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 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.
December 21, 2018
Volcker Rule: Agencies Propose to Implement Community Bank Exemption and Revised Name-Sharing Rule
The five U.S. federal agencies (collectively, the Agencies) responsible for implementing the Volcker Rule have individually released, or are expected to release, a related notice of proposed rulemaking (NPR). The NPR proposes amendments to the Volcker Rule regulations that would implement two statutory changes required by the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA):
1. An exclusion from all Volcker Rule restrictions for community banks and other banking organizations below certain asset size and trading thresholds
2. A modification of the name-sharing restrictions of the Volcker Rule to permit certain banking entities that are investment advisers to share a name with a covered fund, subject to certain continuing limitations
The NPR is separate from the broader Volcker Rule revisions proposed by the Agencies in June 2018, which are still pending. Comments in response to the NPR must be received by the Agencies within 60 days of its publication in the Federal Register.
December 5, 2018
At an open meeting of the Commodity Futures Trading Commission (CFTC) on November 5, 2018, the CFTC Commissioners voted to approve (i) a final rule amending the de minimis exception to the “swap dealer” definition and (ii) a rule proposal that would amend the CFTC’s regulatory framework for swap execution facilities (SEFs) and the on-facility trade execution requirement, along with a request for comment on the practice of “post-trade name give-up” on certain SEFs. The SEF rule proposal would, in a number of important respects, represent an overhaul of the CFTC’s existing approach to SEF regulation.
December 3, 2018
The U.S. Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) Offices of the Whistleblower have issued their Fiscal Year (FY) 2018 Annual Reports to Congress on the agencies’ respective whistleblower programs. Both reports document dramatic increases in the numbers of whistleblower tips and dollar amounts of awards and punctuate the increasing role of whistleblowers in the enforcement programs at both agencies.
November 19, 2018
Two recent enforcement actions and a joint statement add to the U.S. Securities and Exchange Commission’s (SEC or Commission) guidance on digital asset securities.
November 14, 2018
On November 2, the U.S. Securities and Exchange Commission (SEC) voted to adopt amendments requiring broker-dealers to provide investors with new and enhanced disclosures regarding handling of customer orders. As previously detailed in Sidley’s Client Update at the time of proposal, the primary focus of the newly adopted amendments is to provide a level of transparency not previously required for institutional customer orders while providing necessary updates and enhancements to disclosures for retail customer orders under Rule 606 of Regulation NMS. In a significant conceptual change, the amendments require broker-dealers to make institutional customer disclosures for all “not held” orders, as opposed to orders above $200,000, as originally proposed.
Specifically, the amendments to Rule 606 require a broker-dealer, upon a request of a customer who places an order giving such broker-dealer discretion with respect to price and time (i.e. a "not held" order), to provide its customer with a standardized set of individualized disclosures concerning the handling of the customer's orders. These disclosures will provide the customer with information about the broker-dealer's order routing decisions and statistics regarding order execution, including information on fees paid and rebates received from trading venues.
In addition, the amendments enhance previously existing requirements that broker-dealers provide public quarterly reports on retail customer order routing. The rule now requires such reports to cover NMS stock orders of any size that are submitted on a held basis. It continues to cover any order, whether held or not held, for an NMS security that is an option contract with a market value less than $50,000.
In addition to changes related to Rule 606, the amendments provide a new retention requirement for reports produced pursuant to Rule 605 of Regulation NMS. The amendments are published on the SEC’s website and will be published in the Federal Register. The amendments will become effective 60 days from the date of publication in the Federal Register, and the compliance date will be 180 days from the date of publication in the Federal Register.
October 29, 2018
SEC Issues Landmark Order Rejecting Nasdaq and NYSE Arca Market Data Fee Increases
On October 16, 2018, the five SEC Commissioners unanimously upheld the Securities Industry and Financial Markets Association’s (SIFMA) challenge to fee increases for “depth-of-book” market data filed by Nasdaq and NYSE Arca. Simultaneously the SEC remanded over 400 market data fee and other filings back to the exchanges and the national market system plans for consideration under the standards set out in the SIFMA order and an earlier Bloomberg order. These orders have the potential to rewrite the regulation of market data, and potentially other exchange fees, for the entire securities industry. Sidley represented SIFMA in its successful challenge to the market data fees.
