SEC Issues Custody Rule Relief for Fund Managers

Earlier this year, the Securities and Exchange Commission (“SEC”) issued a no-action letter in response to a request by 16th Amendment Advisors LLC (“16th Amendment”) regarding the independent verification and financial statement provisions of Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-2 (the “Custody Rule”). For background on the Custody Rule, read our primer.

Under the Custody Rule, registered investment advisers that have custody of the assets of a pooled investment vehicle must either arrange for an annual surprise examination of the fund’s assets or an annual audit. The examination or audit must be conducted by an independent public accountant that is registered with, and subject to inspection by, the Public Company Accounting Oversight Board.

16th Amendment requested relief from these provisions of Custody Rule, asserting that an examination or audit is unnecessary when the client and investment adviser are the same. Specifically:

  • 16th Amendment’s principal owners, Messrs. Lamp, Lee, and McCarthy, together own a 91% interest in 16th They are listed as control persons on the firm’s Form ADV;
  • The remaining owner, Mr. Sen, owns 9% as a passive investor in 16th He is not invested in the fund but does have access to certain of 16th Amendment’s information as an owner;
  • Lamp, Lee and McCarthy own 100% of the fund and its general partner.

The SEC determined that it would not recommend enforcement action of the Custody Rule for advisers that do not comply with the examination or audit provisions in these circumstances, particularly that the only investors in the funds:

  • Are principals of the adviser, which the SEC defined as those (a) with plenary access to information concerning the management of the adviser, the funds and their general partners; (b) who are listed as “control persons” in Schedule A of the adviser’s Form ADV because of their status as officers or directors; and (c) who have material ownership in the adviser; and
  • Are the principals’ spouses and minor children, including investment vehicles established for their benefit.

While this relief means that advisers like 16th Amendment need not undergo costly audits, firms should carefully consider their circumstances and the criteria outlined above. Custody arrangements are a routine examination area (see the SEC’s Risk Alert for common pitfalls); firms wishing to take advantage of this relief should read the no-action letter in its entirety and consider documenting the basis of its analysis, including retaining all supporting information so it is available in an examination.  Any concerns about the applicability of this relief should be addressed to outside counsel and/or a firm’s compliance consulting firm.

Insider Trading Post-Newman Decision: Next Steps for Fund Managers

Recently, the United States Court of Appeals for the Second Circuit overturned two high-profile insider trading convictions in United States v. Newman.  This came as a surprise to many, none more so than the Securities and Exchange Commission (“SEC”) as it is predicted that this decision will make it more difficult to prosecute insider trading cases.  However, this does not mean that firms should relax their policies and procedures in this important area.   Rather, firms may consider the task of identifying and managing material nonpublic information (“MNPI”) more complex than ever.

The key facts of the case are as follows:

  • An employee, Rob Ray (“Ray”), of Dell’s investor relations department disclosed earnings numbers to a former colleague and friend, Sandy Goyal (“Goyal”). Goyal was an analyst at Neuberger Berman;
  • Goyal then shared this information with another analyst, Jesse Tortora (“Tortora”), at Diamondback Capital LLC (“Diamondback”);
  • Tortora knew that the information originated with a Dell insider (he did not know who exactly at Dell the insider was) and shared that information, as well as where it originated, with Diamondback manager Todd Newman (“Newman”);
  • Tortora also shared this information with a friend and analyst at Level Global Investors LP, who similarly shared it with his manager, Anthony Chiasson (“Chiasson”);
  • Newman and Chiasson both traded on this information with great success and ultimately profited over $72 million.

At trial, these facts led the jury to convict Newman and Chiasson of insider trading. However, the Second Circuit concluded that the government failed to prove two key elements of insider trading.  First, to establish tippee (Newman and Chiasson) liability, there had to be proof that the tipper (Ray) received a benefit from the disclosure of this information.  Second, the court held that the government had to prove that the tippees were aware of the benefit to the tipper. In this case, proving that knowledge would be extremely difficult because the information passed through at least two other people before reaching Newman and Chiasson.

