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Recent SEC Leadership Changes The Securities and Exchange Commission (the “SEC”) announced the appointment of Natasha Vij Greiner and Keith E. Cassidy as interim Acting Co-Directors of the Division of Examinations (the “Division”), effective July 25, 2023, while Division Director Richard Best is on extended medical leave. Greiner and Cassidy will also continue to serve in their current leadership roles within the Division.

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Greiner currently serves as Division Deputy Director, National Associate Director of the Investment Adviser/Investment Company (“IA/IC”) examination program (including the Private Funds Unit) and Associate Director of the Home Office IA/IC examination program. Greiner began her SEC career in the Division as a broker-dealer examiner and has served in a variety of roles across the agency for more than 21 years, including Acting Chief Counsel and Assistant Chief Counsel in the Division of Trading and Markets. Prior to joining the Division, Greiner spent almost a decade in the Division of Enforcement (“Enforcement”), including in its Asset Management Unit, where she investigated possible violations of the federal securities laws and litigated matters in federal district court and administrative proceedings.

Cassidy currently serves as Deputy Director and is the National Associate Director of the Division’s Technology Controls Program with responsibility for examinations of Regulation SCI entities and for overseeing the SEC’s CyberWatch program and the Cybersecurity Program Office. According to the announcement, Cassidy is also an infantry officer in the United States Marine Corps Reserve where he is the Executive Officer of 4th Reconnaissance Battalion and has earned numerous awards, including a Bronze Star. Cassidy previously served as the Director of the Commission’s Office of Legislative and Intergovernmental Affairs, as Chief of Staff and Counsel at the Department of Justice’s Office of Legislative Affairs, and as a legislative assistant in the United States Senate.

SEC Appoints George Botic to the Public Company Accounting Oversight Board The SEC appointed George Botic, CPA, as a Board Member of the Public Company Accounting Oversight Board (“PCAOB”) on September 27, 2023. Botic will replace current Board Member Duane DesParte, CPA, whose current term expires on October 24, 2023.

Prior to this appointment, Botic was the Director of the PCAOB’s Division of Registration and Inspections, which includes the Global Network Firm Inspection Program, the Non-Affiliate Firm Inspection Program, the Broker-Dealer Auditor Interim Inspection Program, and the registration program. Botic oversaw the registration and inspection of all domestic and foreign accounting firms that audit public companies whose securities trade in the United States, as well as all broker-dealer audits. He previously served in various roles at the PCAOB, including as its Director of the Office of International Affairs, special advisor to former Chair James R. Doty, and Deputy Director of the Registration and Inspections Division. Earlier in his career, Botic was a senior manager with PricewaterhouseCoopers.

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Division of Examinations Issues Risk Alert Regarding Investment Adviser Examinations The Division issued a risk alert (the “Risk Alert”) intended to provide additional transparency and insight regarding the scope of investment adviser examinations. The September 6, 2023, Risk Alert provides additional information regarding the Division’s examination selection process and information regarding document requests. The Risk Alert describes how the staff’s risk-based approach is “dynamic” in adapting to changes in market conditions, industry practices, and investor preferences, and that the information provided may better equip advisers for an examination as well as assist firms in their compliance efforts.

The Risk Alert indicates that the Division utilizes a risk-based approach for both selecting advisers to examine and in determining the scope of risk areas in those examinations. When selecting advisers to examine, the Division considers factors such as which advisers provide services, recommend products, or otherwise meet criteria relevant to the focus areas described in the Division’s examination priorities. An adviser may be selected for an examination in order to evaluate firm risks, respond to events that pose risks to investors and the markets, and/or to assess how registrants are adapting to new regulatory requirements. When conducting an examination, the Division leverages technology and utilizes disclosure documents and various filings with regulators such as Form ADV and Form PF in its initial request for information but as an examination progresses it may make requests for additional information.

According to the Risk Alert, the Division selects an adviser to examine based on the firm’s characteristics, on a tip, complaint, or referral, or on the staff’s interest in a particular compliance risk area. In addition, the Risk Alert noted firm-specific risk factors that the Division staff may consider when selecting advisers for examination, such as those related to a particular adviser’s business activities, conflicts of interest, and regulatory history. The Risk Alert provided examples of Division staff’s possible considerations including: (1) prior examination observations and conduct, such as when the staff has observed what it believes to be repetitive deficient practices during more than one review of a firm, significant fee- and expense-related issues, and significant compliance program concerns; (2) supervisory concerns, such as disciplinary history of associated individuals or affiliates; (3) tips, complaints, or referrals involving the firm; (4) business activities of the firm or its personnel that may create conflicts of interest, such as outside business activities and the conflicts associated with advisers dually registered as, or affiliated with, brokers; (5) the length of time since the firm’s registration or last examination, such as advisers newly-registered with the SEC; (6) material changes in a firm’s leadership or other personnel; (7) indications that the adviser might be vulnerable to financial or market stresses; (8) reporting by news and media that may involve or impact the firm; (9) data provided by certain third-party data services; (10) the disclosure history of the firm; and (11) whether the firm has access to client and investor assets and/or presents certain gatekeeper or service provider compliance risks.

