/news/press-release/2020-63.
7 See CPO Help Guide: Filing Extensions and Notice Filings with NFA, https://www.nfa.futures.org/electronic-filing-systems/.
8 Comment Periods for Certain Pending Actions, https://www.sec.gov/rules/proposed.shtml.
9 European Commission Delegated Regulation art. 62, https://ec.europa.eu/transparency/regdoc/.
10 Release No. IC-33817 (Mar. 13, 2020), https://www.sec.gov/rules/other/2020/ic-33817.pdf. The various forms of relief provided by the SEC are subject to conditions that are set out in the respective orders, such as subsequent ratification of votes, notice to the SEC of filing delays, and website disclosure of issues with the delivery of shareholder reports, prospectuses, and Form ADV client brochures.
11 SEC Division of Investment Management, Staff Statement on Fund Board Meetings and Unforeseen or Emergency Circumstances Related to Coronavirus Disease 2019 (COVID-19) (Mar. 4, 2020), https://www.sec.gov/investment/staff-statement-im-covid-19.
12 Staff Guidance for Conducting Annual Meetings in Light of COVID-19 Concerns (Mar. 13, 2020), https://www.sec.gov/ocr/staff-guidance-conducting-annual-meetings-light-covid-19-concerns.

COVID-19 Coverage: Part 1 of 1940 Act Issues to Consider During the Pandemic

In light of the outbreak of coronavirus disease 2019 (COVID-19) and operational disruptions throughout the world, below is a short list of issues that registered investment companies and fund managers should consider at the current time.

  • In-person board meetings: On March 13, the SEC issued an order under the Investment Company Act of 1940 (“1940 Act Order”), allowing fund boards to meet telephonically or by video conference to consider and vote on matters that would otherwise require an in-person vote.1 The relief applies whenever reliance upon it is necessary or appropriate due to circumstances related to current or potential effects of COVID-19 and is available until June 15, 2020. The SEC’s Division of Investment Management previously provided no-action relief for the period from March 4 to June 15.2
  • SEC filings: The 1940 Act Order also provides relief from the timeliness requirements of Form N-CEN, Form N-PORT, and Form N-23C-2, when a fund is unable to meet a deadline due to circumstances related to current or potential effects of COVID-19. The relief for Forms N-CEN and N-PORT applies to filing obligations for which the original due date is on or after March 13 but on or prior to April 30, 2020, while the relief for Form N-23C-2 extends to June 15, 2020. A separate order under the Investment Advisers Act of 1940 provides timeliness relief for Form ADV and Form PF filings and for Form ADV Part 2 client delivery obligations, when the original due date is on or after March 13 but on or prior to April 30, 2020.3 The SEC previously provided relief from timeliness requirements for certain filings under the Securities Exchange Act of 1934.Note that filings not covered by the orders continue to be required on a timely basis, including filings on Form N-LIQUID, Form N-CR, and Form N-MFP, although it is possible that the SEC will consider issues with these forms on an individualized basis. The SEC provided information on contacting the staff with issues, including issues with these filings, in a press release announcing the actions.5
  • Delivery of prospectuses and shareholder reports: The 1940 Act Order also provides relief from the obligations to timely transmit annual and semiannual reports to shareholders and to file them with the SEC. The relief applies when the original due date is on or after March 13 but on or prior to April 30, 2020, and the fund is unable to prepare or transmit the report due to circumstances related to current or potential effects of COVID-19. In addition, the SEC announced that it would not provide a basis for an SEC enforcement action if a fund does not timely deliver a current prospectus because of circumstances related to COVID-19, when delivery was originally required during this period. The position is not available to an initial purchase by the investor of the fund’s shares.
  • Business continuity plans: Business continuity at the current time is key. In most cases, those plans already are in effect. Consideration should be given to contingency planning in the event that fund managers, transfer agents, pricing services, or other service providers are unable to provide services because of employee absences. Funds and fund managers should make and communicate revisions to their plans as they adjust to the developing environment.
  • Liquidity risk management: Fund holdings might become illiquid or less liquid should markets close or freeze up, or if market depth in some securities or asset classes is significantly reduced. Under these circumstances, liquidity risk management program administrators should be prepared to reclassify the liquidity classifications for some classes of investments and to take any other actions necessary to manage liquidity under their liquidity risk management programs. If a fund’s illiquid assets exceed 15% of its net assets, or if its highly liquid investments fall below its highly liquid investment minimum (“HLIM”) for more than seven consecutive calendar days, the fund will be required to promptly report to the fund’s board and to the SEC on Form N-LIQUID. Program administrators should have these communication protocols prepared. In addition, for those funds that currently hold primarily highly liquid assets, and therefore are not required to have an HLIM, the administrator should examine whether the fund can still qualify for that status.
  • Valuation: Funds should examine whether they are able to obtain valid prices for their investments, especially in markets that may be closed or have limited availability. Experience from the 2008 financial crisis shows that vendor reassurances as to the quality of their pricing information may provide false comfort, so vendor prices should be checked for reliability. At this time, we do not expect the SEC to provide relief from the daily pricing requirement.
  • Redemptions: Under Section 22(e) of the 1940 Act, open-end funds generally may not suspend the right of redemption unless the New York Stock Exchange is closed, or the SEC provides guidance that daily redemptions are not required because trading is restricted or an emergency exists. At this point, funds should assume that they must continue to provide daily redemptions. Funds should review any borrowing arrangements that may need to be utilized. We are closely monitoring for any relevant guidance from the SEC or its staff on this topic.
  • Cybersecurity: Firms are at increased risk of cyberattacks, particularly with the use of remote offices and telework. Anxious employees may be more vulnerable to email phishing attacks. Employees should be reminded of the continued need for vigilance.
  • Prospectus disclosures: Funds should review their prospectus disclosures, and particularly their risk disclosures. It may be appropriate to add a pandemic risk factor if this risk is not already addressed. However, funds have different risk profiles, and there is no one-size-fits-all solution for the necessary disclosures.
  • Annual meetings: The SEC staff has provided guidance to both operating companies and funds that is intended to provide regulatory flexibility to companies seeking to change the date and location of the meetings and use new technologies, such as “virtual” shareholder meetings that avoid the need for in-person shareholder attendance, while at the same time ensuring that shareholders and other market participants are informed of any changes.6 The guidance notes that the ability to conduct a “virtual” meeting is governed by state law, where permitted, and the issuer’s governing documents.
  • Exchange-traded funds: ETFs should consider many of the issues outlined above, including the ETF-specific provisions in the liquidity risk management rule, as well as the potential widening of premiums or discounts.
  • Money market funds: Money market funds may face their own liquidity and valuation challenges and reporting requirements, which will vary depending on the type of money market fund at issue.