Nevertheless, the SEC is still vigorously investigating insider trading and bringing both civil and criminal actions and will no doubt have the 2nd Circuit’s holding in mind as it collects evidence. For compliance staff, this may mean more robust policies and procedures rather than relaxing controls around potential MNPI. For example:

  • Any information that may have come, even indirectly, from an insider at a public company should be escalated to compliance immediately;
  • If the firm wishes to trade on that information, it should be subject to a diligence and preapproval process led by the compliance department;
  • Firms should use Restricted and Watch lists to manage all potential MNPI, including any information that it is diligencing;
  • Purposefully avoiding knowledge (aka “willful blindness”) to assert that the firm was unaware of the source of the information, will not suffice and may well lead to an investigation;
  • While there may be circumstances in which the distance between the source of the information and the ultimate traders is relevant, firms should not rely on this as a strategy to manage potential MNPI; and
  • A firm culture, starting from the top, that encourages caution and thoughtfulness will help traders stay clear of any potential insider trading violations.

The Newman decision brings the law of insider trading back to the core elements established in Dirks v. SEC, correctly requiring the government to prove each of the distinct, yet inter-related, elements.  The overall landscape, however, remains changed.  Firms must still identify and manage their risks, establish and enforce policies and, perhaps more than previously, take a proactive approach to identify and manage MNPI.   Even if the government cannot prove a criminal case, civil enforcement is available to the SEC and insider trading will always be a high priority.  If anything, Newman calls upon the SEC to be more diligent in collecting and assembling information during the critical investigation phase.

Private Equity Fees and Expenses: Best Practices for Disclosure

The Office of Compliance Inspections and Examinations (“OCIE”) of the Securities and Exchange Commission (“SEC”) recently completed a two-year review of private equity firms. This review, spurred by concern about transparency on issues such as fees, expenses and valuations, was not to uncover any real wrongdoing, rather, it hopes to lead to increased clarity between firms and investors.

PE firms make most of their profits by restructuring the portfolio companies leading to a merger/acquisition, recapitalization or an initial public offering (“IPO”). The SEC worries that, by not clearly describing fees and expenses, firms are effectively hiding fees from their investors. To avoid confusion and regulatory scrutiny, we have some suggestions for firms to consider in reviewing their fee and expense arrangements:

  • The title “Operating Partner” is often given to consultants that are integral in the process of restructuring the portfolio company. Firms should ensure that their roles, titles and any associated fees or expenses are clearly described in the offering documents;
  • Ensure that the typical costs associated with operation of the fund or parallel vehicles are correctly described in the offering documents and allocated fairly among all vehicles in the fund structure. Any atypical costs or unusual methods of allocation should be emphasized;
  • Investor reporting can be extremely time consuming. To the extent that a firm uses an outside vendor or software platform to prepare reports for investors and charges the cost to the fund, the offering documents should disclose the arrangement;
  • Unlike hedge funds which rely on a management fee to cover most of a fund’s operations, PE funds may charge a variety of fees either at the fund or portfolio company level to maintain operations;
  • For example, firms may charge the portfolio companies a monitoring fee for providing advisory services, which may or may not include directors’ fees. Fund documents usually disclose these, however care should be taken to ensure that anticipated holding periods are accurate and that any acceleration provisions are clear. One strategy for making sure that these disclosures remain accurate over time is to review and re-execute these agreements annually to minimize the possibility of excess fees generated upon exiting the investment;
  • All fee and expense descriptions in the Form ADV, marketing materials and investor reporting should be reviewed and revised as needed for consistency with the fund’s offering documents;
  • All policies relating to fees and expenses should be stated in the firm’s compliance manual and reviewed regularly to keep up with new funds or evolving practices.

The SEC is just beginning to fully understand the workings of private equity funds and their managers. As such, scrutiny of fees and expenses is likely to continue as the SEC examines firms in this space. Investor demand may also increase in favor of more and better transparency. As the SEC begins to roll out new regulations governing these disclosures, firms proactively implementing these tips and best practices may find themselves ahead of the regulatory curve and attracting new investors.

Key Points from the SEC’s Budget Request

On March 24, 2015, Securities and Exchange Commission (“SEC”) Chair Mary Jo White testified before Congress. Her testimony focused on the SEC’s current operations, plans for the future and a $1.722 billion budget request. Chair White explained that the requested money would be primarily used to increase staff, particularly in the Division of Economic and Risk Analysis (“DERA”), and to implement initiatives. Key points of Chair White’s testimony are discussed below.

