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Managing Compliance During COVID-19

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In response to COVID-19, IACC will be monitoring US Securities and Exchange Commission (“SEC”) regulatory developments impacting registered investment advisers (“RIAs” or “advisers”), as well as industry best practices in light of the unprecedented changes to daily work life. The alert enclosed represents Part 1 in a series that IACC will be issuing over the next few months to assist RIAs in managing their compliance programs during these challenging times. In this alert, you will find a summary of the SEC’s current status, as well as all SEC regulatory guidance and relief impacting RIAs that have been issued to date. IACC expects the SEC to provide additional guidance and relief as the situation with COVID-19 unfolds, and we will continue to keep you apprised.

PART 1: SEC COVID-19 ACTIONS IMPACTING INVESTMENT ADVISERS

The coronavirus (COVID-19) pandemic has created an unprecedented disruption in global markets. In response to COVID-19, the US Securities and Exchange Commission (“SEC”) continues to monitor market functions and participants, as well as provide targeted regulatory guidance and relief. Below is a summary of current SEC actions and initiatives impacting registered investment advisers (“RIAs” or “advisers”).

  1. SEC Operations

The SEC remains fully operational with most SEC personnel working from home since March 10th. On March 23rd, The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) announced that:

  • It will be conducting most RIA examinations offsite through correspondence;
  • RIAs relying on SEC regulatory relief related to COVID-19 will not be at a higher risk of an OCIE examination; and
  • RIAs should be aware that they may be contacted by OCIE to discuss the implementation and effectiveness of their business continuity plans.

RIAs should expect SEC examinations to focus on business continuity planning, cybersecurity, electronic communication, and adequate supervision of employees that work remotely. As previously mentioned, the SEC is fully operational and IACC advises RIAs to remain vigilant and prepared

2. SEC Guidance and Relief

Since March, the SEC has issued numerous statements to market participants granting certain exemptions and regulatory relief as a result of hardships created by COVID-19. Summarized below are the SEC actions impacting RIAs, which have primarily addressed the Custody Rule, Form ADV and Form PF, and Registered Funds. The SEC also posted COVID-19 FAQs to answer more specific questions.

A. Custody Rule

Inadvertent Receipt of Client Assets. On March 16, 2020, the SEC updated Question II.1 of the Custody Rule FAQs regarding the meaning of “custody” concerning the inadvertent receipt of client assets. The SEC stated that it would not consider an adviser to have received client assets at an office location inaccessible due to COVID-19 until firm personnel can access the mail or deliveries at that office location.

Surprise Examinations. On March 30, 2020, the SEC added Question IV.7 to the Custody Rule FAQs. The SEC indicated that if an adviser’s independent public accountant failed to complete its surprise examination and submit Form ADV-E by the 120-day deadline due to COVID-19 disruptions, it may instead file such report within 45 days after the original due date. 

Privately Offered Certificated Securities. On April 2, 2020, the SEC added Question VII.4 to the Custody Rule FAQs. The SEC stated that it would not recommend enforcement action against an adviser for not maintaining certificates for privately offered securities with a qualified custodian that is not currently accepting such certificates due to COVID-19 provided:

  • The certificates can only be used to effect a transfer or facilitate a change in beneficial ownership of the security with the prior consent of the issuer or holders of the outstanding securities of the issuer;
  • Ownership of the security is recorded on the issuer’s or transfer agent’s books in the name of the client;
  • The physical certificates contain a legend restricting transfer;
  • The physical certificates are appropriately safeguarded by the adviser and can be replaced upon loss or destruction; and
  • The adviser maintains a record of the custodian’s closure. 

Private Fund Annual Audit. On April 27, 2020, the SEC updated Question VI.9 of the Custody Rule FAQs regarding annual audited financial statements for pooled investment vehicles. The SEC indicated that it would not take action against an adviser that does not distribute the audited financial statements to investors by the deadline due to disruptions from COVID-19.

B. Form ADV and Form PF

Filing Deadlines. On March 13, 2020, the SEC issued an order, which was subsequently amended on March 25, 2020, extending the Form ADV and Form PF deadlines for filings and deliveries that would otherwise be due between March 13 and June 30, 2020. Advisers must now file Form ADV or Form PF, and deliver the brochure (or summary of material changes) and brochure supplement as soon as practicable, but no later than 45 days after the original due date for filing or delivery. In addition, an adviser relying on this order will need to notify the SEC by email and clients by posting a statement on its public website (or directly to clients/private fund investors if it does not have a public website) that it is relying on the relief.