Per the Risk Alert, after an adviser is selected, Division staff assesses the scope of the examination, such as selecting particular areas of the business in which to review. Documents requested will vary from examination to examination depending on the firm’s business model, associated risks, and the reason for conducting the examination. According to the Risk Alert, Division staff request and review documents and information to assist in their understanding of advisers’ operations, disclosures, conflicts of interest, and compliance practices with respect to certain core areas, including but not limited to custody and safekeeping of client assets, valuation, portfolio management, fees and expenses, and brokerage and best execution.

The Risk Alert provided guidance with respect to what may be requested in the staff’s letter to an adviser notifying the firm of the upcoming examination. The initial request for information and documentation typically includes: (1) general information, which provides the staff with an understanding of the adviser’s business and investment activities; (2) information about the compliance risks that the adviser has identified and the written policies and procedures the firm has adopted and implemented to address each of those risks; (3) information to facilitate testing with respect to advisory trading activities; and (4) information for the staff to perform its own testing for compliance in various areas.

SEC Proposes Rule Amendments to the Broker-Dealer Customer Protection Rule The SEC proposed amendments on July 12, 2023, to Rule 15c3-3, the Customer Protection Rule, to require certain broker-dealers to increase the frequency with which they perform computations of the net cash owed to customers and other broker-dealers (known as “PAB account holders”) from weekly to daily (“Proposed Amendments”). Net cash owed to customers and PAB account holders must be held in a special reserve bank account.

The Proposed Amendments would require broker-dealers with average total credits (the amount of cash owed customers and PAB account holders) equal to or greater than $250 million to make the computations necessary to determine the amounts required to be deposited in the customer and PAB reserve bank accounts daily, as of the close of the previous business day. According to the SEC, by reducing the timeframe between computations, the Proposed Amendments would assist broker-dealers more dynamically in matching the net amount of cash owed to customers and PAB account holders with the amount on deposit in the broker-dealer’s customer and PAB reserve bank accounts. The daily customer and PAB reserve computations would safeguard customers and PAB account holders by decreasing the potential for large mismatches to build over time, thereby increasing the likelihood that they are made whole even if a broker-dealer fails.

In addition, the Commission invited comments on whether similar daily reserve computation requirements should apply to broker-dealers and security-based swap dealers with respect to security-based swap customers.

The proposing release was published in the Federal Register on July 18, 2023, and the public comment period ended on September 11, 2023.

“I am pleased to support this proposal because, if adopted, it would help protect customers in the event that a broker-dealer fails,” said SEC Chair Gary Gensler. “A key tenet of our securities laws is the segregation of customers’ cash and securities from a broker-dealer’s own account. Given the speed, scale, and volume of today’s market activity, I believe customers would benefit if broker-dealers carrying large credit balances made daily reserve account calculations and deposits. This frequency would better align with the inflows, swings, and balances that broker-dealers experience in today’s markets.”

SEC Adopts Rules on Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure by Public Companies The SEC adopted the final rules regarding cybersecurity risk management, strategy, governance, and incident disclosure by public companies (the “Cyber Rules”) on July 26, 2023. The Cyber Rules require registrants to disclose material cybersecurity incidents (“Material Incidents”) that they experience and to disclose on an annual basis material information regarding their cybersecurity risk management, strategy, and governance (“Material CRSG Information”).

In the proposing release to the Cyber Rules, which was released in March 2022, the Commission proposed new rules, rule amendments, and form amendments to enhance and standardize disclosures regarding cybersecurity risk management, strategy, governance, and material cybersecurity incidents by public companies that are subject to the reporting requirements of the Securities Exchange Act of 1934 (the “Exchange Act”). According to the Commission’s adopting release, the Cyber Rules will enhance and standardize disclosures regarding cybersecurity risks.

The Cyber Rules require registrants to disclose on the new Item 1.05 of Form 8-K any Material Incident and to describe the material aspects of the incident’s nature, scope, and timing, as well as its material impact or reasonably likely material impact on the registrant. Such disclosure must be filed within four business days after a registrant determines that a cybersecurity incident is material, however, the disclosure may be delayed if the U.S. Attorney General determines that immediate disclosure would pose a substantial risk to national security or public safety and notifies the SEC of such determination in writing.

In addition, the Cyber Rules add Regulation S-K Item 106 (“Item 106”), which will require registrants to describe their processes, if any, for assessing, identifying, and managing material risks from cybersecurity threats, as well as the material effects or reasonably likely material effects of risks from cybersecurity threats including previous cybersecurity incidents. Item 106 will also require registrants to describe the board of directors’ oversight of risks from cybersecurity threats and management’s role and expertise in assessing and managing material risks from cybersecurity threats. These disclosures will be required in a registrant's annual report on Form 10-K.

Under the adopted Cyber Rules, foreign private issuers are required to make comparable disclosures of Material Incidents on Form 6-K and for Material CRSG Information on Form 20-F.