  1. Examination Improvements and Expansion

Chair White noted that the Commission’s duties have significantly increased with their new or expanded jurisdiction including over private fund advisers, along with the growth and increasing complexity of the marketplace. Specifically, Chair White noted that the assets under management of SEC-registered investment advisers has grown by 254 percent and assets under management of mutual funds has grown by 143 percent since the millennium. Chair White pointed to the rapidly expanding securities markets and expanding SEC jurisdictions as reasons for the budget request.

  1. Economic Analysis, Risk Assessment, and Data Analytics

Currently, DERA is the fastest growing division at the SEC. Chair White boasted that a significant number of DERA employees are Ph.D. economists with sophisticated understanding of financial markets. These economists work closely with the rest of the Commission, notably the Division of Trading and Markets, to develop appropriate policies and regulations. DERA also assists the Division of Enforcement (“Enforcement”) to identify potential wrongdoing in the marketplace, calculate proceeds and penalties relating to illegal activities, develop their own and respond to defendant expert testimony, and analyze materiality in insider trading cases.

  1. Enforcement of the Securities Laws

Enforcement investigates and brings charges against alleged violators of federal securities laws. Chair White stated that in 2014 the division achieved its highest number of monetary remedial orders, $4.16 billion, and its highest number of enforcement actions, 755.

Insider trading continues to be a high priority for Enforcement. Staff is currently working on developing and implementing new technologies for tracking suspicious trading patterns.  In addition, Enforcement continues to bring actions against investment advisers that engage in fraudulent conduct, breach fiduciary duty and have deficient compliance programs.

  1. Fiduciary Duty for Broker-Dealers and Registered Investment Advisers

Chair White opined that broker-dealers and investment advisers should adhere to the same fiduciary standards. Some potential issues in implementing the same standards include: identifying and defining terms that are common to both, formulating meaningful applications for the different businesses and lastly providing equally clear and useful guidance to both investment advisers and broker-dealers. Chair White stated that her fellow commissioners and staff will develop investment adviser and broker-dealer fiduciary duty recommendations in the very near future. The commissioners will be giving serious consideration to the SEC’s staff Section 913 study of 2011, which supports creating a uniformed fiduciary standard. DERA will also provide assistance in defining “fiduciary.”

  1. Inspections and Examinations

The Office of Compliance Inspections and Examinations (“OCIE”) is inspects a variety of firms throughout the securities industry. Dodd-Frank greatly expanded the duties of OCIE to include municipal advisers, investment advisers to certain private funds, security-based swap dealers, security-based swap data repositories, major security-based swap participants, and securities-based swap execution facilities. OCIE continues to expand its staff in order to examine as many of these firms as possible. Alternative investment firms, particularly, are among the most likely to be examined by OCIE.

  1. Plans for the Budget

Chair White stated the agency would use the requested funds to create 431 new staff positions focused on enforcement, examinations, and economic risk analysis. Readers may recall that the SEC requested a similar budget allocation last year, which Congress denied.

The budget request is proof of a strong relationship between President Obama and Chair White. While President Obama wants to expand the SEC’s budget, he sought $35 million less than requested in 2014 for the Commodity Futures Trading Commission. The SEC’s power is growing compared to other regulators, and if the budget request is approved, we can expect to see a more technologically advanced agency. Readers should stay updated on Congress’s decision to approve or deny the SEC’s budget request.

OCIE Evaluates Cybersecurity in the Securities Industry

In February, the Securities and Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) released a risk alert regarding the cybersecurity preparedness of the securities industry. OCIE examined 57 registered broker-dealers and 49 registered investment advisers as a part of its “Cybersecurity Examination Initiative” that was announced in the spring of 2014.

OCIE collected information from these firms regarding risks related to cybersecurity policies, remote access to client funds, designations of Chief Information Security Officers (“CISO”) and third party vendors. Key findings of the examinations are discussed below:

  1. Written Cybersecurity Policies

The vast majority of examined broker-dealers and registered investment advisers adopted written cybersecurity policies. However, only half of registered investment advisers had written policies in business continuity plans to counteract cybersecurity attacks. Most firms did not address who would be held responsible for client losses. Only 9% of investment advisers offered security guarantees for client losses. Advisers and broker-dealers should review their business continuity policies and consider any relevant updates with respect to cybersecurity issues.