The procedural status of the SIFMA matter is somewhat complex. Under the Exchange Act, fees must be “fair and reasonable” and not “unfairly discriminatory.” Historically, exchanges submitted proposed fee increases to the SEC for approval with limited if any factual support, and the SEC generally routinely approved them without substantial analysis. In NetCoalition v. SEC, 615 F.3d 525 (D.C. Cir. 2010), the court held that competitive forces could be sufficient to meet the “fair and reasonable” standard of the Exchange Act. Nonetheless, in that case, the court found that the SEC had provided insufficient factual support for its conclusion that exchange market data fees were in fact constrained by significant competitive forces.
After substantial procedural wrangling, the SEC selected two market data filings, the NYSE Arca at issue in NetCoalition and a separate Nasdaq filing, for an unusual fact-finding hearing by a commission administrative law judge concerning whether those fees were “fair and reasonable,” including the issue of whether market data fees were constrained by competition. Both filings proposed substantial price increases for depth-of-book market data concerning securities traded on those respective exchanges — data not available from any other source. In the meantime, the SEC held in abeyance more than 400 challenges filed by SIFMA and Bloomberg LP to market data price increases filed by exchanges and the national market system plans (which administer core “top-of-book” market data required to be provided to all investors).
October 24, 2018
CFTC Proposes to Streamline CPO and CTA Regulations
On October 9, 2018, the Commodity Futures Trading Commission (CFTC) proposed a number of changes in its regulations applicable to commodity pool operators (CPOs) and commodity trading advisors (CTAs) (the Proposal). The Proposal comes out of the CFTC’s Project KISS, which is an agency-wide review of rules with an aim to identify areas that can be simplified. In many respects, the Proposal seeks to codify no-action and interpretive positions previously taken by the CFTC staff, providing increased legal certainty via formal CFTC rules, but it also seeks to expand regulatory relief to CPOs and CTAs.
October 23, 2018
On October 19, 2018, the U.S. Internal Revenue Service (IRS) and the Department of the Treasury (Treasury) issued the long-awaited guidance on the powerful new tax incentives for investments in opportunity zones. These new tax incentives, enacted as part of the 2017 tax reform legislation known as the Tax Cuts and Jobs Act (Tax Act), permit taxpayers to defer and reduce any capital gain they recognized provided that the gain is timely invested in certain funds that in turn invest in opportunity zones. These incentives also exempt from tax all appreciation in the value of the taxpayer’s interests in such funds if they are held for at least 10 years.
This program has generated significant interest by fund managers, fund investors, family offices, investment banks, high net worth individuals and others as a way to defer and reduce taxes.
October 18, 2018
Security-Based Swap Rules Back on Track: SEC Reopens Comment Period for Proposals
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) gives the U.S. Securities and Exchange Commission (SEC) jurisdiction over security-based swaps (SBS) and SBS market participants and requires the SEC to adopt rules to regulate this market. To date the SEC has proposed, but not yet finalized, certain of its key Title VII regulations.
A critical component of the SEC’s Title VII regulatory framework is the registration and comprehensive regulation of SBS dealers (SBS Dealers).1 Implementation of these regulations has been stalled over the past several years pending the SEC’s finalization of certain SBS Dealer regulations, including capital, margin and segregation requirements that were originally proposed in October 2012.
October 12, 2018
CFTC Chairman Giancarlo's White Paper: Cross-Border Swaps Regulation 2.0
On October 1, 2018, the Chairman of the U.S. Commodity Futures Trading Commission (CFTC) published a long-awaited white paper titled “Cross-Border Swaps Regulation 2.0: A Risk-Based Approach with Deference to Comparable Non-U.S. Regulation” (White Paper). We have prepared the following Q&A to answer basic questions regarding the White Paper and its relationship to earlier CFTC actions related to cross-border swaps regulation.
October 12, 2018
On August 13, 2018, President Donald Trump signed into law the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). FIRRMA expands the jurisdiction and powers of the Committee on Foreign Investment in the United States (CFIUS or the Committee), the U.S. interagency committee that conducts national security reviews of foreign investment.
