This post continues our assessment of whether the Limited Derivative User requirements of Rule 18f-4(c)(4) effectively and efficiently accomplish the SEC’s aim of providing “an objective standard to identify funds that use derivatives in a limited manner.” Here we question whether the “gross notional amount” of a derivatives transaction measures the means and consequences, rather than the extent, of its use.
Continue Reading Assessing the Limited Derivatives User Requirements of Rule 18f-4—Notional Amounts

Our last series of posts on Rule 18f-4 have struggled to understand how its Limited Derivatives User requirements are supposed to work. We have done the best we could to explain the process for calculating a fund’s derivatives exposure, including determining the gross notional amount of derivatives transactions and adjustments thereto, excluding closed-out positions and currency and interest-rate derivatives entered into for hedging purposes, and applying the “10% buffer” for these hedges. In this series of posts, we shift our perspective to assessing whether these requirements effectively and efficiently accomplish the SEC’s objectives.
Continue Reading Assessing the Limited Derivatives User Requirements of Rule 18f-4—Costs

Earlier this year, the staff of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) published its annual list of examination priorities, which included firms’ preparation for the transition away from LIBOR as a widely used reference rate for various financial instruments. On June 18, OCIE followed-up with a risk alert that provides additional details about how it evaluates firms’ LIBOR transition preparedness.
Continue Reading OCIE Issues Risk Alert on LIBOR Transition Preparedness

On March 12, 2020, the U.S. Securities and Exchange Commission announced a settlement with an exempt reporting adviser and its two founders for failure to disclose several conflicts of interest and failure to take measures required by the private fund’s offering documents.

The SEC is examining exempt reporting advisers, and although not subject to all

On June 5, 2019, the U.S. Securities and Exchange Commission (“SEC”) adopted a package of rules and interpretations relating to the standards of conduct for broker-dealers and investment advisers, including a new “best interest” rule for broker-dealers. The package was adopted by a 3-1 vote, with Commissioner Robert J. Jackson Jr. as the lone dissenter. Chairman Jay Clayton, who supported the package, stated that the SEC was not adopting a uniform fiduciary rule for broker-dealers and investment advisers. Instead, Chairman Clayton explained that “Regulation Best Interest incorporates fiduciary principles, but is appropriately tailored to the broker-dealer relationship model and will preserve retail investor access and choice.” Chairman Clayton, as well as the SEC’s press release, emphasized that Regulation Best Interest cannot be satisfied by disclosure alone, but rather through compliance with each of the rule’s four substantive obligations.

The actions taken on June 5 include the following:


Continue Reading SEC Adopts Package of Reforms Aimed at Raising the Standard of Conduct for Brokers and Clarifying an Investment Adviser’s Fiduciary Duty

My first post discussed the SEC’s Office of Compliance Inspections and Examination’s (“OCIE’s”) recent Risk Alert (the “Alert”) and specific fund categories in its crosshairs. This post will cover the three remaining fund categories and general examination issues identified by OCIE in the Alert.

Continue Reading OCIE Announces Risk-Based Exam Initiatives for Mutual Funds—Part 2

Recently, the Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert (the “Alert”) identifying six categories of mutual funds and mutual fund advisers it plans to examine: (i) index funds tracking custom-built indexes; (ii) smaller and thinly-traded exchange traded funds (“ETFs”); (iii) funds with aberrational underperformance relative to their peers; (iv) funds with higher allocations to securitized assets; (v) advisers “new” to managing mutual funds; and (vi) advisers who also manage private funds with similar strategies or that share managers with the mutual funds. The Alert provides a list of practices, risk and conflicts for each specific type of fund, but also notes OCIE will also look at standard fund examination topics.

This post reviews the first three specific categories of funds identified in the Alert. A subsequent post will discuss the final three categories, general examination issues mentioned in the Alert and additional considerations for any exam.


Continue Reading OCIE Announces Risk-Based Exam Initiatives for Mutual Funds—Part 1

In the first post on this topic, we provided a simple answer to a question posed by the Director of the SEC’s Division of Investment Management (the “Division”):

To the extent a fund plans to hold cryptocurrency directly, how would it satisfy the custody requirements of the 1940 Act and relevant rules?”

Our simple answer was to treat cryptocurrencies as “financial assets” under Article 8 of the Uniform Commercial Code. In the second post, we explained how this simple answer may be hard to implement when it comes to trading cryptocurrencies, because their markets require trades to settle in the next block. Thus, rather than a custodian implementing a portfolio manager’s instruction to settle a trade, a portfolio manager trading a cryptocurrency will normally need to have immediate control over the transfer of the cryptocurrency, which is inconsistent with the custody requirements of the Investment Company Act of 1940 (the “1940 Act”).

In this post, we consider three potential solutions to the dilemma faced by an investment company that must hold cryptocurrency in compliance with the custody requirements of the 1940 Act while allowing its adviser to trade the cryptocurrency.


Continue Reading Why Blockchain Custody Is So Difficult—Paths Forward?

In our previous post, we provided a simple answer to the following question posed by Director Dalia Blass of the SEC’s Division of Investment Management:

To the extent a fund plans to hold cryptocurrency directly, how would it satisfy the custody requirements of the 1940 Act and relevant rules?”

Our simple answer was to treat cryptocurrencies as “financial assets” under Article 8 of the Uniform Commercial Code. But, as Director Blass knows, this is not the end of the questions relating to custody. Her letter included additional questions, such as:

If the fund may take delivery of cryptocurrencies in settlement, what plans would it have in place to provide for the custody of the cryptocurrency?”

This question relates to a core operation of investment companies: trading.


Continue Reading Why Blockchain Custody Is So Difficult—A Hard Part