Progress bar
Insight

2021 annual regulatory compliance review for private investment funds

Insight 10 February 2022

2021 annual regulatory compliance review for private investment funds

On March 3, 2021, the Securities and Exchange Commission (“SEC”), newly named Division of Examinations (the “Division”), released its annual list of examination priorities for the year. As in years past, the Division’s focus is on issues relating to retail investors and a new focus on Environmental, Social and Governance (“ESG”) matters. Examination priorities relevant to registered investment advisers are summarized below.

Retail investors

Protecting retail investors remains a priority for the Division in 2021 and the foreseeable future. The Division has indicated it will focus on the following key areas:

  • Standards of Conduct: The Division will prioritize examinations to assess compliance with Regulation Best Interest and Form CRS.
  • Fraud, Sales Practices and Conflicts: The Division will continue to focus on whether required disclosures are being made to investors with an emphasis on fees, expenses, and conflicts of interest. They will also assess whether firm actions match their disclosures.
  • Retail Investors: The Division will focus on advice given to retail investors, including: (1) recommendations to individuals saving for retirement; (2) recommendations regarding account type; (3) sales practices for specific products like exchange traded funds, real estate investment trusts, private placements, digital assets and fixed income securities; and (4) firm compliance with the amended definition of Accredited Investor.

Information security

The Division is focused on how firms identify and address information security risks, including cybersecurity related risks. It will review whether firms have taken appropriate steps to: (1) safeguard customer accounts to prevent intrusions; (2) oversee vendors and service providers; (3) address malicious email activities such as phishing or account intrusions; (4) respond to incidents, including those related to ransomware attacks; and (5) manage operational risk with a virtual workforce.

FinTech and digital assets

The Division’s examination in this area will focus on:

  • Automated investment tools and platforms: The Division will assess whether firms are operating consistently with their representations to clients, and ensure they are handling orders in accordance with customer instructions.
  • Use of technology for implementing regulatory compliance: The Division will examine how compliance programs have been integrated.
  • Use of alternative data: The Division will review whether appropriate controls and compliance are created around non-traditional data sources, increasingly used to form investment decisions.
  • Digital assets: For those firms engaged with digital assets, the Division will assess: (1) whether investments are in the best interest of investors; (2) trading policies; (3) safety of client assets; (4) pricing and valuation; and (5) effectiveness of compliance programs.

Anti-money laundering

The Division will continue to examine whether SEC-regulated entities are establishing appropriate anti-money laundering programs including: customer identification processes; meeting Suspicious Activity Reports (“SARs”) filing obligations; conducting due diligence on customers; complying with beneficial ownership requirements; and conducting independent testing of anti-money laundering programs.

LIBOR transition

The Division will assess Registered Investment Advisers’ exposure to LIBOR and understand preparations that are being made for its expected discontinuation.

Registered investment advisers

In addition to the priorities listed in this section, the Division will assess compliance programs of registered investment advisers in several areas:

  • Portfolio management practices
  • Custody of client assets
  • Best execution
  • Fees and expenses
  • Business continuity plans
  • Valuation of client assets
  • Whether firms’ client disclosures for investment strategies match processes
  • Proxy voting policies and procedures

ESG

Due to investor demand, registered investment advisers are offering ESG investment strategies. The Division will review the adequacy of disclosures that registered investment advisers provide clients to determine whether the firms’ processes and practices match their disclosures. In addition, the Division will review fund advertising for misleading statements and will review proxy voting policies and procedures and votes to assess whether they align with these strategies.

On November 18, 2021, the Securities and Exchange Commission’s Division of Enforcement announced its enforcement results for 2021. Key highlights include:

  • The SEC filed 697 enforcement actions, down from 715 the prior year and the lowest number of actions since 2013[1].
  • There were 434 new cases filed in 2021, an increase of 7% compared to the prior year.
  • Investment adviser and investment company cases accounted for 120 standalone actions in the past year, up 21% from 2020.
  • Insider trading cases account for 28 standalone actions.
  • The SEC obtained judgments and orders for nearly $42.4 billion in disgorgement and $1.4 billion in penalties.
  • The SEC awarded $564 million in rewards to 108 whistleblowers.