Disclosure of Office Locations. On March 16, 2020, the SEC updated the Form ADV FAQs concerning Item 1.F. The SEC stated if an adviser has employees that are temporarily teleworking as part of the firm’s business continuity plan due to such circumstances, Item 1.F of Part 1A and Section 1.F of Schedule D do not need to be updated to include the temporary teleworking addresses.

Disclosure of Loans Received. On April 27, 2020, the SEC added Question II.4 to the COVID-19 Response FAQs, which addresses reporting obligations for advisers that receive Payment Protection Program (PPP) loans. The SEC indicated that an adviser seeking a PPP loan to pay employees that perform advisory functions or experiencing conditions likely to impair its ability to meet contractual commitments should disclose this in Form ADV Part 2A.

Wrap-Fee Program Brochure Delivery. On April 27, 2020, the SEC added Question II.5 to the COVID-19 Response FAQs, which addresses advisers that participate in wrap-fee programs and delegate to the program sponsor responsibility for delivery of Form ADV Part 2A to clients. Specifically, if a program sponsor is unable to meet the annual delivery deadline due to COVID-19, the participating adviser may rely on the SEC’s March 25, 2020 order as noted above if:

  • It discloses on its public website (or if it does not have a public website, provide notice as described in the order) that it is relying on the order; and
  • The program sponsor promptly notifies the SEC of each participating adviser that is relying on the order and represents that it has the authority to submit the email on their behalf.

C. Advisers to Registered Funds

Voting and Filing Deadlines. On March 13, 2020, the SEC issued an order, which was subsequently amended on March 25, 2020, granting the following relief:

  • Through August 15, 2020, funds are exempt from the in-person voting requirements to approve investment advisory agreements, principal underwriting agreements, auditors, and plans regarding distribution-related payments from fund assets if:
    • Reliance on the order is necessary or appropriate due to circumstances related to current or potential effects of COVID-19;
    • Votes are cast at a meeting in which all directors may participate and hear each other simultaneously; and
    • The board, including a majority of the directors who are not interested persons of the fund, ratifies the approval at the next in-person meeting.
  • Filing deadlines for Form N-CEN and Form N-PORT, and transmittal and delivery deadlines for annual and semi-annual reports, and the current prospectus, are extended where the original due date is on or after March 13, 2020, but on or before June 30, 2020, provided:
  • The fund is unable to meet a filing deadline due to circumstances related to the potential effects of COVID-19;
  • The fund notifies the SEC via email and discloses on its public website that it is taking advantage of the exemptive order;
  • The fund files the required forms as soon as practicable, but no later than 45 days after the original due date;
  • When filing Form N-Port and N-CEN, the fund includes that it relied on this exemption and the reasons why it was unable to transmit the report on a timely basis;
  • Annual and Semi-Annual Reports are be filed within 10 days of transmitting the reports to its shareholders; and
  • The fund publishes the current prospectus on its public website.

Disclosures. On March 25th, the SEC issued a press release addressing disclosure considerations of public companies, including registered funds. In summary, the press release stated:

  • If a company is aware of a risk related to COVID-19 that would be material to its investors, it should refrain from engaging in securities transactions with the public and discourage directors and officers from initiating such transactions until investors have been appropriately informed about the risk;
  • If a company or its insiders are engaged in transactions, the company should consider what disclosures are required to inform the public of its financial condition;
  • Companies that disclose material information related to the impacts of COVID-19 should avoid selective disclosures and disseminate such information broadly; and
  • Companies should consider whether they may need to update previous disclosure to the extent that the information becomes materially inaccurate.

Mailing Proxy Materials. On March 4, 2020, the SEC issued an order, which was subsequently amended on March 25, 2020, granting relief related to proxy materials, including proxy statements, annual reports, and other soliciting materials, furnished between March 1, 2020, and July 1, 2020. Specifically, funds are exempt from mailing proxy materials when a security holder has a mailing address in an area where delivery service has been suspended, and the fund has made a good faith effort to furnish applicable materials to the security holder. In addition, funds may use the “notice-only” delivery option to provide shareholders with proxy materials sufficiently in advance of a meeting so that they may review the materials and vote on the proposals in an informed manner.

Shareholder Meetings. On March 13, 2020, the SEC announced guidance, which was subsequently amended on April 7, 2020, to assist public companies, including funds, with upcoming shareholder meetings. Specifically:

  • A fund that has mailed and filed its definitive proxy materials can notify shareholders of a change in the date, time or location of its annual or special shareholder meeting without mailing additional soliciting materials or amending its proxy materials if it:
    • issues a press release announcing the change,
    • files the announcement as definitive additional soliciting material on EDGAR, and
    • informs other intermediaries in the proxy process and other relevant market participants, such as a stock exchange, of such change;
  • If a fund expects to conduct a virtual meeting, the fund must notify its shareholders, intermediaries in the proxy process, and other market participants promptly and disclose clear directions as to the logistical details of the virtual meeting; and
  • Where feasible, funds should provide shareholder proponents or their representatives with the ability to present their proposals through alternative means, such as by phone, during the 2020 proxy season.