The adopting release indicates that the terms “public companies,” “companies,” and “registrants” include issuers that are business development companies as defined in section 2(a)(48) of the Investment Company Act of 1940 (the “Investment Company Act”), which are a type of closed-end investment company that is not registered under the Investment Company Act, but do not include investment companies registered under the Investment Company Act.

The final Cyber Rules became effective on September 5, 2023. The Form 10-K and Form 20-F disclosures will be required beginning with annual reports for fiscal years ending on or after December 15, 2023. The Form 8-K and Form 6-K disclosures will be required beginning the later of 90 days after the date of publication in the Federal Register or December 18, 2023. Smaller reporting companies will have an additional 180 days before they must begin providing the Form 8-K disclosure. With respect to compliance with the structured data requirements, all registrants must tag disclosures required under the final rules in Inline XBRL beginning one year after initial compliance with the related disclosure requirement.

“Whether a company loses a factory in a fire—or millions of files in a cybersecurity incident—it may be material to investors,” said SEC Chair Gary Gensler. “Currently, many public companies provide cybersecurity disclosure to investors. I think companies and investors alike, however, would benefit if this disclosure were made in a more consistent, comparable, and decision-useful way. Through helping to ensure that companies disclose material cybersecurity information, today’s rules will benefit investors, companies, and the markets connecting them.”

SEC Proposes Reforms Relating to Investment Advisers Operating Exclusively through the Internet The SEC proposed rule amendments (the “Proposed Amendments”) on July 26, 2023, permitting certain investment advisers that provide investment advisory services through the internet, known as “internet investment advisers” or “robo-advisers,” to register with the SEC. The Proposed Amendments would require an investment adviser, relying on the internet adviser registration rule, to have at all times an operational interactive website through which the adviser provides digital investment advisory services on an ongoing basis to more than one client. The Proposed Amendments would also eliminate the de minimis exception from the current rule by proposing to require that an internet investment adviser provide advice to all of its clients exclusively through an operational interactive website, and make certain corresponding changes to Form ADV.

The Proposed Amendments were published in the Federal Register on August 1, 2023, and the public comment period ended on October 2, 2023.

“In 2002, the SEC granted what was intended to be a narrow exception allowing internet-based advisers to register with the SEC instead of with the states,” said SEC Chair Gary Gensler. “A lot has changed in the 21 years since, and I believe an exemption written in 2002 allows gaps in 2023. Thus, today’s proposal would modernize the internet advisers exemption to better align registration requirements with modern technology and help the Commission in the efficient and effective oversight of registered investment advisers.”

SEC Proposes New Requirements for the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers The Commission proposed new rules (the “Predictive Rule Proposal”) on July 26, 2023, that require broker-dealers and investment advisers (collectively, “Firms”) to take steps to address conflicts of interest associated with their use of predictive data analytics and similar technologies (“PDA Technology”) used to interact with investors in order to prevent Firms from placing their interests ahead of investors’ interests.

According to the Predictive Rule Proposal, Firms’ use of PDA Technology to optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes has accelerated. Generally, PDA Technology is a type of advanced analytics that makes predictions about future outcomes using historical data combined with statistical modeling and data mining techniques to assist companies to find patterns in data to identify risks and opportunities to make more informed decisions about where to invest clients’ funds.

According to industry sources, use of PDA Technology may benefit investors in providing greater market access, efficiency, and returns. According to the SEC, the Predictive Rule Proposal is important because Firms may use PDA Technology in a manner that places their own interests ahead of investors’ interests causing investors to suffer financial harm. Also, given the scalability of PDA Technology, there is a potential for Firms to reach a broad audience at a rapid speed so that any resulting conflicts of interest could cause harm to investors on a broader scale than previously possible.

The Predictive Rule Proposal would require Firms to evaluate and determine whether their use of PDA Technology in investor interactions involves a conflict of interest that results in the Firms’ interests being placed ahead of investors’ interests. In addition, Firms would be required to eliminate, or neutralize the effect of, any such conflicts and be permitted to employ tools that they believe would address these risks, consistent with the proposal, which are specific to the particular technology they use. The Predictive Rule Proposal would also require Firms to have written policies and procedures reasonably designed to achieve compliance with the proposed rules and to make and keep books and records related to these requirements.

The proposing release was published in the Federal Register on August 9, 2023, and the public comment period ended on October 10, 2023.

Subsequent to the Predictive Rule Proposal’s issuance, the Investment Company Institute (“ICI”) and 15 other trade associations, including the National Association of Investment Companies, Managed Funds Association, and the American Investment Council, requested that the SEC extend the 60-day comment period for the Predictive Rule Proposal. In a letter dated August 15, 2023, the trade organizations (including a diverse group of market participants, such as registered investment advisers and broker-dealers, registered and private funds, as well as institutional and individual investors) reasoned that “the dramatic, incredibly expansive nature of [the proposal’s] restrictions would without question have a severely chilling effect on firms’ use of technology” and that it is appropriate to extend the comment period by 60 days because of “the shifting nature of the regulatory and commercial landscape resulting from [the SEC’s] proposals and new rules, as well as the cumulative burden on registrants, service providers, and investors ...”