Please do not hesitate to reach out to your Stradley Ronon contact, or to any member of Stradley’s Coronavirus Task Force, with any questions and concerns you may have during this period. You can reach Sara Crovitz at 202.507.6414 or scrovitz@stradley.com, or John Baker at 202.419.8413 or jbaker@stradley.com.

_________

1 Release No. IC-33817 (Mar. 13, 2020), https://www.sec.gov/rules/other/2020/ic-33817.pdf. The various forms of relief provided by the SEC are subject to conditions that are set out in the respective orders, such as subsequent ratification of votes, notice to the SEC of filing delays, and website disclosure of issues with the delivery of shareholder reports, prospectuses, and Form ADV client brochures.
2 SEC Division of Investment Management, Staff Statement on Fund Board Meetings and Unforeseen or Emergency Circumstances Related to Coronavirus Disease 2019 (COVID-19) (Mar. 4, 2020), https://www.sec.gov/investment/staff-statement-im-covid-19.
3 Release No. IA-5463 (Mar. 13, 2020), https://www.sec.gov/rules/other/2020/ia-5463.pdf.
4 Release No. 34-88318 (Mar. 4, 2020), https://www.sec.gov/rules/other/2020/34-88318.pdf.
5 Press Release 2020-63, SEC Takes Targeted Action to Assist Funds and Advisers, Permits Virtual Board Meetings and Provides Conditional Relief from Certain Filing Procedures (Mar. 13, 2020), https://www.sec.gov/news/press-release/2020-63.
6 Staff Guidance for Conducting Annual Meetings in Light of COVID-19 Concerns (Mar. 13, 2020), https://www.sec.gov/ocr/staff-guidance-conducting-annual-meetings-light-covid-19-concerns.

SEC Updates Form CRS FAQs

On February 11, 2020, the staff of the Securities and Exchange Commission (SEC) updated its Frequently Asked Questions on Form CRS with regard to a number of topics:

Legal Representative:  Similar to the update on Regulation Best Interest, the staff clarified that the term “legal representative” would not cover regulated financial services industry professionals including a workplace retirement plan representative (e.g., plan sponsor, trustee, other fiduciary), except in limited circumstances.  The staff further noted, however, that a formerly regulated financial services industry professional who is not currently regulated, would be considered a “non-professional” and, thus, a covered legal representative.