FIRRMA authorizes CFIUS to conduct pilot programs to implement provisions of the legislation that did not become effective immediately upon enactment. On October 10, the U.S. Department of the Treasury issued interim regulations to conduct a FIRRMA pilot program that addresses specific risks to U.S. critical technologies. Separately, CFIUS issued updated regulations formally implementing some of FIRRMA’s provisions that became effective upon enactment.
The FIRRMA pilot program expands the scope of transactions subject to review by CFIUS to include certain noncontrolling investments made by foreign persons in U.S. businesses involved in critical technologies related to specific industries. The program also makes mandatory the filing of a “declaration” (an abbreviated CFIUS notice) for all transactions that fall within its specific scope.
October 2, 2018
One Pie, Many Slices: Recent Court Decisions Carve Up SEC and CFTC Jurisdiction in Virtual Currency
Three recent actions in federal court illustrate the interplay among federal regulators overseeing virtual currency, offer important support for the increasingly aggressive assertion of jurisdiction by the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) and provide guidance as to when a virtual currency may be considered a commodity subject to the CFTC’s jurisdiction or a security subject to the federal securities laws:
- On September 26, Judge Rya W. Zobel of the U.S. District Court for the District of Massachusetts handed down an important decision in a case alleging the fraudulent sale of a virtual currency called My Big Coin (MBC). In denying the defendants’ motion to dismiss, Judge Zobel confirmed the CFTC’s sweeping assertion of authority to police virtual currency markets under the antifraud and manipulation provisions of the Commodity Exchange Act (CEA) and its implementing regulations.
- On September 11, Judge Raymond J. Dearie of the U.S. District Court for the Eastern District of New York denied a motion to dismiss the United States’ indictment for fraud under the Securities Exchange Act of 1934 (Exchange Act) in connection with the sale of virtual currencies claimed to be backed by real estate and diamonds. In denying the defendants’ motion to dismiss, Judge Dearie found that the virtual currencies at issue could reasonably be considered investment contracts and thus securities
- On September 27, the SEC and the CFTC filed parallel complaints in the U.S. District Court for the District of Columbia against an online trading platform and its CEO offering swaps based on underlying securities and commodities funded with bitcoin, alleging violations of the federal securities and commodities laws.
September 18, 2018
On September 11, the Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) separately announced three “first of their kind” enforcement actions against participants in the digital asset (or “token”) market:
- In the Matter of TokenLot LLC. The SEC took action against a token sale website for operating as an unregistered broker-dealer in violation of the federal securities laws.
- In the Matter of Crypto Asset Management, LP. The SEC entered an order against a digital asset hedge fund manager for failing to register its fund as an investment company and offering and selling its fund’s securities in an unregistered offering.
- Department of Enforcement vs. Timothy Tilton Ayre. In its first disciplinary action involving digital assets, FINRA filed a complaint alleging that a registered person of a member firm violated federal securities laws and FINRA rules in its offering of a blockchain token as an unregistered security.
September 6, 2018
ISDA U.S. Resolution Stay Protocol: GSIBs to Amend QFC Transactions with Buyside Counterparties
On August 22, the ISDA 2018 U.S. Resolution Stay Protocol (the Protocol) was opened for adherence by the International Swaps and Derivatives Association Inc. (ISDA). The Protocol will be used to amend a range of swaps, other derivatives, short-term funding transactions, securities lending transactions and other qualifying financial contracts (QFCs).
August 23, 2018
The Commodity Futures Trading Commission (CFTC) has issued a notice of proposed rulemaking (NPR) proposing to codify the CFTC’s existing policies and procedures governing how clearing organizations organized outside of the United States may seek an exemption from registration as a derivatives clearing organization (DCO) for the clearing of CFTC-regulated swaps. By codifying these policies and procedures, the CFTC hopes to promote cross-border comity and make the exemption application process more transparent and less burdensome for non-U.S. clearing organizations.