Particular SEC Division of Enforcement areas of focus over the past year are noted below.

  • Eight broker dealers and investment adviser firms were sanctioned for failures in their cybersecurity policies and procedures[2], resulting in the takeover of firm personnel cloud-based email accounts by unauthorized parties, exposing the personal information of thousands of clients. The action resulted in fines between $200,000 and $300,000.
  • A $10 million settlement with the operator of an online digital asset trading platform[3] alleging it met the definition of an “exchange” under federal securities laws and had failed to register as an exchange or qualify for an exemption.
  • A $170 million settlement with a UK-based investment adviser as a result of alleged inadequate disclosures, material misstatements, and misleading omissions surrounding the transfer of its highest-performing traders from its flagship investment fund to a proprietary fund benefitting the firm’s own personnel.[4]
  • A $97 million settlement with an investment adviser alleging inaccuracies and misleading statements related to conflicts of interest in recommending rollover of client’s retirement assets.[5]
  • Two investment firms and a Miami-based investment adviser representative were charged for engaging in a “cherry-picking” scheme where they funnelled millions of dollars in trading profits to certain preferred accounts.[6]
  • The SEC charged a hedge fund sub-adviser, its principal, and a trader for providing erroneous order-making information to broker-dealers, causing those broker-dealers to violate Regulation SHO which resulted in the clients avoiding costs associated with borrowing the relevant stock.[7]
  • An action against an investment adviser for compliance failures associated with sales of a volatility-linked exchange-traded product as part of the Enforcement Division’s ETP Initiative.[8]
  • A civil action against mutual fund advisers alleging the advisers and their portfolio managers made false and misleading statements to investors regarding risk management practices, including misleading statements regarding the use of historical event stress testing and prioritizing a consistent risk profile over returns.[9]
  • Charges against two investment advisers, their owners, and their managers alleging the defendants made a series of false representations and misstatements to three private funds regarding conflicts, security of funds, valuation of assets, and other items causing a private fund to engage in conflicted transactions.[10]

[1] https://www.sec.gov/news/press-release/2021-238?utm_medium=email&utm_source=govdelivery

[2] https://www.sec.gov/news/press-release/2021-169

[3] https://www.sec.gov/news/press-release/2021-147

[4] https://www.sec.gov/news/press-release/2020-308

[5] https://www.sec.gov/news/press-release/2021-123

[6] https://www.sec.gov/news/press-release/2021-105

[7] https://www.sec.gov/news/press-release/2021-156

[8] https://www.sec.gov/news/press-release/2021-130

[9] https://www.sec.gov/news/press-release/2021-89

[10] https://www.sec.gov/litigation/litreleases/2021/lr25128.htm

Several proposed or adopted rules will impact registered investment advisers.

Increases to the Advisers Act Qualified client thresholds

On June 17, 2021, the SEC issued an order amending Rule 205-3 under the Advisers Act, raising the dollar amount thresholds for qualified clients:

  • The assets under management test increased to $1,100,000 from $1,000,000
  • The net worth test increased to $2,200,000 from $2,100,000 

Marketing Rule revisions

On December 22, 2020, the SEC adopted final rules and rule amendments under the Advisers Act to govern advertisements by registered investment advisers and payments to solicitors. On October 29, 2021, the Division of Investment Management announced that it was rescinding certain staff statements and no-action letters relating to the prior advertising rule.

Annual regulatory agenda

On June 11, 2021, the SEC’s Office of Information and Regulatory Affairs released the Spring 2021 Unified Agenda of Regulatory and Deregulatory Actions. The agenda included the following items:

  • Third party service providers: The SEC’s Division of Investment Management is considering recommending that the Division seek public opinion on the role of certain third-party service providers such as index and model providers, and the implications for the asset management industry.
  • ESG: The Division is considering recommending that the SEC propose requirements for investment companies and advisers related to ESG factors including ESG claims and related disclosures.
  • Filing Requests for Form 13F and ADV-NR: The Division is considering recommending that the SEC proposed amendments to rules and forms to require electronic submission for the following types of filings: (1) applications for orders under any section of the Investment Advisers Act of 1940; (2) confidential treatment requests for filings made under Section 13F; and (3) ADV-NR.
  • Rule 14a-8 amendments: On September 22, 2020, the SEC adopted amendments to modernize Rule 14a-8, which became effective January 4, 2021. The final amendments apply to any proposal submitted for an annual or special meeting to be held on or after January 1, 2022. It also provides for a transition period with respect to the ownership thresholds that will allow shareholders that meet specified conditions to rely on the $2,000/one-year ownership threshold for proposal submitted for an annual or special meeting to be held prior to January 1, 2023.
  • Proxy voting advice: On July 22, 2020, the SEC adopted amendments to the federal proxy rules relating to proxy voting adviser businesses. The amendments generally categorize the voting advice issued by these firms as a solicitation, placing additional conditions on these firms to qualify for exemptions from the information and filing requirements under the proxy rules. These amendments became effective on November 2, 2020, and proxy advisors are required to comply with the new requirements beginning on December 1, 2021.

Material terms of securities lending transactions

On November 18, 2021, the SEC proposed a new rule, Exchange Act Rule 10c-1, to increase transparency in the securities lending market and ensure regulators have access to timely and comprehensive information about the market for securities lending.

The proposal would require lenders of securities to provide the material terms of securing lending transactions to a registered national securities association (“RNSA”). The terms of a securities lending transaction that would be made public include the following:

  • Legal name of the issuer of the securities to be borrowed
  • Ticker symbol of those securities
  • Time and date of the loan
  • Name of the platform
  • Amount of loaned securities
  • Rates, fees, charges and rebates for the load
  • Type of collateral provided for the loan and the percentage of the collateral provided to the value of the loaned securities
  • Termination date of the loan
  • Borrower type 

SEC chair discusses cryptocurrencies at Aspen Security Forum

On August 3, 2021, SEC Chair Gary Gensler spoke at the Aspen Security Forum, offering his views on the regulation of cryptocurrencies.

SEC modernizes filing fee disclosure and payment methods

On October 3, 2021, the SEC adopted amendments to modernize filing fee disclosure and payment methods. The amendment revised most fee-bearing forms and schedules. The amendment also added new options to pay filing fees by automated clearinghouse and debit and credit cards and eliminated options to pay fees via paper checks and money orders. The amendments will be effective on January 31, 2022. They also provide for a transition period for compliance with structuring requirements.

SEC outlines observations from examinations in advisory fee calculations

On November 10, 2021, the SEC’s Division of Examinations issued a risk alert based on observations of whether (1) advisers have implemented policies and procedures reasonably designed to result in fees that are fair and accurate, and (2) disclosed fees that clients can understand the costs associated with the advisers’ services.

Proxy voting disclosures

On September 29, 2021, the SEC proposed amendments to Form N-PX to enhance the information that funds report annually about their proxy votes. The proposal, if adopted, would require a fund to:

  • tie the description of each voting matter to the issuer’s form of proxy and categorize each matter by type to help investors identify votes of interest and compare voting records;
  • use a structured data language via an SEC-supplied web-based form or an Extensible Markup Language file;
  • disclose how its securities lending activity impacted its voting; and
  • provide its proxy record on its website.

Below is a summary of key filing requirements applicable to registered investment advisers of private funds.

Form ADV

Registered investment advisers must file an updated Form ADV Part 1 and Part 2A with the SEC within 90 days after the investment adviser’s fiscal year-end and deliver the updated Form ADV Part 2A, or a summary of the changes made, to clients within 120 days following the adviser’s fiscal year-end. Although underlying investors of private funds managed by the advisers are not “clients” under the Advisers Act, it is generally considered best practice to deliver the updated Form ADV Part 2A to these underlying investors on an annual basis.

“Exempt reporting advisers” are subject to similar reporting requirements with respect to sections in Form ADV Part 1 that apply to them. Once the adviser reports in its annual amendment to Form ADV that its regulatory assets under management (RAUM) attributable to private funds have reached $150 million, it must register with the SEC within 90 days of filing the amendment.