Delivery requirements: The staff clarified that where one adviser (Firm A) provides advice to another unaffiliated adviser (Firm B) but has no advisory contract (oral or written) with Firm B’s clients, absent other facts or circumstances that would indicate that Firm A provides investment advisory services to Firm B’s retail investor clients, Firm A would not be required to deliver a Form CRS to Firm B’s retail investor clients. The staff also indicated that an amendment to an existing account agreement solely to add another account holder or beneficiary would not trigger a Form CRS delivery requirement but that converting an account at a dual registrant from a brokerage account to advisory account (and presumably vice versa) would require delivery of Form CRS even if the investor initially received Form CRS upon opening the original account. The staff also clarified that a broker-dealer acting solely as a qualified custodian to an investment adviser’s retail investment advisory clients would not need to deliver a Form CRS. Finally, the staff discussed when a state-registered adviser transitioning to SEC registration is required to deliver its Form CRS.

Affiliates: The staff clarified that affiliated investment advisers (or affiliated broker-dealers) may create and deliver a combined Form CRS. The staff also indicated that a firm with multiple affiliates can combine disclosure in one Form CRS, but the staff cautioned that the page limits still apply and that the firm “should be mindful of the potential that additional information from multiple affiliates could “obscure or impede understanding.”  It also should be mindful that it is required “to present brokerage and investment advisory information with equal prominence and in a manner that clearly distinguishes and facilitates comparison.”

Sub-advisers: The staff stated that in circumstances where an adviser replaces a sub-adviser, and there are no changes to the advisory agreement, services, investments, or conflicts of interest that would make the information in the adviser’s Form CRS materially inaccurate, the staff would not object if the firm does not consider this a material change that would require the adviser to amend its Form CRS. The staff did not clarify the types of changes to the advisory agreement, services, investments or conflicts that would be considered material changes.

Disciplinary history: The staff clarified that a firm that reports disciplinary history related to its parent company in response to Item 11 on the firm’s Form ADV and Items 11A-K on the firm’s Form BD must answer “yes” to Item 4 in Form CRS.

Foreign language: Finally, the staff stated that it would not object to the delivery of a complete translation of Form CRS in a foreign language so long as the firm also delivers a separate English Form CRS at the same time.

SEC Proposes Expanded ‘Accredited Investor’ Definition

Introduction
On December 18, 2019, a divided SEC proposed amendments (the Proposal) to the definition of “accredited investor” under Rule 501(a) of Regulation Dby modestly expanding the categories of individuals and institutions that would qualify as accredited investors and, therefore, have access to the private markets.2  While such amendments, if adopted, would likely require most private fund managers to update their funds’ subscription agreements to reflect these new categories, the Proposal would be unlikely to expand significantly the pool of available investors for most private funds.3 In his public statement4 in connection with the Proposal, however, Chairman Jay Clayton framed the Proposal as “an important step . . . [with] more to come in this space in the coming months . . . .”5  Further, echoing language from the SEC’s June 2019 Concept Release,6 Chairman Clayton specifically referred to “examining whether appropriately structured funds can facilitate greater Main Street investor access to private investments . . . .”7

Below, please find a discussion of certain changes addressed in the Proposal that may be relevant to private fund managers.

Natural Persons with Professional Certifications 
In the Proposal, a majority of the SEC stated its belief that “relying solely upon financial thresholds may unduly restrict access to investment opportunities for individuals whose knowledge and experience render them capable of evaluating the merits and risks of a prospective investment . . . in a private offering, irrespective of their personal wealth.”As such, the proposed rule set forth in the Proposal (the Proposed Rule) would allow individuals with specified certifications, designations, or other credentials to qualify as accredited investors even if they do not meet the wealth or income tests currently in place. The SEC expects this category would initially include natural persons who hold either a Series 7 or Series 82 license or those who have taken and passed a Series 65 exam. Details, however, would be contained in a separate SEC order, which would provide the flexibility to add or delete particular qualifying certifications without additional rulemaking (i.e., without notice and comment or economic analysis).

Natural Persons Who Are Knowledgeable Employees of Private Funds 
In addition, the Proposed Rule would expand the definition of accredited investor to include “knowledgeable employees”
of private funds.10 This amendment would provide that knowledgeable employees would be eligible to invest in their employers’ funds even if they do not otherwise qualify as accredited investors under the financial threshold tests.