Liquidity. On March 23, 2020, the SEC issued an order providing flexibility to open-end funds (other than money market funds) and insurance company separate accounts registered as UITs (qualifying funds) for short-term funding.

Borrowing

From March 23, 2020, through at least June 30, 2020, qualifying funds are permitted to borrow from their affiliated persons (or affiliated persons of such persons) on a collateralized basis provided:

  • The fund board, including a majority of uninterested persons of the fund or the insurance company, reasonably determines that such borrowing:
    • is in the best interests of the fund and its shareholders or unitholders, and
    • will be to satisfy shareholder redemptions; and
  • Before relying on the relief for the first time, the open-end fund or separate account notifies the SEC that it is relying on this exemptive order.

Existing Interfund Lending Orders

In addition, any open-end fund currently relying on an interfund lending order may:

  • Make loans through the facility in an aggregate amount that does not exceed 25% of its net assets; and
  • Borrow or make loans, provided that:
    • the term of any interfund loan made in reliance of the exemptive order does not extend beyond the relief period granted by the SEC’s order,
    • the fund’s board, including a majority of the independent directors, reasonably determines that the maximum term for interfund loans is appropriate, and
    • the loans will remain callable, and subject to early repayment on the terms as described in the existing interfund lending order.

 To rely on this relief, the respective fund must:

  • Ensure any loan under the facility is otherwise to be made in accordance with the terms and conditions of the exiting interfund lending order;
  • Notify the SEC via email prior to relying on the relief for the first time, stating that the fund is relying on the order; and
  • Disclose on its public website that it is relying on the order and that the order modifies the terms of the fund’s existing interfund lending order before relying on this relief for the first time.

New Interfund Lending Arrangements

Open-end funds may participate in new interfund lending arrangements provided:

  • The fund satisfies the terms and conditions for relief in the recent interfund lending order precedent, except that:
    • the fund may rely on the same relief provided to funds and separate accounts with existing interfund lending orders,
    • the fund need not include disclosure noting the fund’s reliance on an interfund lending order in the fund’s registration statement or shareholder report, and
    • money market funds may not participate as borrowers in any interfund facility;
  • The fund notifies the SEC via email prior to relying on the relief for the first time;
  • The fund discloses on its public website that it is relying on the order to utilize an interfund lending or borrowing facility before relying on the relief for the first time; and
  • The fund includes disclosure regarding the material facts about its participation in the facility in any prospectus supplement or a new or amended registration statement or shareholder report it files while it is relying on this relief.

Deviation for Policy

An open-end fund may deviate from its policy on lending and borrowing disclosed in its registration statement without shareholder approval if:

  • The fund board, including a majority of the independent directors, reasonably determines that such lending or borrowing is in the best interest of the fund and its shareholders;
  • The fund promptly notifies its shareholders of the deviation by filing a prospectus supplement and including a statement on the fund’s public website; and
  • The fund notifies the SEC via email before relying on the relief for the first time.

Affiliated Purchases of Debt Securities

On March 26, 2020, the SEC issued a no-action letter to the Investment Company Institute granting temporary relief for affiliated purchases of debt securities from open-end funds that are not ETFs or money market funds. Such transactions will only be permitted if:

  • The purchase price is paid in cash;
  • The purchase price equals the debt security’s fair market value;
  • Any profit from a subsequent sale of such security by the purchaser is paid back to the fund; and
  • Within one business day of any such purchase, the fund publicly posts on its website and informs the SEC via email of the name of the fund, the name of the affiliated purchaser, the securities purchased (including a legal identifier if available), the amount purchased and the total price paid.

On March 19, 2020, the SEC issued a no-action letter to the Investment Company Institute granting temporary relief for affiliated purchases of securities from money market funds. Such transactions will only be permitted if:

  • The purchase price of the security equals the fair market value;
  • The terms do not otherwise conflict with applicable banking regulations or the exemption issued by the Board of Governors of the Federal Reserve System on March 17, 2020; and
  • The fund files Form N-CR, reports the transactions under Part C and discloses in Part H that the transactions were conducted in reliance on this no-action letter promptly.

3. How Can IACC Help?

IACC appreciates the opportunity to serve the RIA community and provide support during these volatile times. If you have any questions or are finding it difficult to manage your compliance program in the current environment, please do not hesitate to contact us at 941-786-4482 or advisercomplianceconsultants@outlook.com. We specialize in SEC regulatory compliance for RIAs and are happy to answer any questions that you have.

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