Dear Clients and Friends,
As the developments affecting the investment management industry continue to unfold, we have once again prepared our semi-annual compendium of relevant Sidley Updates for our investment fund and adviser clients and friends.
The compendium includes a summary of each Sidley Update year-to-date, in reverse chronological order, along with a link to its full text. We have included all of the updates, making the compendium repetitive in instances where we revisited a topic to report on emerging information and breaking news in the industry.
If you would like additional information on any of these topics, please contact the Sidley lawyer with whom you usually work.
June 28, 2018
On June 5, 2018, the Securities and Exchange Commission (SEC) staff updated its “Staff Responses to Questions about the Custody Rule” (FAQs) by issuing two new sets of frequently asked questions, FAQs II.11 and II.12 (New FAQs). The New FAQs substantially modify a portion of the staff’s tripart February 2017 guidance under the Investment Advisers Act of 1940 (Advisers Act) Rule 206(4)-2 (Custody Rule). The Investment Management Guidance Update (2017 Guidance Update) portion of the February 2017 guidance addressed what the staff has termed “inadvertent custody,” that is, imputing custody to a registered investment adviser (RIA) where provisions in a custodial agreement between the RIA’s client and its custodian permit the custodian to accept instructions from the RIA to transfer assets from the custodial account for any purpose other than authorized trading, even though (i) the adviser is not a party to the custodial agreement and (ii) the authority provided in the custodial agreement conflicts with provisions in the advisory agreement between the RIA and the client (Inadvertent Custody).
June 19, 2018
CFTC Proposes Changes to Swap Dealer De Minimis Exception
The Commodity Futures Trading Commission (CFTC) has issued a notice of proposed rulemaking (NPR) proposing changes to the de minimis exception under its definition of “swap dealer” (the De Minimis Exception).
The CFTC proposed that the threshold applicable for purposes of the De Minimis Exception (the Threshold) be maintained at $8 billion rather than reduced to $3 billion, as required by earlier rulemaking. That change would be straightforward, and the market has long expected it.
More significantly, the CFTC proposed changes to the manner in which swap dealing activity is measured for purposes of the De Minimis Exception, including in relation to “hedging” swaps and to swaps related to certain customer loans. Arguably, the proposed changes would effectively alter how swap dealing is defined under rules that the CFTC and the Securities and Exchange Commission (SEC) jointly adopted in 2012 (Joint Rules). Accordingly, the NPR drew a stinging dissent from one Commissioner on procedural grounds. The NPR also sought public comment regarding several related aspects of the De Minimis Exception, suggesting the potential for additional important changes, including how cleared and/or exchange-traded swaps are treated for purposes of the De Minimis Exception.
Comments in response to the NPR must be submitted on or before August 13, 2018.
June 7, 2018
Volcker Rule—Changes Proposed by U.S. Federal Agencies
The five U.S. federal agencies that are principally responsible for banking and financial market regulation in the United States (collectively, the Agencies) have approved a notice of proposed rulemaking (NPR) that proposes significant revisions to the final rule (Final Rule) implementing the Volcker Rule.
The revisions would leave intact the core restrictions on proprietary trading and covered fund activities. However, the revisions would make certain significant changes to those restrictions. For example, the revisions to the proprietary trading restrictions would eliminate the first prong of the “trading account” definition, which addresses the intent of a banking entity when it purchases and sells financial instruments, and would add a new prong that addresses those financial instruments that are recorded by a banking entity at fair value under applicable accounting standards. The revisions to the compliance program requirements would eliminate almost all of the “enhanced minimum standards” set forth in Appendix B of the Final Rule. The revisions to the covered fund restrictions would be more limited, but the Agencies sought comment regarding many other aspects of those restrictions, including the base definition of “covered fund” (and certain express exclusions from that definition) and the definition of “ownership interest” (as it relates to debt securities issued by covered funds that are securitization issuers).
Recently passed legislation exempts community banks and other small banking organizations from the Volcker Rule and modifies the name-sharing restrictions of the Final Rule. Changes to the Final Rule required by that legislation are expected to be the subject of a separate rulemaking and are not dealt with in the NPR.
Comments in response to the NPR must be received by the Agencies within 60 days of its publication in the Federal Register.