Financial Thresholds Unchanged 
In addition to requests for comment on the various proposed amendments, the Proposal also requests comment on whether the financial thresholds within the definition should be adjusted. As drafted, the Proposed Rule would not modify the current levels of $200,000, $1 million, and $5 million, which have been largely unchanged since 1982. Specifically, the Proposal requests comment on, among other things, whether indexing for inflation would be an appropriate benchmark. During the open meeting, Commissioner Allison H. Lee voiced her concern that, by not increasing the financial thresholds or adjusting them to reflect inflation, the Proposed Rule would “codify the toll that 37 years of inflation has already taken.”11

Clients of Registered Investment Advisers or Broker-Dealers as Accredited Investors 
Similarly, although not included in the Proposed Rule, the Proposal seeks comment on whether investors should be considered accredited if they are advised by a registered investment adviser or broker-dealer but do not otherwise meet the financial thresholds. Commissioner Robert J. Jackson, Jr. voiced his concern that such an approach would have a detrimental effect on investors, pointing to evidence that “brokers who put investors in private securities are unusually likely to be the subject of both customer complaints related to sales practices and regulatory inquiries about misconduct.”12 In response to Commissioner Jackson’s concern, Chairman Clayton noted that he views such an approach “with skepticism due to the lack of alignment of interests and sophistication.”13

Additional Proposed Changes 
The Proposed Rule also includes other additions and clarifications to Rule 501 as well as corresponding changes to other securities laws, certain of which are highlighted below:

  • Rule 501(a)(1) would be expanded to include registered investment advisers as well as any Rural Business Investment Company.14
  • Rule 501(a)(3) would be expanded to include limited liability companies, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5 million.
  • Rule 501(a)(5) and (6) would be expanded to include “spousal equivalents”15 under the net worth and income tests.16
  • Rule 501(a)(9) would be added as a “catch-all” to include any entity, not formed for the specific purpose of acquiring the securities offered, that owns investments17 in excess of $5 million.
  • Rule 501(a)(12) would be added to include any family office18 that, among other requirements, has at least $5 million in assets under management and whose prospective investment is directed by a person with certain financial sophistication.

Finally, in addition to the changes outlined above with respect to the definition of accredited investor for purposes of Regulation D, the Proposed Rule would make corresponding changes to applicable definitions within Rules 215, 163B and 144A under the Securities Act as well as Rule 15g-1 of the Securities and Exchange Act of 1934, as amended.

Conclusion
While the Proposed Rule would likely have a minimal impact on the fundraising audience available to most private fund managers, Chairman Clayton’s remarks make clear that the SEC will continue to focus on greater access for retail investors to private markets, “particularly as a component of an investment portfolio that is analogous to the portfolio of a well-managed pension fund.”19 Further, the Chairman went on to highlight his belief that:

it is important to focus on solutions that provide access to investment opportunities on substantially the same terms as those that would be available to institutional investors with protections – including alignment of interest between individuals and institutions, and transparency – that are akin to the protections in our public market. This alignment of interest is extremely important to me and I ask that commenters please recognize that I and many of my colleagues are skeptical of approaches that do not have either (1) demonstrated financial sophistication of the individual investor or (2) clear, ongoing alignment of interest with the sponsor.”20

 As such, if viewed in the broader context of the various topics explored in the Concept Release, which included, among other things registered feeder funds into private funds, modifications to the interval fund structure, and the ability to charge performance fees to registered funds, the Chairman’s remarks and the Proposal itself imply there could, indeed, potentially be “more to come.”

The comment period will close 60 days after the Proposal is published in the Federal Register.


1 Many private securities, including most private funds, are offered pursuant to an exemption from registration under Regulation D of the Securities Act of 1933, as amended (the Securities Act).

See Amending the “Accredited Investor” Definition, (proposed Dec. 18, 2019) (to be codified at 17 C.F.R. pts. 230, 240).

For example, the Proposal would not change the definition of “qualified client” under
Rule 205-3 of the Investment Advisers Act of 1940 (the Advisers Act), nor would it change the definition of “qualified purchaser” under Section 2(a)(51)(A) of the Investment Company Act of 1940 (the Investment Company Act).

Jay Clayton, Chairman, U.S. Sec. & Exch. Comm’n, “Modernizing the Accredited Investor Definition” (Dec. 18, 2019), (Clayton’s Remarks).

Id.

Concept Release on Harmonization of Securities Offering Exemptions, 84 Fed. Reg. 30,460 (proposed June 18, 2019) (to be codified at 17 C.F.R. pts. 210, 227, 230, 239, 240, 249, 270, 274, 275).