The trade organizations’ letter also addressed the unprecedented rule proposals issued by the Commission in the past two years as well as its implications that the Predictive Rule Proposal would have on other recently implemented rules such as the Investment Advisers Act of 1940 (the “Advisers Act”) marketing rules, which regulates investment advisers’ marketing communications.

“We live in an historic, transformational age with regard to predictive data analytics, and the use of artificial intelligence,” said SEC Chair Gary Gensler. “Today’s predictive data analytics models provide an increasing ability to make predictions about each of us as individuals. This raises possibilities that conflicts may arise to the extent that advisers or brokers are optimizing to place their interests ahead of their investors’ interests. When offering advice or recommendations, firms are obligated to eliminate or otherwise address any conflicts of interest and not put their own interests ahead of their investors’ interests. I believe that, if adopted, these rules would help protect investors from conflicts of interest—and require that, regardless of the technology used, firms meet their obligations not to place their own interests ahead of investors’ interests.”

SEC Enhances the Regulation of Private Fund Advisers The SEC adopted new and amended rules on August 23, 2023, which enhance the regulation of investment advisers to private funds known as “Private Fund Adviser Rules” (the “Private Fund Rules” or the “Reforms”). The SEC’s initial proposed rules were issued on February 9, 2022, and met with intense industry discussion with two rounds of comment periods. According to the SEC, the new rules and amendments are designed to protect private fund investors by increasing transparency, competition, and efficiency in the private funds market. The adopted Private Fund Rules focus on reporting and disclosure obligations as well as impose restrictions and disclosure requirements with respect to certain activities.

Per the SEC release, the Reforms are designed to enhance transparency. The final rules will require private fund advisers registered with the Commission (“Registered Advisers”) to provide investors with quarterly statements detailing certain information regarding fund fees, expenses, compensation, and performance. Registered Advisers will also be required to obtain and distribute to investors an annual financial statement audit of each private fund they advise which meets the requirements of the audit provision in the Advisers Act custody rule (rule 206(4)-2) and, in connection with adviser-led secondaries transaction, a fairness opinion or valuation opinion will be required. An adviser-led secondary transaction is one which offers fund investors the option between selling all or a portion of their interests in the private fund and converting or exchanging them for new interests in another vehicle advised by the adviser or any of its related persons.

The Reforms also require Registered Advisers to prepare and distribute to the fund’s investors a summary of any material business relationships the adviser has, or has had within the prior two years, with the independent opinion provider. In addition, the Private Fund Rules include amendments to the books and records rule under the Advisers Act for Registered Advisers.

According to the SEC, to address certain conflicts of interest that have potential to lead to investor harm, the Private Fund Rules include a new rule--“the restricted activities rule”--that prohibits all private fund advisers (whether registered or not) from engaging in the following activities unless they provide appropriate specified disclosure and, in some cases, obtain investor consent:

Charging or allocating to the private fund regulatory, examination, or compliance fees or expenses of the adviser, unless such fees and expenses are disclosed to investors;

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Reducing the amount of an adviser clawback by actual, potential, or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders, unless the adviser discloses the pre-tax and post-tax amount of the clawback to investors;

Charging or allocating fees and expenses related to a portfolio investment on a non-pro rata basis unless the allocation approach is fair and equitable and the adviser distributes advance written notice of the non-pro rata charge and a description of how the allocation approach is fair and equitable under the circumstances; and

Borrowing money, securities, or other private fund assets, or receiving a loan or an extension of credit, from a private fund client without disclosure to, and consent from, fund investors.

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In addition, the Reforms also impose the “preferential treatment rule” which, according to the SEC, addresses the material negative effects of specific types of preferential treatment on other investors. The Reforms prohibit all private fund advisers from providing preferential terms to investors regarding: a) certain redemptions from the fund, unless the ability to redeem is required by applicable law or the adviser offers the preferential redemption rights to all other investors without qualification; and b) certain preferential information about portfolio holdings or exposures, unless such preferential information is offered to all investors. In addition, the SEC adopted a disclosure-based exception to the proposed prohibition, including a requirement to provide certain specified disclosure regarding preferential terms to all current and prospective investors. As such, the Reforms prohibit all private fund advisers from providing preferential treatment to investors, unless certain terms are disclosed in advance of an investor’s investment in the private fund and all terms are disclosed after the investor’s investment.

The Private Fund Rules also include a “legacy status” provision applicable to certain of the restricted activities and preferential treatment provisions so that advisers and investors would not be required to renegotiate governing agreements for existing funds. Such legacy status will apply to those governing agreements entered into in writing prior to the compliance date and with respect to funds that have commenced operations as of the compliance date.

The Reforms also include amendments to the compliance rule under the Advisers Act requiring all registered advisers, including those that do not advise private funds, to document in writing the required annual review of their compliance policies and procedures. According to the SEC, written documentation of the annual review will help the Commission to determine advisers’ compliance with the rules and identify potential weaknesses in compliance programs.

