Compliance and Regulatory Services (“CARS”) Hot Topics for January 2016
For this month, we thought to highlight some of the SEC’s regulatory initiatives for the past year. In 2015, the SEC was very active with an aggressive agenda that resulted in many new regulations and rule proposals that will be sure to prove to be challenging to implement for many advisers, especially the medium-to-smaller advisers that are already have a difficult time with the cost of compliance. It appears as though the route the SEC has taken will make it extremely difficult for many smaller advisers to operate because of the cost of implementing some of these regulations and proposed rules, if and when they are adopted.
As new regulations are adopted the costs for new resources, including additional staffing, technology and software, are accretive to fixed costs. This adds to the overall operational expenses of managing an advisory firm, and may cause smaller advisers to either go back in-house or sell out to larger asset managers. There just does not seem to be any real easy solution for asset managers in this regulatory environment. To provide a sense of what management firms are facing these days, consider some of the following:
For asset managers of mutual funds, including liquid alts, and business development companies, the SEC has proposed 2 regulations that will add to the already onerous reporting and ongoing compliance requirements for 1940 Act registered investment companies.
- The first is a liquidity management regulatory rule proposal. This would require the implementation of a liquidity risk management program and enhanced disclosures directly related to fund liquidity and redemption practices. One of the elements of the risk program requires, among other things, classifying assets into various buckets based on the amount of time an asset would be able to be converted to cash without market impact, ongoing assessment and management of liquidity, establishing a 3-day liquid asset minimum, and board review and approval. This proposed regulation also codifies the 15% illiquid asset limit in terms of reporting. To read further, please click here: Liquidity Management Rules for Mutual Funds and ETFs
- The second impacts the use of derivatives. If adopted as proposed, it would limit the degree to which managers of mutual funds and ETFs can use derivatives and would also require them to implement a derivative risk management program administered by a derivatives risk manager. This program would also involve segregating assets to limit exposure to certain predetermined thresholds by offsetting the derivative exposure relative to assets. Please click here for overview of the new derivatives proposal: Derivative Rules for Registered Funds and Business Development Companies
There is also the SEC’s Form ADV proposal that will amend Part 1 to capture and report more information on separately management accounts, derivatives, notional exposure, metrics for determining a relying adviser and more supervisory oversight of branch locations.
This is in addition to the SEC’s cyber security risk alert that makes clear that the SEC is expecting registered advisers to develop a cybersecurity framework administered by a CTO or CISO.
If that wasn’t enough, there is also the FinCEN proposal that would make registered investment advisers subject to the BSA and Patriot Act of 2011anti-money laundering (“AML) requirements, which will be overseen by the SEC. Historically, advisers would rely on an administrator and pretty much almost ignore AML. It seems as though the adoption of this rule will be a game changer to the current modus operandi.
The above is not even close to an exhaustive list of SEC and related regulatory agencies 2015 initiatives and to do so would in and of itself be too exhausting to list.
Our Take: The SEC is on a tear and it doesn’t look like it is going to slow down anytime soon. All one can do is be prepared to address the onslaught of new regulations and have the SEC’s questions answered before they are asked. This is a relatively easy task with the right resources, dedication and commitment to implement the fundament elements of these initiatives in the form of procedures and controls designed to reasonably ensure compliance. During the process, smaller advisers may be left behind, forced to find a way to meet these initiatives, or become part of a larger organization with more extensive resources. At this pace, we may be seeing the end of the mid- to small-investment adviser.
(Complete Listing: http://www.finra.org/Industry/Regulation/Notices/2014/index.htm)
FINRA Rule Filings List:
(Complete Listing: http://www.finra.org/Industry/Regulation/RuleFilings/2014/index.htm)