Clayton’s Remarks, supra note 4.

Proposal, supra note 2, at 27.

9 Under the Proposal, “knowledgeable employee” would be defined as it is under Investment Company Act Rule 3c-5(a)(4).

10 Funds excepted from the definition of investment company under Sections 3(c)(1) and 3(c)(7) of the Investment Company Act.

11 Allison H. Lee, Comm’r, U.S. Sec. & Exch. Comm’n, “Statement on the Proposed Expansion of the Accredited Investor Definition” (Dec. 18, 2019) (noting that the failure to increase the thresholds to account for 37 years of inflation reflects a 550% increase in the number of qualifying households and that, if not adjusted in the future, in 30 years, 57.3% of U.S. households would qualify).

12 Jay Clayton, Chairman, U.S. Sec. & Exch. Comm’n, Remarks During Open Meeting (Dec. 18, 2019), webcast available here (2:05:05–2:05:10).

13 Robert J. Jackson Jr., Comm’r, U.S. Sec. & Exch. Comm’n, “Statement on Reducing Investor Protections around Private Markets” (Dec. 18, 2019).

14 As defined pursuant to the Consolidated Farm and Rural Development Act.

15 Defined as “a cohabitant occupying a relationship generally equivalent to that of a spouse.” Proposal, supra note 2, at 152.

16 The staff also proposed adding a note to Rule 501(a)(5) to clarify that the calculation of “joint net worth” can be the aggregate net worth of an investor and his or her spouse or spousal equivalent and that the securities being purchased by an investor relying on the joint net worth test need not be purchased jointly.

17 As defined in Investment Company Act Rule 2a51-1(b).

18 As defined under Advisers Act Rule 202(a)(11)(G)-1. Note that Rule 501(a)(13) would also be added to include any “family client,” as defined under the same Advisers Act rule. Proposal, supranote 2, at 152.

19 Clayton’s Remarks, supra note 4.

20 Id.

Information contained in this publication should not be construed as legal advice or opinion or as a substitute for the advice of counsel. The articles by these authors may have first appeared in other publications. The content provided is for educational and informational purposes for the use of clients and others who may be interested in the subject matter. We recommend that readers seek specific advice from counsel about particular matters of interest.

Copyright © 2020 Stradley Ronon Stevens & Young, LLP. All rights reserved.

New SEC Proposal May Complicate Proxy Voting & Engagement by Advisers

At an open meeting on November 5, 2019, a majority of the Securities and Exchange Commission (“SEC”) voted to recommend two proposals amending the federal proxy rules.1Commissioners Robert Jackson Jr. and Allison Herren Lee opposed these proposals.2 The first proposal conditions reliance on certain existing exemptions under the proxy rules by proxy voting advice businesses such as Institutional Shareholder Services (“ISS”) and Glass Lewis, upon compliance with additional conflicts disclosure and procedural requirements, including permitting issuers to review and provide responses to proxy businesses’ reports.3 The second proposal would amend the proxy rules applicable to the submission of shareholder proposals, including enhanced eligibility requirements and more onerous resubmission limits. The components of each of these two proposals are summarized below. Comments on the proposals are due 60 days after publication in the Federal Register.

I. Amendments to Exemptions From the Proxy Rules for Proxy Voting Advice

The first proposal would amend the proxy rules applicable to companies that regularly provide proxy voting advice to asset managers and others (“proxy businesses”), such as ISS and Glass Lewis. The proposed amendments would (1) clarify that proxy businesses’ voting advice constitutes a solicitation, (2) require additional conflict disclosure in voting advice, (3) provide issuers up to two opportunities to review the proxy advice before it is delivered to clients, (4) provide issuers the opportunity to require in the advice that is delivered to clients a hyperlink to the issuer’s views on that advice and (5) enumerate specific examples of what may constitute misleading statements by proxy businesses. The proposed amendments would increase costs for proxy businesses and may shorten the amount of time asset manager clients have to review proxy advice prior to the vote.