Certain states impose “notice filing” requirements, requiring advisers to file their Form ADV with the relevant state securities authorities. They may also be subject to certain Blue Sky requirements. An adviser should review its compliance obligations on a periodic basis to determine whether any additional state requirements have been triggered.

In addition to the annual reporting requirements, Form ADV Part I, Part 2A, and Part 2B must be amended promptly wherever information reported becomes materially inaccurate.

Form PF

A registered adviser who advises one or more private funds and has at least $150 million in RAUM attributable to private funds must file Form PF with the SEC. The frequency of the reporting obligation and the amount of information that must be reported on Form PF will vary depending on the size of the adviser and the type of private funds managed by it.

  • Registered advisers that have at least $150 million in RAUM are required to file Form PF within 120 days after the end of the adviser’s fiscal year.
  • An adviser with at least $1.5 billion in RAUM attributable to hedge funds as of any month-end during the preceding fiscal quarter must file Form PF within 60 days of each quarter-end.
  • An adviser with at least $2.0 billion in RAUM attributable to private equity funds as of the most recent fiscal year must file Form PF within 120 days of the fiscal year-end.

An adviser with at least $1.0 billion in RAUM attributable to private liquidity funds must file Form PF within 15 days of each quarter-end.

Form D and Blue Sky Filings

A private fund conducting an offering under Rule 506 must file a Form D with the SEC on its filer management system, EDGAR, within 15 days of the initial sale of securities in such. Form D must be amended annually on or before the first anniversary of the last notice filed or to correct a material mistake as soon as possible. For certain specified types of changes in information, however, the private fund is not required to amend Form D until the next annual filing is due.

Compliance with Rule 506 is very important for compliance with Blue Sky laws, since, under Section 18 of the Securities Act, the states are pre-empted from regulating offerings that comply with Rule 506. Without such compliance, a state where an investor purchases the issuer’s securities can require a pre-sale filing and regulate the required disclosure and other aspects of the offering. Provided that an offering is made in compliance with Rule 506, the Blue Sky laws of many states currently require that a hard copy of Form D be filed with the relevant state authority within 15 days following the initial sale of securities in that state, along with the state’s required filing fee. In addition, some states’ Blue Sky laws require that copies of amended SEC filings also be filed with the state, and some states require annual renewal and associated fees. The penalties for failing to make timely filings can be significant, so it is important for advisers to maintain updated calendars to ensure compliance.

Schedules 13F

An adviser is required to file a Form 13F with the SEC if it exercises investment discretion over $100 million or more in Section 13(f) securities as of the last trading day of any month in any calendar year. In general, Section 13(f) securities include U.S.-listed equity securities, certain equity options and warrants, shares of closed-end investment companies and certain convertible debt securities. An adviser must file a Form 13F for the last quarter of the calendar year during which the reporting threshold is met and for the first three quarters in the subsequent calendar year, even if its holding level has dropped below $100 million. In each case, Form 13F will be due within 45 days of quarter-end.

Schedules 13D and 13G

A person that has direct or indirect beneficial ownership of more than 5% of a class of outstanding voting equity securities of a U.S. public company is required to file Schedule 13D or Schedule 13G, if eligible, with the SEC. “Beneficial ownership” is defined to include the direct or indirect power to (i) vote the securities; or (ii) exercise investment authority over the securities, including the right to acquire the securities within 60 days (such as through the exercise of an option or a convertible security). Under this definition, “beneficial owners” may include a private fund, its investment adviser and certain controlling persons and/or parent companies of the adviser. Schedule 13D. Schedule 13D must be filed within 10 days after crossing the 5% threshold and must be amended promptly following (i) a material increase or decrease in the filer’s holding; or (ii) a material change in the Schedule 13D. An increase or decrease is deemed “material” if it equals at least 1% of the outstanding securities and may, depending on the facts and circumstances, be considered “material” even if it is less than 1%.

Audited Financial Statements Delivery

Rule 206(4)-2 of the Advisers Act (the Custody Rule) requires registered advisers with custody of client assets to implement certain safeguards designed to protect client assets against the risk of loss, misuse or misappropriation. Among other things, it requires assets of an adviser’s clients to be held by a qualified custodian and to be subject to surprise annual examinations by an independent public accountant that is registered with and subject to inspection by the Public Company Accounting Oversight Board (PCAOB).