May 29, 2018
President Trump Signs Financial Services Regulatory Reform Legislation
On May 24, 2018, President Donald Trump signed into law the Economic Growth, Regulatory Relief and Consumer Protection Act (the Act). The Act is effective immediately except as otherwise stated in certain provisions.
The Act makes many significant modifications to the post-crisis financial regulatory framework, although it leaves the core of that framework intact.
One major consequence of the Act may be an increased potential for mergers, acquisitions and organic growth among regional and midsize banks, as well as community banks, because of provisions that increase the thresholds that must be met before various financial regulatory requirements apply.
May 7, 2018
On April 18, the U.S. Securities and Exchange Commission (SEC) released for comment three proposals intended to enhance the standard of conduct for investment professionals and to reaffirm and clarify the terms of existing relationships between investors and investment professionals:
- Regulation Best Interest: A new rule that would require broker-dealers and associated persons to act in the best interest of a retail customer when recommending a securities transaction or investment strategy involving securities.
- Investment Adviser Interpretation: An interpretation of the fiduciary standard of conduct for registered investment advisers and proposed new requirements for licensing and continuing education, delivery of account statements to clients with investment advisory accounts and financial responsibility.
- Form CRS/Relationship Summary: A new rule that would require broker-dealers and registered investment advisers to provide a brief relationship summary to investors at the beginning of a relationship and in connection with any material changes.
This Update provides an overview of the nearly 1,000 pages of the proposal releases and highlights several key takeaways.
May 2, 2018
Five Priorities for Dodd-Frank Swaps Reform
On April 26, 2018, Commodity Futures Trading Commission (CFTC) Chairman J. Christopher Giancarlo published a white paper entitled “Swaps Regulation Version 2.0: An Assessment of the Current Implementation of Reform and Proposals for Next Steps,” co-authored with CFTC Chief Economist Bruce Tuckman. The white paper was released just after the Chairman completed a “fireside chat” discussion with Scott O’Malia, chief executive officer of the International Swaps and Derivatives Association (ISDA), during the ISDA Annual General Meeting (ISDA AGM). Discussing the white paper during the fireside chat, the Chairman noted that it is essentially an assessment of what’s working and what’s not from the CFTC’s perspective with regard to its implementation of Title VII of the Dodd-Frank Act of 2010 (Dodd-Frank). The Chairman also likened the reference to “Version 2.0” in the white paper’s title to an updated version of software – which seeks to improve and build on an existing base platform. Accordingly, the white paper reflects the Chairman’s ambitious agenda to begin making what he sees as necessary improvements to the regulatory structure the CFTC put in place with respect to swaps in the wake of the adoption of Dodd-Frank. The white paper is an important document that sets forth the framework under which the CFTC will pursue its coming refresh of the swaps rules.
The white paper addresses five areas: swaps central counterparties, swaps reporting, swaps execution, swap dealer capital and the commercial end user clearing exception.
April 10, 2018
On April 3, 2018, the Financial Crimes Enforcement Network (FinCEN) issued new frequently asked questions (FAQs) regarding its customer due diligence rule (CDD Rule).
The CDD Rule applies to banks, broker-dealers in securities, mutual funds, futures commission merchants and introducing brokers in commodities (collectively, covered financial institutions or CFIs).
The CDD Rule includes four core elements of customer due diligence, each of which should be included in the anti-money-laundering (AML) program of a CFI: (1) customer identification and verification, (2) beneficial ownership identification and verification, (3) understanding the nature and purpose of customer relationships to develop a customer risk profile, and (4) ongoing monitoring for reporting of suspicious transactions and, on a risk basis, maintaining and updating customer information. The second element - the beneficial ownership requirement - is new. FinCEN has described the other elements as preexisting AML program requirements for CFIs, although the third and fourth prongs were, at most, implicit requirements.
April 9, 2018
On March 23, 2018, President Donald Trump signed the Consolidated Appropriations Act of 2018, which includes the Small Business Credit Availability Act (SBCAA). The SBCAA permits, subject to certain requirements, a business development company (BDC) to significantly increase the amount of debt it incurs. In addition, it mandates that the Securities and Exchange Commission revise, not later than one year after the date of its enactment, certain applicable securities offering and proxy rules in order to reduce disparities in registration and reporting requirements for BDCs as compared to other issuers.