  • Definition of “Solicitation.” The SEC’s proposal would amend the definition of “solicitation” under Rule 14a-1(l) and Section 14(a) to include any proxy voting advice that makes a recommendation to a shareholder as to its vote, consent or authorization on a specific matter for which shareholder approval is solicited and that is furnished by a person who markets such advice separately from other forms of investment advice and sells such advice for a fee.4 This definition encompasses voting recommendations promulgated under proxy businesses’ benchmark voting policies or sets of guidelines. The SEC emphasized that the definition of solicitation should continue to be construed broadly. However, the SEC clarified that it intended that proxy voting advice furnished by a person such as a broker-dealer or an investment adviser made only in response to unprompted client requests would continue to be excluded under the definition.
  • Conflicts of interest disclosures. Proposed Rule 14a-2(b)(9)(i) requires that persons who provide proxy voting advice and rely on the solicitation exemptions in Rules 14a-2(b)(1) or 14a-2(b)(3) provide additional written disclosures about material conflicts of interest in their proxy voting advice to clients.5
  • Timely review and feedback period. Proposed Rule 14a-2(b)(ii), as a condition of relying on exemptive Rules 14a-2(b)(1) and 14a-2(b)(3), would require a standardized opportunity for timely review and feedback by issuers and certain other soliciting persons of proxy voting advice before the advice is disseminated to the proxy business’ clients. This would be required regardless of whether the advice on the matter is adverse to an issuer’s own recommendation, subject to certain conditions.6 The proxy business can condition this receipt of proxy voting advice on the issuer agreeing to keep the contents of the proxy voting advice confidential. The length of time for review and feedback varies depending on how far in advance of the shareholder meeting the issuer has filed a proxy statement (see table below). The proxy business would not be required to accept any suggested revisions. However, in accepting or rejecting any revisions, the proxy business would be subject to Rule 14a-9, which prohibits any materially misleading misstatements or omissions.
  • Final notice of voting advice. In addition to the review and feedback period and as a condition of relying on the exemptions in Rules 14a-2(b)(1) and 14a-2(b)(3), proxy businesses would be required to provide a final notice of voting advice to issuers at least two business days prior to the delivery of the proxy voting advice to their clients. This is required regardless of whether the issuer commented on the version it received during the review and feedback period. This final notice should contain a copy of the proxy voting advice that the proxy business will deliver to its clients, including any revisions to the advice as a result of the review and feedback period. As in the review and feedback period, proxy businesses can condition an issuer’s receipt of the proxy voting advice on the issuer keeping the contents of the proxy voting advice confidential.
  • Hyperlink to issuer’s statement. Under proposed Rule 14a-2(b)(9)(iii), as a condition of relying on the exemptions in Rules 14a-2(b)(1) and 14a-2(b)(3), a proxy business must, upon request, include in its proxy voting advice and in any electronic medium used to deliver the advice a hyperlink (or other analogous electronic medium) that leads to a written statement by the issuer about its views of the proxy business’s voting advice, regardless of whether the advice is consistent with the issuer’s recommendation. Thus, asset managers relying on proxy voting advice could be confronted with conflicting views of facts or analysis in such advice with very little time to evaluate and determine whether such disagreements should impact the asset manager’s decision on how to vote. Notably, the SEC requested comments on whether proxy businesses should be required to disable the automatic submission of votes unless a client clicks on the hyperlink and/or accesses the issuer’s response or otherwise confirms any prepopulated voting choices before the proxy business submits the votes to be counted. Moreover, an asset manager’s determination to vote in accordance with a proxy business recommendation when such recommendation is subject to an issuer written statement could be subject to increased scrutiny.7
  • Anti-fraud provisions. Currently, Rule 14a-9 prohibits any proxy solicitation from containing false or misleading statements or omissions with respect to any material fact. Proposed Rule 14a-9 would elaborate on the current examples of what might constitute misleading information by including failure to disclose information such as the proxy business’s methodology, sources of information and conflicts of interest.

II. Procedural Requirements and Resubmission Thresholds Under Rule 14a-8

The second proposal would amend the shareholder proposal process to (1) provide a tiered approach for eligibility, (2) require certain documents when a proposal is submitted by a shareholder representative, (3) require shareholder-proponents to state when they would be able to meet with the issuer with respect to the proposal and (4) clarify that each shareholder may submit one proposal to an issuer for a particular shareholder meeting.

  • Ownership Eligibility Requirements. Currently, Rule 14a-8 requires a shareholder to have continuously held at least $2,000 in market value or 1% of the issuer’s securities for at least one year by the date the proposal is submitted. Under the proposed amendments, a shareholder would be able to submit a Rule 14a-8 proposal if the shareholder satisfies one of the three following continuous ownership requirements.