August 23, 2018
Effective Oct. 31, National Futures Association (NFA) members engaging in virtual currency activities will be subject to new NFA disclosure requirements. These disclosure requirements are set forth in Interpretive Notice 9073 (Interpretive Notice), which NFA announced Aug. 9 in a notice to members. The new disclosure requirements are imposed on NFA member commodity pool operators (CPO), commodity trading advisers (CTA), futures commission merchants (FCM) and introducing brokers (IB) who engage in activities involving spot market virtual currencies or virtual currency derivatives. In announcing these requirements, NFA pointed to concerns about customer understanding of virtual currency, the substantial risk of loss prevalent in virtual currency trading and NFA’s limited authority to regulate spot market virtual currency transactions. NFA members engaged in any level of virtual currency activity (derivatives, i.e., futures, options and swaps, as well as spot transactions) will be subject to these new disclosure requirements.
August 22, 2018
Fintech Without Borders: Regulators Consult on Global Financial Innovation Network
On August 7, a group of regulators from 11 jurisdictions published a consultation (the Consultation) on the Global Financial Innovation Network (the GFIN), which aims to promote international cooperation on innovation and the use of technology in financial services (FinTech) and in regulatory processes (RegTech).
The group — which includes the U.S. Consumer Financial Protection Bureau, the UK Financial Conduct Authority (the FCA), the Hong Kong Monetary Authority (HKMA) and the Monetary Authority of Singapore (MAS) — is one of the first major collaborative efforts on FinTech and RegTech issues among regulators in developed financial services markets. The Consultation builds on the FCA’s proposal earlier this year to create a “global sandbox” for innovative financial services firms.
This Update summarizes the proposed role of the GFIN, the issues on which its founding regulators are consulting and how these may affect financial services firms.
August 13, 2018
New CFIUS and Export Control Legislation Will Pose New Hurdles to Investment and Trade
On August 13, 2018, President Trump signed into law the National Defense Authorization Act for Fiscal Year 2019, which includes the Foreign Investment Risk Review Modernization Act (FIRRMA) and the Export Control Reform Act (ECRA).
Certain provisions of the law will take effect as soon as the bill is enacted, but the substantive provisions that are most significant (e.g., expansion of the categories of covered transactions and the mandatory filing requirements) will not. It will likely be several months before the relevant agencies finalize implementing regulations. However, the Administration has the authority to adopt a pilot program to implement some or all of the provisions of the law before regulations are issued.
July 31, 2018
Initial Margin Requirements on the Horizon: FAQs for Buy Side Firms
The regulatory requirements for posting and collecting initial margin (IM) currently apply principally to the uncleared over-the-counter (OTC) derivatives of swap dealers and other large banking organizations. Starting as soon as later this year, and then continuing next year and the year after, the IM requirements will also apply to uncleared OTC derivatives of end-users (Buy Side Firms) that have significant uncleared OTC derivative portfolios. The most important phase-in dates for such Buy Side Firms are likely to be September 1, 2019 and September 1, 2020.
July 16, 2018
LIBOR’s Final Chapter: Practical Considerations for Buy Side Market Participants
LIBOR (London Interbank Offered Rate) and other interbank offered rates (IBORs) are interest rate benchmarks that are widely used for many financial instruments, including swap agreements, securitizations and lending contracts. However, regulators globally have determined that existing interest rate benchmarks must be reformed. The European Union has adopted rules that regulate benchmark interest rates, and in July 2017, the UK Financial Conduct Authority (FCA) announced that, at the end of 2021, “it would no longer be necessary for the FCA to persuade, or compel, banks to submit to LIBOR.” Since that announcement, regulatory agencies, trade groups and financial market participants have begun preparing to transition to alternative risk-free rates (RFRs). On June 12, 2018, International Swaps and Derivatives Association, Inc. (ISDA) published a consultation (the ISDA Consultation) seeking market input regarding how ISDA’s standard documentation should be amended to implement fallbacks for certain key IBORs. On the same day, the Chairman of the U.S. Commodity Futures Trading Commission called the discontinuation of LIBOR a “certainty.”
At this time, the details of successor rates to LIBOR and other IBORs are still being determined. Not coincidentally, a recent survey of key market participants reveals that most have not developed robust transition plans to address the phase out of LIBOR. This Sidley Update offers an overview of key challenges related to the LIBOR transition and the impact that it may have on buy side participants in the derivatives markets (Buy Side Participants), and it highlights some of the issues and actions that Buy Side Participants should consider in preparation for LIBOR’s phase out.