  1. Role of Third Party Vendors

OCIE focused on the examined firms’ monitoring of third party vendors that have access to firm networks. 32% of investment advisers required third party vendors to conduct “cybersecurity risk assessments” and only 24% had cybersecurity requirements in their contracts. In contrast, almost 75% of broker-dealers had cybersecurity requirements in their third party vendor contracts. OCIE considers sharing of information with vendors to increase the likelihood of cyber-related incidents. Investment advisers should consider following the lead of these broker-dealers and include cybersecurity requirements in their third party vendor contracts.

  1. CISO or Chief Technology Officer (“CTO”)

Whether a firm designated a CISO or a CTO tended to vary on the type of firm: 68% of broker-dealers versus 30% of registered investment advisers identified a CISO. Registered investment advisers typically assigned CISO duties to a CCO or CTO.  Though compliance will naturally be involved in cybersecurity policies for financial firms, given the complexity of these issues, technology experts should be more deeply and substantively involved.

  1. Cybersecurity Incidents

About 75% of both broker-dealers and registered investment advisers that were examined had experienced a cybersecurity incident. The most common issues involved fraudulent emails or malware.   The fraudulent emails, in particular, should be considered a serious issue, given the Regulation S-ID requirements that became effective in May 2013 for SEC-registered investment advisers and others registered with the Commodity Futures Trading Commission.  Read our article on this topic here.

Almost all examined firms had written policies in place, but 25% of broker-dealers cited employees not following procedures as a reason for losses, highlighting the importance of initial and ongoing training for all employees on key points of the policies.  Consider holding a separate, more detailed training for those involved in client services, finance and other areas more likely to be on the front lines of a cyber-attack.

Even the smallest client loss, reimbursed by the firm, can damage its relationship with the client in question; a series of losses or other failures could erode confidence across the client base and invite regulatory scrutiny.  Firms should be proactive in not only adopting policies, but emphasize training, monitoring and reevaluating policies in light of evolving threats.

  1. Final Thoughts

Many firms modeled cybersecurity policies and procedures on published works by the National Institute of Standards and Technology, the International Organization for Standardization and the Federal Financial Institutions Examination Council. Additionally, many firms considered industry organizations as means to gain more information about cybersecurity risks.

The OCIE risk alert highlights the cybersecurity priorities for OCIE and current industry practices. Investment advisers should recognize that cybersecurity testing will likely become a part of standard OCIE examinations in the future.  Proper cybersecurity requires ongoing monitoring, robust training and possibly expensive IT infrastructure. However, firms must consider their duty to safeguard client information and assets. The time and money spent on cybersecurity can prevent a loss of client trust and a firm’s reputation.

Implications of Basel III for Hedge Fund Managers

In January, Bank of America cut ties with 150 hedge fund managers in its prime brokerage group because they were viewed to be unprofitable. Goldman Sachs also made drastic changes to their client lending strategy last year. JP Morgan has warned hedge fund managers in a report about the serious changes heading their way this year. Brokers made these moves as a result of upcoming Basel III obligations for brokers.

Basel III is an international accord that is meant to encourage a return to traditional banking practices after the 2008 crisis. The accord purposefully reduces brokers’ activities and profitability in favor of less risk and market safety. The three Basel III obligations that are forcing brokers to alter their relationships with hedge fund managers are:

  • Limited leverage;
  • Increased liquidity requirements; and
  • Increased capital requirements.

Brokers are becoming wary of dealing with many hedge funds because they greatly affect these limits. Following are additional thoughts on the changing relationships between hedge fund managers and brokers:

  • Small hedge funds require a significant amount of capital compared to other investments and are not necessarily very profitable. Bank of America and Goldman Sachs, among others, believe that the clients that affect these limits are no longer valuable;
  • Hedge funds that invest in high-quality liquid assets will likely survive the brokers’ scale-down of their prime broker clients;
  • Hedge funds that do not produce healthy return on equity for brokers will be severely affected this year and in 2018, when limitations become mandatory. Hedge fund managers should be aware of brokers’ plans to redirect their resources away from businesses that are expected to earn low returns on equity; and
  • On a purely domestic side of regulations and politics, whether or not President Obama vetoes delaying the implementation of the Volcker Rule will have significant effects on how brokers handle their relationships with hedge fund managers. The Volcker Rule greatly reduces but does not completely restrict brokers’ investments in hedge funds and private equity. The Volcker Rule will require brokers’ to make more cuts to managers that underperform.