    Shareholders would not be allowed to aggregate their securities with other shareholders’ securities to meet the minimum ownership thresholds. This tiered approach reflects the SEC majority’s understanding that a shareholder’s long-term investment in an issuer’s securities makes it more likely that a shareholder’s proposal is meaningful to the issuer and not for personal gain.
  • Co-filing/co-sponsoring shareholder proposals. Under the proposed rules, shareholders would be able to continue to co-file or co-sponsor shareholder proposals as a group if each shareholder in the group meets the eligibility requirements.
  • Use of a representative to submit a shareholder proposal. To address issuers’ concerns about whether a shareholder truly supports the proposal submitted on his/her behalf, proposed amendments to Rule 14a-8 would require shareholders who use representatives to submit their proposals or otherwise act on their behalf in connection with the proposal to provide the issuer with written documentation confirming the representative has authority to act on behalf of the shareholder.
  • Shareholder engagement with the issuer. The SEC proposal also would require a statement from each shareholder-proponent that he/she is able to meet with the issuer in person or via teleconference no fewer than 10 calendar days nor more than 30 calendar days after submission of the shareholder proposal. The shareholder would also be required to include contact information, business days and specific times that he/she is available to discuss the proposal with the issuer.
  • One-proposal limit. Rule 14a-8(c) currently provides that each shareholder may submit no more than one proposal to an issuer for a shareholders’ meeting. The SEC proposed amendments to address issuer concerns that proponents try to evade the one-proposal limitation, for example, by a shareholder submitting a shareholder proposal in its own name and simultaneously serving as a representative to submit a different proposal on another shareholder’s behalf for consideration at the same meeting.
  • Resubmissions. Currently, under Rule 14a-8(i)(12), an issuer can exclude a proposal if the matter was voted on at least once in the past three years and did not receive at least (i) 3% of the vote if previously voted on once, (ii) 6% of the vote if previously voted on twice or (iii) 10% of the vote if previously voted on three or more times. The proposed amendments to the resubmission thresholds would raise the current resubmission thresholds from 3%, 6% and 10% to 5%, 15% and 25%.8 Shareholders would be allowed to resubmit substantially similar proposals after a three-year “cooling-off” period.
  • “Momentum” requirements. In addition to the proposed amendments to the resubmission thresholds, the SEC proposed to amend Rule 14a-8(i)(12) to allow issuers to exclude proposals dealing with substantially the same subject matter as proposals previously voted on by shareholders three or more times in the preceding five calendar years that would not otherwise be excludable under the proposed 25% threshold if (i) the most recently voted-on proposal received less than a majority of the vote cast and (ii) support declined by 10% or more compared to the immediately preceding shareholder vote on the matter. The proposal stated that the purpose of the amendment is to relieve management and shareholders from repeatedly considering proposals in which shareholder interest has declined.

III. Conclusion

With regard to the first proposal, the SEC would permit a one-year transition period after publication of the final rule in the Federal Register. Issuers receiving shareholder proposals for 2020 annual meetings should continue analyzing proposals under existing rules. Interested parties are encouraged to express their views during the 60-day comment period.

The two proposals are part of the SEC’s ongoing work to “enhance the accuracy, transparency and effectiveness of our proxy voting system.”9 The split vote on the proposals, however, reflects the ongoing debate over shareholder engagement. In particular, Commissioners Jackson and Lee expressed concerns that the proposals “shift power away from shareholders and toward management” and limit investors’ ability to “hold corporate insiders accountable.”10

___________

1 Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice, Release No. 38-87457 (Nov. 5, 2019); Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8, Release No. 34-87458 (Nov. 5, 2019).

2 Robert J. Jackson Jr., Commissioner, SEC, Statement on Proposals to Restrict Shareholder Voting (Nov. 5, 2019); Allison Herren Lee, Commissioner, SEC, Statement on Shareholder Rights (Nov. 5, 2019).

3 Rule 14a-2(b)(1) exempts solicitations by persons who do not seek the power to act as proxy for a shareholder and do not have a substantial interest in the subject matter of the communication beyond their interest as a shareholder. Rule 14a-2(b)(3) exempts proxy voting advice furnished by an adviser to any other person with whom the adviser has a business relationship.

4 The SEC’s proposed amendment would codify the definition from its recent proxy interpretation. Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice, Release No. 34-8671 (Aug. 21, 2019). The interpretation is subject to a lawsuit by Institutional Shareholder Services (“ISS”), which argued that proxy voting advice is not a solicitation. In addition, ISS challenged the interpretation on procedural grounds. Complaint, Institutional S’holder Servs. Inc. v. SEC, No. 1:19-cv-03275 (D.D.C. Oct. 31, 2019).