April 3, 2018
On April 2, 2018, the Internal Revenue Service (IRS) issued Notice 2018-29 (Notice), providing important interim partial relief from the withholding tax obligations imposed on the transfer of partnership interests by foreign persons, including:
- Suspension of secondary partnership liability following a failure by the transferee to withhold tax;
- Transferees (and partnerships making distributions) are permitted to rely on previously collected IRS Forms W-9 in lieu of the need to collect non-foreign certification from the transferors/partners;
- De minimis exceptions eliminating withholding requirement if (i) the partnership certifies that the amount of effectively connected gain that would be recognized if the partnership sold all of its assets is less than 25 percent of total gain; or (ii) the transferor certifies that in the prior three years less than 25 percent of the income allocable to it from the partnership was effectively connected income;
- No withholding required with respect to nonrecognition (tax free) transactions;
- No withholding required if transferor certifies that it has no gain on the transfer; and
- In case of distributions, the partnership may rely on its own books and records or on the partner’s certification to determine tax basis, and no withholding is required if the amount distributed does not exceed tax basis.
Taxpayers may rely on the interim guidance in the Notice pending the issuance of regulations. The modification or suspension of withholding provided in the Notice does not affect a foreign transferor’s substantive tax liability under the Internal Revenue Code.
March 22, 2018
Fifth Circuit Vacates U.S. Department of Labor Fiduciary Rule
On Thursday, March 15, 2018, in a two-to-one decision, the U.S. Court of Appeals for the Fifth Circuit vacated the Department of Labor’s (DOL) fiduciary rule and related exemptions (the Rule) in its entirety. The Rule, among other things, jettisoned DOL’s prior definition of “fiduciary,” which had been in effect for 40 years, and thereby dramatically expanded the circumstances under which financial and insurance professionals become fiduciaries for purposes of the Employee Retirement Income Security Act (ERISA) and the prohibited-transaction provisions of the Internal Revenue Code. As the Fifth Circuit explained, the prior definition “captured the essence of a fiduciary relationship known to the common law as a special relationship of trust and confidence between the fiduciary and his client.” The Rule departed from this common law understanding by eliminating the requirements that an “‘investment advice fiduciary’sbusiness … be its ‘regular’ work on behalf of a client” and that “the client’s reliance on that advice [be] the ‘primary basis’ for her investment decisions.”
March 12, 2018
On February 26, 2018, the U.S. Financial Industry Regulatory Authority (FINRA) proposed new FINRA Rule 3290 (the Proposed Rule) that will greatly simplify a member’s obligation to supervise its personnel engaged in both investment advisory and broker-dealer activities and clarify the treatment of “dual-hatted” personnel who perform services both for the member and a non-broker-dealer affiliate (such as an affiliated investment adviser, a bank or an insurance company). The Proposed Rule will consolidate and replace current FINRA Rule 3270 (Outside Business Activities of Registered Persons) and FINRA Rule 3280 (Private Securities Transactions of an Associated Person) and, according to FINRA, is intended to reduce unnecessary burdens and confusion while strengthening investor protections relating to outside activities.
In addition to simplifying and clarifying a member’s supervisory obligations regarding the outside business activities of registered persons, the Proposed Rule maintains existing notice requirements and clarifies FINRA’s expectations regarding the review of a registered person’s outside, investment-related activities.
March 1, 2018
On Feb. 23 and 24, 2018, senior officials at the annual SEC Speaks conference shared their observations about the current state of financial regulation and the regulatory and enforcement priorities of the Securities and Exchange Commission (SEC). Representatives of each division and each Commissioner, including new Commissioners Hester Peirce and Robert Jackson, offered remarks. Among the topics that received significant attention from nearly all panelists were cryptocurrencies and protection of retail investors.
February 28, 2018
Investment advisers registered with the Securities and Exchange Commission (SEC) (each, an RIA) are subject to certain annual requirements under the Investment Advisers Act of 1940 (the Advisers Act); some of these requirements also either apply to exempt reporting advisers (each, an ERA) or warrant consideration as best practices for ERAs. This Sidley Update reminds investment advisers about certain annual regulatory and compliance obligations, including a number of significant 2018 reporting or filing deadlines.
This Sidley Update also reminds advisers that are registered as commodity pool operators (CPOs) or commodity trading advisors (CTAs) with the Commodity Futures Trading Commission (CFTC) and members of the National Futures Association (NFA) of certain CFTC and NFA reporting requirements.