Despite some recent optimism, it is notable that 661 funds shut down in the first three quarters of 2014. In particular, firms with declining or stagnant profits should prepare for the possibility of changes in their broker’s policies and practices.  Any small hedge fund manager, however successful should also consider the potential shift in their brokers’ priorities as a result of Basel III.

Primer:  Custody Rule for SEC-Registered Investment Advisers

Custody arrangements will always be reviewed in a routine regulatory examination. Violations of Rule 206(4)-2, more commonly referred to as the Custody Rule (the “Rule”) are also rapidly becoming a key enforcement area for the Securities and Exchange Commission (“SEC”). This primer will cover the important points of the Rule and discuss the most common violations.

  1. The Rule

At its most basic, the Rule:

  • Defines custody as “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them;
  • Requires safekeeping of client assets, which means maintaining them at a qualified custodian such as a bank or broker-dealer. Assets must be in a segregated account either for each client under its name, or in an account that contains only clients’ assets with the adviser’s name as agent or trustee;
  • Requires the adviser to notify clients when accounts are opened for them and reasonably believe, after due inquiry, that custodians deliver account statements directly to clients at least quarterly; and
  • Requires independent, surprise verification of assets by an accountant. Private fund managers can satisfy this requirement by arranging for their funds to be audited annually (more on this in the next section).


  1. Important Nuances

Though simple on its face, there are some important nuances to consider:

  • An adviser can have custody through an affiliate (e.g., the general partner, or equivalent of a private fund);
  • The authority to obtain possession of funds or securities creates custody, regardless of whether such authority is exercised;
  • The accountant retained to provide either the surprise verification or the annual audit of a fund must be an independent public accountant that is both registered with and inspected by the Public Company Accounting Oversight Board or PCAOB.


  1. Common Violations

The SEC’s National Examination Program (“NEP”) staff recognized four common deficiencies during their recent investigations:

  • Advisers often failed to recognize that they had custody under the Rule. The NEP staff cited examples of advisers having physical or electronic possession of assets, but not fulfilling their Rule obligations;
  • Some surprise exams were not conducted on a “surprise” basis. The NEP staff collected evidence suggesting that the examinations were being conducted at a predictable time each year;
  • Certain advisers did not meet the qualified custodian requirements. Advisers that commingled client’s assets with employee or propriety assets were in violation of the Rule. The NEP staff also noted that some client assets were held in an adviser’s name, but not in an account that was under the adviser’s name as an agent or trustee for the client and that held only client assets; and
  • Some audits were considered to be unacceptable. Some auditors could not be considered to be independent under Regulation S-X or were not registered with the PCAOB. In other instances, audited financial statements were not prepared in accordance to generally accepted accounting principles standards.


  1. Compliance Tips

To comply with the Rule, adviser should consider:

  • Creating policies and procedures that address the application of the Rule. Advisers should consider how future Rule changes may alter their policies. SEC press releases about rule changes can be found here. Advisers should also consider how changes in their business may affect their Rule obligations and update policies accordingly; and
  • Ensuring that all parties involved consistently follow the prescribed procedures. The Rule is quite technical, and it is important that all parties involved understand the Rule, policies, and procedures.

Many violations of the Rule were the result of advisers not recognizing and understanding their obligations. These issues can be avoided by establishing clear written policies and procedures, distributing them firm-wide and training key staff on their role in implementing the adviser’s custody rule procedures.

SEC Announces Examination Priorities for 2015

The Office of Compliance Inspections and Examinations (“OCIE”) of the Securities and Exchange Commission (“SEC”) released its 2015 examination priorities for investment advisers, broker-dealers, and transfer agents. OCIE will focus its efforts on issues related to market-wide risks, analyzing data to prevent illegal activity and protecting investors who are saving for retirement, which are discussed in turn below:

  1. Assessing Market-Wide Risk

OCIE intends to examine widespread firm and industry structural risks. OCIE will closely monitor the largest of broker-dealers and asset managers. Large firms allow for better understanding of market trends as a whole. Additionally, clearing agencies will face increased scrutiny in 2015. As we have previously discussed, the SEC will examine broker-dealers’ cybersecurity compliance programs. Lastly, OCIE will increase their efforts of tracking firms’ trading history against their best execution policies. OCIE intends to work with the Division of Trading and Markets and other regulatory agencies to address market-wide risks.

