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From Securities Regulation Daily, March 7, 2014

Panelists consider investment management developments at PLI conference

By Amy Leisinger, J.D.

At the Practising Law Institute’s annual investment management conference, panelists concurred that the industry has seen a busy year, with the implementation of JOBS Act requirements, changing examination priorities and a new registration regime for municipal advisors. Moreover, they noted, the asset management industry has been involved in approximately 20 percent of the enforcement cases brought by the SEC in the last year, indicating an ever-increasing need for industry participants to focus on compliance with both new requirements and existing obligations.

IM Director Champ’s comments. In discussing developments in the SEC’s Division of Investment Management, Director Norm Champ noted that investors predominantly invest in registered funds overseen by the division and that these funds manage more than $16 trillion in assets. With respect to this large responsibility, he said, money market fund regulatory reform remains an important focus, together with using Form N-MFP data to inform policy decisions and rulemaking. The division will also focus on variable annuity disclosures and the potential for use of summary documents to enhance investor understanding of this information, Champ explained, and will consider a proposed rule regarding target date funds to further investor protection.

According to the director, the staff must keep pace with continued innovation by registered investment companies. To do this, the staff will need better data on mutual fund activities generally; it will engage in more interaction with registrants to evaluate issues at industry, firm, and product levels in an effort to more effectively monitor risks. The more detail we have, the more efficiently we will be able to use staff resources, Champ explained.

In addition to providing advice in over 30 no-action letters and over 100 exemptive applications, Champ said that the division has been concentrating on release staff positions in the form of guidance pieces. With guidance activities now centralized, he explained, the staff has been able to move resources around to release additional information on a broad variety of topics to the public, most recently guidance on fixed income market conditions, funds’ investment in commodities, knowledge-employee investments and the venture capital fund exemption, among other issues. We intend to continue to issue staff guidance on regular basis, he stated.

In conclusion, the director highlighted the effective coordination both within the Commission and with other financial regulators in connection with the recent implementation of the Volcker Rule, as well as the adoption of identity theft red flags rules and provisions implementing JOBS Act requirements. He hopes staff members and regulatory agencies will continue to work together on new issues, such as derivatives use by funds and fund complexes. Our financial system is going to be stronger if we collaborate and cooperate, he stated.

Regulation by other domestic and foreign agencies. Panelists also considered CFTC and domestic broker-dealer initiatives affecting the investment management industry and trends in ERISA regulation of asset managers. While noting that the organization does not regulate investment management directly, Thomas Selman of Financial Industry Regulatory Authority, Inc. (FINRA) advised that the industry should consider FINRA’s actions and guidance in relation to distributions and supervision of broker-dealer conflicts of interests. Broker-dealers may be producing material for investment management companies and advisers and may be required to file it with FINRA to ensure due diligence. Susan C. Ervin of Davis Polk & Wardwell LLP noted that industry participants also need to consider CFTC actions and their effects on investment management. The CFTC has expanded registration obligations and, while harmonization of regulations between SEC and CFTC regulations has been completed, certain disclosure obligations exist beyond substituted compliance. Further, Melanie Franco Nussdorf of Steptoe & Johnson LLP also cautioned that ERISA “foot faults” can be expensive, and, as regulators continuing to evaluate rules governing fiduciaries under ERISA, funds and advisers should take care to consider all possible implications.

In considering the effects of global regulatory reform on U.S. asset managers, panelists discussed overseas compensation and remuneration regulations, derivatives reform, hedge fund requirements and trading obligations. According to Christopher D. Christian of Dechert LLP, asset managers are looking abroad to grow their businesses due to demographic and broad fiscal changes. However, the panelists explained, registering a fund overseas requires consideration of a number of regulators, including the G20, the Financial Stability Board and the International Organization of Securities Commissions, just to name a few. Compliance issues in offering mirror funds outside the U.S. present a number of unique issues as well, including determinations regarding product structures, fund governance and applicable portfolio holdings disclosures. According to the panelists, global regulation will change the way investment companies operate, and U.S. asset managers should think globally and engage in work of international regulatory bodies even before an obligation becomes domestic law.

Compliance, inspections, and enforcement. In addressing adviser and fund compliance issues and in preparing for SEC examinations, Andrew Bowden, director of the SEC’s Office of Compliance Inspections and Examinations (OCIE), recommended that it may be appropriate to consider whether not addressing a problem or talking to Commission staff may create additional problems down the road. We want to promote compliance and recognize that most companies try to do the right thing, he said, and, as such, we release information to tell the industry where we see risks and common deficiencies. The office hopes that the new, never-before-examined-adviser initiative focusing on entities registered for more than 3years that have not been examined will assist OCIE in its work. This is “not a game of gotcha,” and there is no target on anyone’s back, Bowden emphasized. With limited resources, OCIE needs to be smart about which entities to examine and what issues to search for, using all available data to make these decisions, he explained.

On the issue of enforcement, Julie Riewe, co-chief of the Division of Enforcement’s Asset Management Unit, noted that, for registered funds, the Division of Enforcement is looking at valuation, prioritization of board governance issues and cherry-picking activities. However, she stated, something as basic as noncompliance with the custody rule may lead to more serious violations and an enforcement action. Enforcement personnel may be present at examinations, but firms should not necessarily be concerned; often, these individuals are present only to provide expertise or gain experience, she explained.

Private fund regulation. Panelists also considered issues affecting private funds and their advisers. The unique issues surrounding overmarking and undermarking in valuation and promised co-investment arrangements may cause problems for these entities, the panelists explained. Further, new compliance obligations and applicable duties may require additional staffing for private funds and private fund advisers, they stated. They applauded the SEC’s new guidance on venture capital funds that clears up issues regarding direct fund investment and its recent Managed Funds Association no-action letter removing some of the “blunt edges” regarding fund investment by knowledgeable employees, but noted that further guidance on Rule 506(c) and the lift of the ban on general solicitation may be warranted. Clarification on obligations could perhaps lift the veil of secrecy some say covers the private fund industry, the panelists concluded.

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