With respect to private fund clients, however, an adviser, rather than complying with the surprise audit requirement, may comply with the Custody Rule by relying on the Audit Provision under part (b)(4) of the Custody Rule. To rely on the Audit Provision, the adviser must have an independent public accountant (that is registered with and subject to inspection by the PCAOB) conduct an annual audit of each private fund client and deliver audited financial statements to all of its private fund investors. The audited financial statements must be delivered: within 120 days of the private fund’s fiscal year-end (by April 30, 2021, if the fiscal year ends on December 31); or within 180 days of the private fund’s fiscal year-end, if the private fund is a fund-of-funds (by July 1, 2021, if the fiscal year ends on December 31).

Currently, only auditors to public companies are subject to regular inspection by the PCAOB. However, on December 11, 2019, the staff of the SEC’s Investment Adviser Regulation Office in the Division of Investment Management issued a no-action letter which affirmed continuing relief that the SEC would not recommend enforcement action against an adviser engaging an auditor that is not subject to inspection by the PCAOB to audit the financial statements of a pooled investment vehicle in connection with the annual audit provision, on the condition that such auditor was (i) registered with the PCAOB, and (ii) engaged to audit the financial statements of a broker or a dealer as of the commencement of the professional engagement period and as of each calendar-year end. This relief was permitted by the SEC through the date the SEC would approve a PCAOB-adopted permanent program for the inspection of broker and dealer auditors.

Privacy Policy Delivery

Following changes to the Gramm-Leach-Bliley Act contained in Section 75001 of the Fixing America’s Surface Transportation Act of 2015 (the FAST Act), and subsequent 2019 conforming rulemaking from the CFTC, 2018 rule amendments from the U.S. Bureau of Consumer Financial Protection and 2019 staff guidance from DoE, delivery of annual privacy notices is now required only if a financial institution’s privacy policies and practices have changed since the last distribution of a privacy notice. Specifically, if there has been any change to the privacy policy that would permit non-public client information to be disclosed to non-affiliated third parties, and the new disclosure is not covered in the existing notice, the financial institution must deliver an updated notice to clients and provide them a reasonable opportunity to opt out of the new disclosure.

Schedule K-1

Delivery Under IRS rules, partnerships are required to deliver certain information on Schedule K-1 to their partners on or before the day on which the return for the relevant taxable year is required to be filed. As required by IRS rules issued in 2012, a partnership must obtain a partner’s affirmative consent for the partnership to validly deliver Schedule K-1 to the partner electronically (e.g., via email or by posting the Schedule K-1 on a web portal). For the consent to be valid, it must be obtained from a partner in the same electronic manner in which the partnership will deliver the Schedule K-1 to the partner. The applicable IRS rules also prescribe certain other requirements for electronic delivery of Schedule K-1s, including certain disclosures, which must be provided to partners regarding electronic delivery of Schedule K-1s. In addition to these IRS rules, states or other jurisdictions may impose security requirements for maintenance and transmission of sensitive personal information (such as individual Social Security numbers), which a partnership may need to comply with when delivering Schedule K-1s to its partners.

New Issues Investor Reaffirmations

If a private fund intends to invest in “new issues,” the adviser will often obtain annual reaffirmations from the private fund’s investors relating to each such investor’s eligibility to participate in profits and losses from new issues. Reaffirmation may be obtained by sending out notices asking each investor to notify the adviser if the investor’s new issues status has changed or by including a representation in the investor’s subscription agreement, whereby the investor agrees to notify the adviser of any subsequent change in its new issues status.

ERISA/VCOC Annual Certifications and Compliance

Many private funds that accept investments from investors subject to ERISA are operated in such a manner that the assets of such private funds do not constitute the “plan assets” of ERISA investors for 104 purposes of ERISA.