The Reforms as they pertain to industry providers are:

SEC-Registered Private Fund Advisers

Quarterly Statement Rule: New Rule 211(h)(1)-2

Private Fund Audit Rule: New Rule 206(4)-10

Adviser-Led Secondaries Rule: New Rule 211(h)(2)-2

Books and Records Rule Amendments: Amended Rule 204-2

All Private Fund Advisers

Restricted Activities Rule: New Rule 211(h)(2)-1

Preferential Treatment Rule: New Rule 211(h)(2)-3

All Registered Advisers

Compliance Rule Amendments: Amended Rule (206(4)-7(b))

Notably, the Private Fund Rules do not apply to investment advisers with respect to securitized asset funds they advise<a>.</a>

The SEC distinguished compliance dates for the Private Fund Rules:

Quarterly Statement and Private Fund Audit Rules. For larger and smaller private fund advisers, the compliance date is 18 months after publication in the Federal Register.

Adviser-Led Secondaries Rule, the Preferential Treatment Rule, and the Restricted Activities Rule. For advisers with $1.5 billion or more in private funds assets under management, the compliance date is 12 months after the date of publication in the Federal Register; and for advisers with less than $1.5 billion in private funds assets under management, 18 months after the date of publication in the Federal Register.

Amended Advisers Act Compliance Rule. For registered advisers, compliance will be required 60 days after publication in the Federal Register.

“Private funds and their advisers play an important role in nearly every sector of the capital markets,” said SEC Chair Gary Gensler. “By enhancing advisers’ transparency and integrity, we will help promote greater competition and thereby efficiency. Consistent with our mission and Congressional mandate, we advance today’s rules on behalf of all investors—big or small, institutional or retail, sophisticated or not.”

SEC Reopened Comment Period for Enhanced Safeguarding Rule for Registered Investment Advisers Proposal The SEC reopened the comment period on August 23, 2023, for its proposed rule Safeguarding Advisory Client Assets that would redesignate and amend the current custody rule under the Advisers Act to enhance protections of customer assets managed by registered investment advisers. This rule was proposed by the Commission on February 15, 2023, and the initial comment period ended on May 8, 2023.

The comment period was reopened to allow interested persons additional time to analyze the issues and prepare comments in light of the final rules and amendments. The comment period will remain open until 60 days after the date of publication in the Federal Register, which was published on August 30, 2023.

ICI Submits Letter to SEC on Aggregated Impact of Rulemaking The ICI submitted a letter (the “Letter”) to the SEC on August 17, 2023, acknowledging that the SEC has issued numerous “interconnected rule proposals” over the last two-and-a-half years, and according to the ICI, without analyzing them holistically. The Letter raises the concern that the “unprecedented” number of proposals in a short period of time has not afforded regulated entities or market participants the time needed to fully process, digest, and evaluate the interconnections and interdependencies of the rules.

In its Letter, the ICI requests that the SEC: 1) “publish a thorough analysis of the cumulative effects of the interconnected rules that accounts for interconnections and dependencies among them and any other rules the SEC has proposed or intends to propose in the near term; 2) reopen the comment periods for the interconnected rules; and 3) finalize the rules holistically, not one at a time or in isolated series, taking into account not just the expected effects on investors and our capital markets but also practical realities such as implementation timelines as well as operational and compliance requirements.” The Letter also recommends that the SEC publish, for public notice and comment, proposed phased multi-year implementation schedules.

SEC Adopts Rule Enhancements to Prevent Misleading or Deceptive Investment Fund Names The final “Fund Names Rule” was adopted by the Commission in a 4-to-1 vote (the “Final Rule”) on September 20, 2023. The amendments to the Names Rule will require a greater number of funds to adopt an 80 percent investment policy, including funds with names suggesting a focus in investments with particular characteristics; for example, terms such as “growth” or “value,” or certain terms that reference a thematic investment focus, such as the incorporation of one or more ESG factors.

In addition, the Final Rule includes a new quarterly review which requires funds to review their portfolio assets’ treatment under its 80 percent investment policy at least quarterly and includes specific time frames–generally 90 days–for getting back into compliance if a fund deviates from its 80 percent investment policy. The adopted amendments require enhanced prospectus disclosure requirements for terminology used in fund names, including a requirement that any terms used in the fund’s name that suggest an investment focus must be consistent with those terms’ plain English meaning or established industry use. With respect to the terms used in a fund’s name, the SEC indicated in the Final Rule release that fund managers will determine how featured terms are defined. Additional N-PORT reporting and recordkeeping requirements for funds regarding compliance with the names-related regulatory requirements were also adopted.

The Final Rule becomes effective 60 days after publication in the Federal Register and according to the Final Rule, fund groups with net assets of $1 billion or more will have 24 months to comply with the amendments, and fund groups with net assets of less than $1 billion will have 30 months to comply.

“As the fund industry has developed over the last two decades, gaps in the current Names Rule may undermine investor protection,” said SEC Chair Gary Gensler. “Today’s final rules will help ensure that a fund’s portfolio aligns with a fund’s name. Such truth in advertising promotes fund integrity on behalf of fund investors.”