This Sidley Update provides important information regarding:
- selected recent regulatory developments that may affect an adviser’s filing obligations and compliance program, including changes to Form ADV and new recordkeeping requirements;
- SEC guidance published in 2017 related to the Advisers Act “Custody Rule,” advertising restrictions and managing cybersecurity risks;
- SEC examination priorities for 2018.
- recent SEC enforcement proceedings that reflect SEC concerns relevant to advisers;
This Sidley Update does not purport to be a comprehensive summary of all of the compliance obligations to which advisers are subject; please contact your Sidley lawyer to discuss these and other requirements under the Advisers Act, the Commodity Exchange Act and other regulations that may be applicable to investment advisers, CPOs and/or CTAs.
February 13, 2018
Securities and Exchange Commission Launches Share Class Selection Disclosure Initiative
On February 12, 2018, the U.S. Securities and Exchange Commission (SEC or Commission) issued a press release announcing the Share Class Selection Disclosure Initiative (SCSD Initiative) to encourage investment advisers to self-report certain violations of the Investment Advisers Act (Advisers Act) relating to selection of mutual fund share classes. Under the SCSD Initiative, the SEC Division of Enforcement will show relative leniency toward investment advisers who self-report violations relating to share class conflicts of interest from the receipt of Rule 12b-1 fees. For those self-reporting advisers, the Enforcement Division will recommend favorable settlement terms, including no civil money penalty, in any resulting enforcement action. The SCSD Initiative aligns with the Clayton Commission’s emphasis on retail investor protection and its desire to allocate the SEC’s resources efficiently. Stephanie Avakian, Co-Director of the Enforcement Division, commented on this theme in the initiative’s accompanying release by saying, “This focused initiative reflects our effort to allocate our resources in a way that effectively targets the continued failure by some advisers to disclose conflicts of interest around share class selection and, importantly, is intended to facilitate the prompt return of money to victimized investors.”
February 12, 2018
Office of Compliance Inspections and Examinations Publishes 2018 Exam Priorities
On February 7, 2018, the Office of Compliance Inspections and Examinations (OCIE) of the U.S. Securities and Exchange Commission (the Commission) released its annual National Exam Program Examination Priorities (Exam Priorities). As has been widely reported, the Exam Priorities’ general focus areas include:
- retail investors;compliance and risks in critical market infrastructure;
- oversight of the Financial Industry Regulatory Authority (FINRA) and Municipal Securities Rulemaking Board (MSRB);
- cybersecurity;
- (AML) programs.
February 9, 2018
The Court of Appeals for the D.C. Circuit earlier today handed a victory to our client, the Loan Syndications and Trading Association (LSTA), in its longstanding effort to secure relief from U.S. risk retention requirements for managers of open market CLOs. CLOs—collateralized loan obligations—are an important type of securitization providing capital support for and investment opportunities related to syndicated loans.
January 11, 2018
The Investment Funds and Advisers 2017 Year-End Client Update Recap
Dear Clients and Friends,
As the developments affecting the investment management industry continue to unfold, we have once again prepared our annual compendium of relevant Sidley Updates for our investment fund and adviser clients and friends.
The compendium includes a summary of each 2018 Sidley Update, in reverse chronological order, along with a link to its full text. We have included all of the Updates, making the compendium repetitive in instances where we revisited a topic to report on emerging information and breaking news in the industry.
If you would like additional information on any of these topics, please contact the Sidley lawyer with whom you usually work.
January 8, 2018
NFA Adopts Notice Requirements for CPOs and CTAs That Trade Virtual Currency Products
On December 14, 2017, the National Futures Association (NFA) issued reporting requirements (Reporting Requirements) obliging any NFA member commodity pool operator (CPO) or commodity trading advisor (CTA) to notify the NFA immediately once it has executed a transaction involving any virtual currency transaction or virtual currency derivative (including futures, options or swaps) on behalf of a commodity pool or a managed account. The adoption of the Reporting Requirements follows recent announcements by various futures exchanges and swap execution facilities regulated by the Commodity Futures Trading Commission (CFTC) to offer derivatives on virtual currency products. The NFA pointed to the volatility of the underlying virtual currency products as justification for the new requirements.
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