  1. Use of Data Analytics

As SEC Chair Mary Jo White noted in her speech at the New York Times DealBook Conference in December, OCIE will increase its use of data analytics in examinations. OCIE will use data to identify individuals that are repeat offenders and will examine their employers. Additionally, data analytics will be used to identify excessive trading, market manipulation, and pump-and-dump schemes. Lastly, the OCIE will test firms’ anti-money laundering policies with collected data.

  1. Protecting Investors Saving for Retirement

The most significant theme of OCIE’s examination priorities is the protection of retail investors and investors saving for retirement. This includes investigating the suitability and sales practices for retirement products to individual investors. OCIE intends to examine branch office practices for deviations from the policies set out in compliance programs. Two types of companies the OCIE will examine closely are alternative investment companies and fixed income investment companies. The SEC considers alternative investment companies to be those that make returns that are uncorrelated to the stock market. Companies that act as both broker-dealers and registered investment advisers will likely be examined for the appropriateness of account types offered to their clients.

In addition to these three themes, the OCIE intends to examine transfer agents, municipal advisers, and never-before-examined registered investment company complexes. The SEC will also place significant emphasis on examining fees and expenses in private equity funds. OCIE noted many inconsistencies among private equity advisers in 2014 and plans to act on those findings in 2015. Advisers should review the SEC’s release in its entirety and consult their legal counsel and/or compliance consultant to best prepare for their next examination.

Mary Jo White’s Remarks at NYT DealBook Conference

On December 14, 2014 Chair Mary Jo White of the Securities and Exchange Commission (“SEC”) spoke at the New York Times’ DealBook Opportunities for Tomorrow Conference. She concentrated on the SEC’s future enhancements of risk monitoring and regulatory safeguards for the asset management industry, specifically: data reporting, portfolio composition risk controls and transition planning for advisers. Following are some key takeaways:

  • Chair White spoke about how the SEC relies on data reporting in order to understand the industry. She noted the rapid growth of the industry from $4 billion assets under management in 1940 to $63 trillion assets under management in 2014. As a result, the SEC has implemented new data reporting tools largely due to the Dodd-Frank Act. However, the SEC still only receives information from about a quarter of all registered firms. The SEC will release new recommendations for modernizing and enhancing avenues for data reporting that are already in place.


  • She also addressed portfolio composition risk and operational risk. Portfolio composition risk refers to the risk of mixing a fund’s investments. These can include risks associated with liquidity and leverage. Noting that operational risk involves the possibility of internal process and system failures, she emphasized these in relation to exchange-traded funds (ETFs) and the use of derivatives by mutual funds. The SEC will likely require broader portfolio composition and operational risk management policies for advisers to these types of funds in the future.


  • The final focal point of Chair White’s speech was transition planning and stress training for investment advisers. She pointed out that clients are severely at risk when an investment adviser is no longer able to operate. One especially problematic example is if there are restrictions on the use of a client’s money that is held by an investment adviser. The SEC is preparing recommendations for avoiding issues related to the termination of an investment advisory arrangement.

Chair White’s speech at the New York Times is a sign that the SEC is becoming increasingly interested in data reporting, portfolio composition risk controls and transition planning for advisers. The SEC is planning on new rules or amendments for each of these core points. In addition, there will likely be more reporting requirements for private funds in the near future. Investment advisers should keep an eye out for the possibility of new obligations in all of these areas.

Primer: Holdings Reporting for Investment Advisers

There are several provisions in the Securities Act of 1933 (“Securities Act”) or the Securities Exchange Act of 1934 (“Exchange Act”) that require investment advisers to report their holdings or other investment activity to the SEC. Most of these filings are available to the public via the SEC’s Electronic Document Access and Retrieval (“EDGAR”) system, with some exceptions, which are discussed below. Notably, many of these filings are required whether a firm is registered with the SEC or not (including Exempt Reporting Advisers and state registrants).  Deadlines and other requirements may also vary depending on a firm’s registered status.  These are discussed in more detail below.

  1. EDGAR Filing Generally

EDGAR requires market participants to file electronically with the SEC, enables the SEC to catalog and analyze filing data, and allows the public to quickly search most filings. First-time filers will need to apply for EDGAR access by filing Form ID with the SEC on its EDGAR Filer Management website (“Filer Management”). Form ID asks for basic business and contact information and an 8 character “Passphrase” selected by the filer. Within 48 hours, the SEC will assign a Central Index Key (“CIK”) number to the filer, which will be emailed to the contact person identified on the Form ID. Once a CIK number has been assigned, filers must return to Filer Management to generate the passcodes (“Codes”) used to make filings.