Update to SEC’s Rulemaking Spring 2023 Agenda The Office of Information and Regulatory Affairs released the Spring 2023 Unified Agenda of Regulatory and Deregulatory Actions (the “Agenda”) on June 13, 2023. (See “SEC Releases Rulemaking Spring 2023 Agenda” in Blank Rome’s&nbsp;<a href="https://www.blankrome.com/publications/regulatory-update-and-recent-sec-actions-19">Investment Management Regulatory Update</a>&nbsp;dated July 2023.) Since then, three previously proposed rules were adopted in July, August, and September 2023: (i) the final rule on Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure (effective on September 5, 2023); (ii) the Private Fund Advisers: Documentation of Registered Investment Adviser Compliance Reviews final rule (issued on August 23, 2023, and effective November 13, 2023); (iii) the Fund Names Rule ( will become effective 60 days after publication in the Federal Register). (See “SEC Adopts Rules on Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure by Public Companies,” “SEC Enhances the Regulation of Private Fund Advisers,” and “SEC Adopts Rule Enhancements to Prevent Misleading or Deceptive Investment Fund Names” in this Regulatory Update.)

Third Quarter Final Rules

Cybersecurity Risk Management for Investment Advisers, Registered Investment Companies, and Business Development Companies

Rule Enhancements to Prevent Misleading or Deceptive Investment Fund Names

The following rules were proposed within the third quarter and are also discussed within this Regulatory Update:

Third Quarter Proposed Rules:

Daily Computation of Customer and Broker-Dealer Reserve Requirements under the Broker-Dealer Customer Protection Rule

Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers

Exemption for Certain Investment Advisers Operating Through the Internet

Valuation a Key Focus for SEC Enforcement Unit At a recent Practicing Law Institute’s (“PLI”) annual investment management conference in July 2023, Co-Chief of the SEC Enforcement Division’s Asset Management Unit (“Enforcement AM Unit”) Andrew Dean discussed why the SEC will continue to scrutinize valuation procedures among asset managers and advisor firms. Dean noted reasons why valuation is of important concern including that: (i) marking hard-to-value securities inconsistently can lead to inflated positions, in turn inflating management and performance fees which can mislead investors and potential investors; and (ii) the valuation process is “opaque to investors typically.”&nbsp; He also noted that auditors who oversee hard to value assets are important gatekeepers.

Dean’s comments echoed those of Vanessa Horton, associate regional director of the SEC’s examination unit, who spoke at an ICI conference earlier in March. Horton provided insight that the Division would look specifically at board compliance with respect to the fair valuation rule, record-keeping and reporting requirements, and whether fund sponsors have adjusted their process since September 2022.

Directors Charged with Liquidity Rule Violations Fight Back in Court An investment advisory firm and two former directors charged with violating the liquidity rule in May 2023 filed a motion to dismiss Enforcement’s first action under Rule 22e-4 since it went into effect in 2019, citing that the SEC overstepped its authority and breached the defendant’s rights. The SEC charged an investment adviser for aiding and abetting violations of the rules relating to liquidity risk management by an open-end investment company that it advised and whose liquidity risk management program it administered. The SEC also charged the Fund's two independent trustees and two officers of both the advisory firm and of the Fund it advised with aiding and abetting liquidity rule violations by the Fund.

In its original complaint, the SEC alleged the Fund had held approximately 21% to 26% of its net assets in illiquid investments between June 2019 to June 2020 and neither the Fund nor its officers presented a plan to the board to reduce the fund's illiquid investments to 15% or lower, as the liquidity rule required, and did not file the required disclosures with the SEC. Further, the fund's officers classified the largest illiquid investment as a “less liquid” investment against the advice of fund counsel and auditors, and ignored restrictions, transfer limitations, and the absence of any market for the shares during this time in making such classification.

The defendants argued that the rule was invalid, and that the regulator had both exceeded its authority by introducing it and violated their due process by failing to give fair notice that the conduct was prohibited. With respect to the aiding and abetting violations, the defendants claimed that they were unaware of the illiquid classification of shares in question until approximately six months after the fund identified such shares in a letter to the SEC. The defendants argued that “to substantially assist…and seek to make something succeed necessarily requires the alleged aider and abettor to have taken or performed some action to assist the primary violation.” The defendants also argued that the complaint failed to allege that the independent trustees consciously assisted the alleged violation. The case is ongoing in the Northern District of New York. (See “SEC Charges Investment Adviser and Fund Trustees with Liquidity Rule Violations” in Blank Rome’s&nbsp;<a href="https://www.blankrome.com/publications/regulatory-update-and-recent-sec-actions-19">July 2023 Regulatory Update</a>.)

SEC Charges New Jersey-Based ETF Manager for Fraudulent Conduct and Bars Founder The SEC charged&nbsp;<a>Samuel Masucci</a>&nbsp;and ETF Managers Group LLC (“ETFMG”), an SEC-registered investment adviser based in Summit, New Jersey that he founded and controls with disadvantaging an exchange traded fund (the “ETF”) and misleading the ETF’s trustees to obtain $20 million in rescue financing to avoid a possible bankruptcy. Masucci and ETFMG agreed to pay a combined $4.4 million to settle the charges.