July 13, 2018
New York City Announces Positions on the Taxability of Deferred Fee Income
On June 29, the New York City Department of Finance issued Finance Memorandum 18-6 to provide insight into the Department’s position on the New York City unincorporated business tax (UBT) issues arising with respect to the treatment of deferred income arising from the provision of services. Finance Memorandum 18-6 is generally understood to be directed at the taxability of deferred management and incentive fees earned by investment advisors and addresses the character, timing, and apportionment methodology used to determine the taxability of that deferred income.
July 12, 2018
Investment Funds, Advisers and Derivatives – Mid-Year Recap of Our 2018 Client Updates
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. 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 (the 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 (the NPR) that proposes significant revisions to the final rule (the 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 postcrisis 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.
FinCEN issued new FAQs on the CDD Rule on July 19, 2016. These FAQs are timely because the May 11, 2018 compliance date for the CDD rule is fast approaching.
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 (the SBCAA). The SBCAA permits, subject to certain requirements, a business development company (a BDC) to significantly increase the amount of debt it incurs. In addition, it mandates that the Securities and Exchange Commission (the 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 9, 2018
U.S. Risk Retention: LSTA v. SEC Concludes; Thoughts on Its Broader Applicability
The LSTA v. SEC litigation, which established that the U.S. risk retention rules do not apply to managers of open-market CLOs, is now effectively concluded, subject only to the highly unlikely possibility of a petition to the U.S. Supreme Court by the government. This results from a recent District Court action implementing the Court of Appeals’ ruling in favor of the LSTA and the securitization industry.
This Sidley Update provides details about the District Court action and offers some thoughts about the applicability of LSTA to other securitization structures. Our thoughts are based principally on the central teaching of the case: To be a “sponsor” falling within the legitimate statutory scope of the risk retention requirements, a party must, as a substantive matter, “actually be a transferor” of the securitized assets to the issuer, directly or indirectly.
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’s’ business … 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.”
The Fifth Circuit, in reversing the lower court’s decision upholding the Rule, stated that the Rule “conflicts with the plain text of the ‘investment advice fiduciary’ provision [in ERISA] ... and it is inconsistent with the entirety of ERISA’s ‘fiduciary’ definition.” As a result, DOL “lacked statutory authority to promulgate the Rule with its overreaching definition of ‘investment advice fiduciary.’ ”
The court went on to explain that, even if ERISA were silent or ambiguous regarding this definition, the Rule, for a host of reasons, does not satisfy the reasonableness test for upholding an agency’s interpretation and “bears hallmarks of ... arbitrary and capricious exercises of administrative power.” Among other things, the Fifth Circuit explained that the best interest contract exemption (the BIC Exemption), one of the exemptions included in the Rule, would impermissibly create a private right of action for owners of individual retirement accounts (IRAs). The court stated that the BIC Exemption circumvents the statutory rules applicable to IRAs. The court pointed out that IRAs are not subject to ERISA but, instead, are subject to Section 4975 of the Internal Revenue Code, which does not provide a private right of action for owners of IRAs. The court also noted the significant impact the Rule has had on the financial services industry and the confusion created by the Rule, including the BIC Exemption. Sidley represented the Indexed Annuity Leadership Council and several of its members as appellants in the Fifth Circuit.
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
- anti-money laundering (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.
In late 2014, the SEC and the three primary federal banking regulators (Federal Reserve, OCC and FDIC) issued regulations implementing Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 941 sought to require certain participants in a securitization to retain economic interests reflecting risk associated with the assets underlying the securitization. The statute directed the agencies to issue regulations “to require any securitizer to retain an economic interest in a portion of the credit risk for any asset that the securitizer, through the issuance of an asset-backed security, transfers, sells, or conveys to a third party.” Rejecting a range of arguments presented by LSTA and many other industry participants, the agencies concluded that managers of open market CLOs were “securitizers” for this purpose and thus subject to the risk retention regulations. As a result, since late 2016, managers of open market CLOs have had to retain interests in CLOs representing financial exposure to the performance of the loans supporting CLOs, beyond the exposure that investors would otherwise have required them to retain.
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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