These Codes are all 8 characters and are randomly assigned by Filer Management. They include:

  • Password (NB: this is not the same as the Passphrase that filers select initially). The Password expires annually on the anniversary of its assignment and must be changed within 10 days of that anniversary (the “Grace Period”). The Password is used for all EDGAR filings;
  • CCC: This is the CIK Confirmation Code and must also be used for all EDGAR filings; and
  • PMAC: This is the Password Modification Access Code and can be used to update only the Password within the Grace Period. Following expiry of the Grace Period, filers must use their CIK and Passphrase to generate an entirely new set of Codes.

Filers should ensure that their Passphrase and Codes are kept in a secure location and updated as needed. This will prevent unauthorized use (including access to confidential filings) and avoid delays when making filings.

  1. Schedule 13D and 13G

Generally, a Schedule 13D filing is required where a person (including entities) beneficially owns more than 5% of a class of publicly traded equity securities of an issuer for the purpose of changing or influencing control (in other words, is an activist investor, or anticipates becoming one). A shorter form Schedule 13G is applicable where a person holds the position in the ordinary course of business and not for the purpose of changing or influencing control of the issuer (i.e., is a passive investor).

A person “beneficially owns” a security if it has or shares the power to vote or dispose of the security. To the extent that an investment adviser has discretionary authority over client accounts, it may be a beneficial owner for purposes of these filings. A person also beneficially owns any securities that it has the right to acquire (e.g. exercise of an option), if the right is exercisable within sixty days.

The initial Schedule 13D or 13G, as applicable, is due within ten days following the acquisition that causes the person to cross the 5% threshold.  Thereafter, 13D must be amended promptly (no more than two days) following a material change, including a 1% change in ownership. SEC or State registered investment advisers have the luxury of longer deadlines. If at the end of their fiscal year a registered adviser is still over 5%, they have forty-five days to file their initial 13G, which is amended annually thereafter. Additional requirements apply at 10% and 20% ownership thresholds, or if a passive investor becomes an activist and must file on 13D.

  1. Form 13F

Any investment adviser that on the last trading day of any month of a calendar year exercises investment discretion over $100 million or more invested in equity securities traded on stock exchanges or the Nasdaq is subject to reporting on Form 13F. The SEC compiles a list of “13F Securities” which is published quarterly on its website. The filing is due in mid-February (the exact deadline will vary depending on the calendar) using data as of December 31. Thereafter, a quarterly 13F report is required forty-five days after the end of each calendar quarter. Firms that met the threshold and then fell below will still need to make the initial and quarterly filings the following year.  See also the SEC’s 13F FAQ.

13F is a public filing, though filers can request confidential treatment.

  1. Form 13H

Any investment adviser who directly or indirectly exercises investment discretion over transactions in US exchange-listed securities equal to or greater than either (a) 2 million shares or $20 million per calendar day or (b) 20 million shares or $200 million per calendar month must report identifying and other data about itself and its affiliates to the SEC on Form 13H promptly (within ten days) after reaching the either of the foregoing activity levels. Thereafter, an annual 13H report is required within forty-five days after the end of each full calendar year (the same timeframe as for 13F and 13G for registered investment advisers). Interim amendments are required following any change to the information provided on the form.

Options must be included in calculating the thresholds. The SEC’s 13H FAQ is a useful resource for calculations and other questions.

13H is a confidential filing and is not searchable via EDGAR (though it is filed on the EDGAR system; it is subject to an earlier cut-off time than public filings).

  1. Section 16

Section 16 of the Exchange Act mandates filings by certain insiders of public companies. Officers, directors and 10% shareholders are all considered insiders with respect to the shares of the public companies that employ them, or in which they hold 10% of the outstanding shares. Investment advisers registered with the SEC may be eligible for relief from the filing requirement if their aggregate holdings (i.e. across all funds and clients) meet the 10% threshold. However, if a single fund or another client meets that threshold, it will still be required to file.

The filings are made on Form 3 (initial filing), Form 4 (amendment filing) and Form 5 (annual filing). Amendments must be filed promptly, no later than two days following the change. It is best practice to file as soon as possible following the change, e.g., the same business day, especially given the increased SEC enforcement focus on this area.

See also the SEC’s guidance and electronic filing FAQs.