The SEC’s order issued on August 1, 2023, found that, in 2019, in exchange for $20 million in financing and other services, Masucci agreed to keep the ETF’s securities lending business at the broker-dealer that provided the financing despite offers with better terms from other securities lenders that could have benefited investors. According to the SEC order, Masucci knowingly failed to disclose this joint arrangement between himself and his firm, the fund, and the broker-dealer to the fund’s independent trustees, instead telling them that the fund had no other viable options.

The SEC’s order found that Masucci and&nbsp;<a>ETF</a>MG violated Sections 206(1) and 206(2) of the Advisers Act and that Masucci, ETFMG, and its parent company,&nbsp;<a>Exchange Traded Managers Group LLC</a>, violated Section 17(d) of the Investment Company Act and Rule 17d-1 thereunder. Without admitting or denying the SEC’s findings, Masucci agreed to a cease-and-desist order, to pay a $400,000 penalty, and to an associational bar under the Advisers Act and a prohibition under the Investment Company Act with a right to reapply after three years. ETFMG and the parent company agreed to censures, to a cease-and-desist order, and to pay, jointly and severally, a civil penalty of $4 million.

Fund Administrator Charged for Missing Red Flags to a Fraud The SEC announced on August 7, 2023, that it settled charges against&nbsp;<a>Theorem Fund Services LLC</a>, a fund administrator (the “Fund Administrator”), for failing to respond to red flags relating to a fraud against a private fund and its investors.

The Fund Administrator provided administration services to a fund managed by&nbsp;<a>EIA All Weather Alpha Fund Partners</a>&nbsp;(“EIA”) and&nbsp;<a>Andrew M. Middlebrooks</a>, both of whom the SEC charged in May 2022 with fraud for allegedly engaging in a scheme that included the misappropriation and misuse of investors’ funds over a five-year period. According to the order, during the Fund Administrator’s engagement, the fund suffered significant losses as a result of trading by EIA and Middlebrooks; however, the Fund Administrator, at the direction of EIA and Middlebrooks, calculated the net asset value, which did not recognize the losses, and sent investors account statements that materially overstated the value of their investments.

The SEC’s order finds that the Fund Administrator was a cause of certain of EIA’s and Middlebrooks’ violations of the 1933 Act and of the Advisers Act and Rule 206(4)-8(a)(1) thereunder. The Fund Administrator agreed, without admitting or denying the SEC’s findings, to a cease-and-desist order and to pay a civil penalty of $100,000. In addition, the Fund Administrator agreed to pay disgorgement of $18,000 and prejudgment interest of $4,271.

“Fund administrators are important gatekeepers in the private fund space,” said Andrew Dean, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “Here, TFS failed to live up to its gatekeeper responsibilities and distributed inaccurate account statements to investors despite clear red flags.”

SEC Charges 11 Wall Street Firms with Widespread Recordkeeping Failures The SEC announced charges on August 8, 2023, against 10 firms in their capacity as broker-dealers (the “Broker-Dealers”) and one dually registered broker-dealer and investment adviser (the “BD and IA”) (collectively, the “Firms”) for widespread and longstanding failures by the Firms and their employees to maintain and preserve electronic communications. These actions stem from the SEC’s continuing sweep to ensure that regulated entities, including broker-dealers and investment advisers, comply with their recordkeeping requirements.

The Firms admitted the facts set forth in their respective SEC charging papers, acknowledged that their conduct violated recordkeeping provisions of the federal securities laws, agreed to pay combined penalties of $289 million as outlined below, and have begun implementing improvements to their compliance policies and procedures to address these violations:

A securities firm together with a clearing service and an investment advisory firm agreed to pay a $125 million penalty;

A multi-asset servicing specialist and an investment banking firm have each agreed to pay penalties of $35 million;

A capital markets firm and a securities firm have each agreed to pay penalties of $25 million;

An investment banking firm has agreed to pay a $15 million penalty;

An independent investment bank and a wealth management, brokerage, and advisory firm have each agreed to pay penalties of $10 million; and

A financial services firm has agreed to pay a $9 million penalty.

The SEC’s investigation uncovered pervasive and longstanding “off-channel” communications at the Firms. As described in the SEC’s orders, the Firms admitted that from at least 2019, their employees often communicated through various messaging platforms on their personal devices, including iMessage, WhatsApp, and Signal, about the business of their employers. The Firms did not maintain or preserve the substantial majority of these off-channel communications, in violation of the federal securities laws.

The Broker-Dealers were charged with violating certain recordkeeping provisions of the Exchange Act and with failing to reasonably supervise with a view to preventing and detecting those violations. The BD and IA was additionally charged with violating certain recordkeeping provisions of the Advisers Act and with failing to reasonably supervise with a view to preventing and detecting those violations. The failures involved employees at multiple levels of authority, including supervisors and senior executives.