5 Currently, proxy businesses relying on the exemption under Rule 14a-2(b)(3) provide conflicts of interest disclosures, for example, on their websites. However, in its proposal, the SEC asserted these disclosures may be inadequate because they are often vague or boilerplate.

6 Proxy businesses would not be required to extend the timely review and feedback period or provide the final notice to persons conducting solicitations that are exempt pursuant to Rule 14a-2 or to shareholder-proponents who submit proposals pursuant to Rule 14a-8 and whose proposal will be voted upon at the issuer’s upcoming meeting.

7 In particular, the SEC’s recent guidance regarding proxy voting responsibilities of investment advisers includes a statement that for an investment adviser to form a reasonable belief that its voting determinations are in the best interest of the client, it should conduct a reasonable investigation into potential factual errors. Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, Release No. IA-5325 (Aug. 21, 2019).

8 Specifically, Rule 14a-8(i)(12) would provide that a shareholder proposal may be excluded from an issuer’s proxy material if “the proposal addresses substantially the same subject matter as a proposal previously included in the issuer’s proxy materials within the preceding five calendar years, and if the most recent vote occurred within the preceding three calendar years and was: (i) less than 5 percent of the votes cast if previously voted on once; (ii) less than 15 percent of the votes if previously voted on twice; and (iii) less than 25 percent of the votes if previously voted on three times or more.”

9 Jay Clayton, Chairman, SEC, Statement of Chairman Jay Clayton on Proposals to Enhance the Accuracy, Transparency and Effectiveness of Our Proxy Voting System (Nov. 5, 2019).

10 See supra note 2.

SEC Proposals Would Modernize Investment Adviser Advertising Rule & Expand the Cash Solicitation Rule

On November 4, 2019, the Securities and Exchange Commission (Commission) voted seriatim to issue proposed amendments to the rules under the Investment Advisers Act that prohibit certain investment adviser advertisements offering a more flexible principles-based approach, permitting, notably, testimonials and endorsements under certain circumstances. The proposed amendments, if adopted, would likely be welcomed relief to the industry, which has clamored for modernization of the advertising rules for years. The Commission also proposed amendments that would broaden the current cash solicitation rule to apply regardless of whether an adviser pays a solicitor cash or non-cash compensation and would apply to the solicitation of current and prospective investors in private funds.

Investment adviser advertisements

The proposed advertising rule: (i) modifies the definition of “advertisement,” including adding to the types of communications to cover broadcasts that are not live (e.g. webinars); (ii) replaces the current four per se prohibitions with a set of principles that are reasonably designed to prevent fraudulent or misleading conduct and practices; (iii) provides certain additional restrictions and conditions on testimonials, endorsements, and third-party ratings; and (iv) includes tailored requirements for the presentation of performance results, based on the sophistication of the intended audience (i.e. includes a new category of “non-retail” investors comprised of qualified purchasers and knowledgeable employees). The proposed rule also would require internal review and approval of most advertisements by a “designated employee.” It also would require each adviser to report additional information regarding its advertising practices in its Form ADV, which appears largely designed to assist examination staff.

Replacing the current strict prohibitions with a more flexible principles-based approach will be gratifying to the industry, which has requested such modernization for years. Under the proposal, for example, testimonials and endorsements would be permitted so long as the advertisement meets general anti-fraud type prohibitions, subject to certain disclosures about the person giving the testimonial or endorsement and any cash or non-cash compensation paid by or on behalf of the adviser. Similarly, the proposed rule replaces the prohibition on past specific recommendations with a “fair and balanced” approach, which also incorporates the sophistication of the intended audience. This should be welcomed by private fund advisers, particularly in the private equity context, where case studies are particularly helpful in explaining the adviser’s investing approach. Less welcomed for private fund advisers is that the proposal would specifically include private fund adviser advertising in scope despite the acknowledged “overlap” with current rule 206(4)-8.

Payments to solicitors

The proposed amendments would broaden the current cash solicitation rule to apply regardless of whether an adviser pays a solicitor cash or non-cash compensation (including free or discounted services, directed brokerage and awards or other prizes) and would apply to the solicitation of current and prospective investors in private funds. The Commission recognized that the broader rule could have unintended consequences. For example, to avoid capturing investors who participate in “refer-a-friend” programs, the proposed rule would add an exemption for certain de minimis compensation (i.e. $100 or the equivalent in non-cash compensation in a 12-month rolling period). The proposed amendments eliminate certain process and disclosure requirements but include additional disclosure about a solicitor’s conflict of interest.