Typically, such a fund will either be operated as a “venture capital operating company” (VCOC) or so that “benefit plan investor” equity participation is not “significant” (i.e., under the ERISA 25% limit), and the sponsor of such a private fund often will contractually agree with its ERISA investors to deliver an annual certification as to the private fund’s continued compliance with the VCOC requirements and/or the 25% benefit plan investor limit. Private funds that accept investments from ERISA investors should conduct the VCOC or 25% benefit plan investor limit analysis as applicable, whether or not they are required to annually certify compliance with respect thereto and should be prepared to deliver any required or requested certifications in a timely manner. Private funds that are designed to hold “plan assets” and that actually are holding “plan assets” of ERISA investors may need to provide the ERISA investors with certain information relating to any changes to the fees or expenses paid by the fund, also known as a 408(b)(2) notice, by reference to the relevant section of ERISA.

Filing

Who it pertains to

Deadline

February 2022

Form 13F

Investment managers that manage over $100M in Section 13(f) securities

February 14 for the quarter ending December 31, 2021

Schedule 13G Annual Amendment

Beneficial owners of at least 5% of a class of outstanding equity securities of a U.S. public company eligible to file Schedule 13G

February 14 for 2021

March 2022

Form ADV Annual Update

Registered investment advisers and exempt reporting advisers

March 31 for an investment adviser with a December 31 fiscal year-end

April 2022

Form PF

Large liquidity fund advisers

April 15 for the quarter ending March 31, 2021

Form PF

Registered investment advisers with at least $150 million in RAUM attributable to private funds

April 30 for an investment adviser with a December 31 fiscal year end

Delivery of annual audited financial statements to private fund investors

Registered investment advisers (except for funds of funds)

April 30 for private funds with a December 31 fiscal year end

May 2022

Form 13F

Investment managers that manage over $100M in Section 13(f) securities

May 16 for the quarter ending March 31, 2022

Form PF

Large hedge fund advisers

May 30 for the quarter ending March 31, 2022

June 2022

Delivery of Annual Audited Financial Statements to Private Fund Investors

Registered investment advisers of fund of funds

June 29 for fund of funds with a December 31 fiscal year end

July 2022

Form PF

Large liquidity fund advisers

July 15 for the quarter ending June 30, 2022

August 2022

Form 13F

Investment managers that exercise investment discretion over $100M in Section 13(f) securities

August 15 for the quarter ending June 30, 2022

Form PF

Large hedge fund advisers

August 29 for the quarter ending June 30, 2022

October 2022

Form PF

Large liquidity fund advisers

October 15 for the quarter ending September 30, 2022

November 2022

Form 13F

Investment managers that oversee more than $100M in Section 13(f) securities

November 14 for the quarter ending September 30, 2022

Form PF

Large hedge fund advisers

November 29 for the quarter ending September 30, 2022

Other Deadlines

Form D

Private funds conducting an offering under Regulation D

Initial Filing: Within 15 days of the initial sale of securities

Annual Amendment: Anniversary date of the previous Form D filing

Interim Amendment: As soon as practicable after certain changes in information

Schedule 13D

Beneficial owners of at least 5% of a class of outstanding equity securities of a U.S. public company

Initial Filing: Within 10 days of crossing the 5% threshold

Amendment: Promptly after any material change in beneficial ownership percentage

Schedule 13G

Beneficial owners of at least 5% of a class of outstanding equity securities of a U.S. public company eligible to file Schedule 13G

Initial Filing: Within 45 days of year-end or within 10 days of crossing the 5% threshold.

Annual Amendment: Within 45 days of year-end.

Interim Amendment: Within 10 days of month-end or promptly if holding exceed 10% or  if it thereafter increases or decreases by over 5%

Should you require any further details, please reach out to Daryoush and Stacey directly to find out how Sanne can assist you or your business.

Let's talk

Regulatory Overview
Background image
Daryoush Niknejad General Counsel, North America
Card link - Go to a specific page
Swiper Scrollbar

Other insights from Daryoush Niknejad

Image
Insight 3 May 2022
SEC examination priorities for 2022
Card link - Go to a specific page
Image
Insight 23 March 2022
SEC proposals aplenty, the “RIC-ification” of private funds and the impact on clients
Card link - Go to a specific page
Image
Insight 7 March 2022
SEC proposes short sale disclosure rule
Card link - Go to a specific page