In addition to the financial penalties, the Firms were ordered to cease and desist from future violations of the relevant recordkeeping provisions and were censured. The Firms also agreed to retain independent compliance consultants to, among other things, conduct comprehensive reviews of their policies and procedures relating to the retention of electronic communications found on personal devices and their respective frameworks for addressing non-compliance by their employees with those policies and procedures.

“Compliance with the books and records requirements of the federal securities laws is essential to investor protection and well-functioning markets. To date, the Commission has brought 30 enforcement actions and ordered over $1.5 billion in penalties to drive this foundational message home. And while some broker-dealers and investment advisers have heeded this message, self-reported violations, or improved internal policies and procedures, today’s actions remind us that many still have not,” said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. “So here are three takeaways for those firms who haven’t yet done so: self-report, cooperate and remediate. If you adopt that playbook, you’ll have a better outcome than if you wait for us to come calling.”

SEC Charges a FinTech Investment Adviser for Misrepresenting Hypothetical Performance of Investments and Other Violations The SEC announced charges against&nbsp;<a>a New York-based financial tech investment adviser&nbsp;</a>(“FinTech Adviser”), marking the first violation of the SEC’s amended marketing rule. The FinTech Adviser was charged with using hypothetical performance metrics in advertisements that were misleading and with multiple compliance failures that led to misleading disclosures about custody of clients’ crypto assets, the use of improper “hedge clauses” in client agreements, the unauthorized use of client signatures and the failure to adopt policies concerning crypto asset trading by employees.

According to the SEC’s order on August 21, 2023, for a period ranging from August 2021 to October 2022, the FinTech Adviser, which offers multiple complex strategies to retail investors through its mobile trading app, made misleading statements on its website regarding hypothetical performance, including by advertising “annualized” performance results as high as 2,700 percent for its crypto strategy. The order alleged that the FinTech Adviser’s advertisements were misleading because they failed to include material information, for example, that the hypothetical performance projections assumed that the strategy’s performance in its first three weeks would continue for an entire year. The order also found that the FinTech Adviser violated the marketing rule by advertising hypothetical performance metrics without having adopted and implemented required policies and procedures or taking other steps required by the Commission’s marketing rule, which was amended in December 2020.

Additionally, the SEC’s order found that the FinTech Adviser (1) made conflicting disclosures to clients about how it custodied crypto assets; (2) included in its client advisory agreements liability disclaimer language that created the false impression that clients had waived non-waivable causes of action against the FinTech Adviser; and (3) contrary to representations, failed to adopt policies and procedures concerning employee personal trading in crypto assets. The FinTech Adviser self-reported to the SEC staff that it failed to ensure that client signatures were obtained for certain types of transactions in client accounts and agreed to settle related charges, cooperate with the investigation, and consent that it violated the Advisers Act. Without admitting or denying the SEC’s findings, the FinTech Adviser agreed to a cease-and-desist order, a censure, and to pay $192,454 in disgorgement, prejudgment interest, and an $850,000 civil penalty that will be distributed to affected clients.

“When offering and marketing complex strategies, investment advisers must ensure the accuracy of disclosures made to existing and prospective investors. The Commission amended the marketing rule to allow for the use of hypothetical performance metrics but only if advisers comply with requirements reasonably designed to prevent fraud,” said Osman Nawaz, Chief of Enforcement Divison’s Complex Financial Instruments Unit. “[The FinTech Adviser’s] advertisements and disclosures painted a misleading picture of certain of its strategies for investors. This action serves as a warning for all advisers to ensure compliance.”

A Global Banking and Financial Services Firm Settles with SEC for Charging Excessive Advisory Fees The SEC charged a global banking and financial services firm (the “Firm”) on August 25, 2023, for overcharging at least 10,900 investment advisory accounts more than $26.8 million in advisory fees. The Firm agreed to pay a $35 million civil penalty to settle the SEC’s charges.

According to the SEC’s order, certain financial advisers from the Firm and its predecessor firms agreed to reduce the firm’s standard, pre-set advisory fees for certain clients and made handwritten or typed changes on the clients’ investment advisory agreements that reflected the reduced fees at the time their accounts were opened. However, in certain instances, the account processing employees at&nbsp;<a>the Firm&nbsp;</a>including its predecessor firms failed to enter the agreed-upon reduced advisory fee rates into the firms’ billing systems when setting up the clients’ accounts. Additionally, according to the SEC’s order, the Firm failed to adopt and implement written compliance policies and procedures reasonably designed to determine whether the billing systems it adopted contained accurate data and to prevent overbilling of the clients that the firm acquired through its predecessor firms and certain of its own new clients. As a result, the Firm and its predecessor firms overcharged certain clients who opened accounts prior to 2014 for advisory fees through the end of December 2022.

The Firm paid the affected accountholders approximately $40 million, including interest, to reimburse those account holders for the overcharging.

Regulatory Update and Recent SEC Actions: October 2023

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Regulatory Update and Recent SEC Actions: October 2023

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