Hot Topics to Cover in Your Next Mock Exam

Recent examinations by the Securities and Exchange Commission (“SEC”) focused on a number of initiatives including presence exams, newly-registered advisers and firms that had been registered for a number of years but never examined. With these initiatives completed or coming to an end, exams on key topics such asprivate equity, valuations, conflict of interest disclosures andcybersecurity are getting more attention. Although only the SEC only examines about 10% of registrants annually, firms should assume that they will be one of them and prepare accordingly.

One of the best ways to prepare is to hire a law firm or compliance consultant to perform a mock exam; see our previous article, 7 Tips to Get the Most Out of Your Mock Examination, for useful considerations when planning a mock exam. In addition, firms might consider emphasizing the following hot topics in their next mock exam:

  1. Cybersecurity. The SEC is increasingly concerned with the security of client and firm information stored electronically, as well as the risk of cyber-attacks. Many firms already have policies and procedures in place for handling data loss, but as cyber-related crimes become more commonplace and sophisticated, policies must be reviewed and updated regularly. Recently, the SEC stated that an outdated policy, or one that fails to protect sensitive or confidential data, could be construed as a possible violation of federal securities laws.
  2. Advertising/Marketing. SEC exams always cover advertising and marketing activities. Firms should remember that any piece that is distributed to more than one person is subject to the SEC’s advertising rules (this could encompass market commentary, client/investor letters and other routine outreach and reporting).   In particular:
    • Content should be balanced and accurate;
    • Opinions should be clearly stated;
    • Support for factual statements should be maintained in the firm’s files;
    • Performance information should include appropriate disclosures and records of calculations should be kept.

Recent exams indicate that the SEC closely scrutinizes performance numbers, asks for backup documentation and seeks confirmation that materials are approved by compliance.

  1. Fees and Expenses. Private equity firms, particularly, should prioritize fee and expense structures and how they are disclosed. The SEC carefully examines these and, indeed, has shown some skepticism about common and expected practices (see our article on best practices for disclosure of private equity fees and expenses). Firms should review and, as necessary, revise funds’ offering documents, ADV disclosures and firm policies to address current regulatory and investor expectations.
  2. Safety of Client Assets and Custody. The SEC routinely examines firms’ custodial arrangements for compliance with the custody rule (see our primer). Recently, this has become such a concern the SEC that released a Risk Alert on the subject and recurring or serious issues have been referred to enforcement (see SEC v. Water Island Capital, SEC v. Sands Brothers Asset Management). Though simple on its face, there are some pitfalls that can be avoided by implementing clear policies and procedures in this important area.
  3. Personal Trading. The SEC always reviews firm policies and access persons’ personal trading. Of particular concern is whether these policies and procedures mitigate the potential for conflicts of interest with client trading. Firms should ensure that they have complete records of all access persons’ accounts, holdings and trades, including any required preapprovals.
  4. Insider Trading. Insider trading is at the top of the SEC’s priority list and will likely remain there for the foreseeable future (see our primer on detecting and preventing insider trading). Especially since the Newman decision clarified the elements and proof required for a criminal conviction (see our analysis and next steps), firms can expect SEC staff to be extremely thorough in examining a firm’s insider trading policies and procedures. Firms should consider activities that create risk, such as using expert networks, deals with public companies and any other situation in which the firm may receive, even inadvertently, material non-public information. Once these risks are identified, policies and procedures should be reviewed and upgraded as needed to meet any new or changing risks.
  5. Conflicts of Interest. A constant concern for the SEC, every mock exam should closely review:
    • Risk controls;
    • Allocation of investment opportunities;
    • Compensation arrangements;
    • Disclosure of side-by-side management of asset and performance based fee accounts;
    • Any other potential conflicts of interest, depending on the firm’s business strategies.
  6. Internal Reviews. Interestingly, there is no requirement in the Advisers Act or rules to document annual or other reviews. However, the SEC usually asks for such documentation in an examination. Firms that have not previously documented annual or interim reviews should begin doing so (see our tips for conducting the annual review); all firms should ensure that their documentation is available to produce in an exam and perhaps consider enhancements to their reviews and reporting processes.


Policy and Disclosure Considerations for Private Equity Co-Investment

In recent years the Securities and Exchange Commission (“SEC”) has focused heavily on private equity firms. Perhaps more so than for other firms, the SEC is concerned about conflicts of interest, particularly regarding external co-investment: the leveraging of a primary fund’s diligence of a portfolio company to offer a secondary investment opportunity to limited partners or others. The incentives for such an investment include higher returns through lower fees in a portfolio company that has already been thoroughly examined.

The SEC’s main concerns regarding these transactions include:

  • Whether the fund appropriately discloses to all limited partners how it selects co-investors from the pool of limited partners;
  • Appropriate disclosure regarding allocation of costs for diligence and research among the primary funds and co-investment vehicles;
  • The co-investment process must be consistent with the firm’s fiduciary duty to the primary fund(s);
  • Funds’ offering documents, Form ADV disclosures and policies and procedures must appropriately discuss co-investment procedures.

As the KKR enforcement action made clear, firms must review (and upgrade, if needed) their policies and procedures around co-investment activities, including how they allocate research and deal costs. Firms should consider:

  • Implementing clear policies and procedures outlining co-investment practices, including:
    • When, how and to whom these opportunities will be presented;
    • How broken deal expenses will be shared amongst the fund, co-investment vehicles, and the firm; and
    • How co-investment fees are determined.
  • Satisfying fiduciary duty obligations for the primary fund prior to making the deal available to co-investors;
  • Documenting all parts of the investment process and involving the compliance team to monitor it; and
  • Reviewing co-investment processes on an ongoing basis to ensure that they are executed in accordance with policies and procedures.

Legal counsel will likely be heavily involved in preparing the deal documents and should be consulted regarding the disclosure issues. Firms should also consider leveraging their compliance consulting team on policy matters and ongoing monitoring.

SEC Issues Needed Guidance on Personal Securities Reporting in Discretionary Accounts

In June of this year, the Securities and Exchange Commission (“SEC”) issued guidance on subsection (b)(3)(i), the (“Reporting Exception”), of SEC Rule 204A. The rule states that registered investment adviser “access persons” (employees with access to non-public information regarding securities transactions or those who are involved in making securities recommendations to clients) must report all personal securities holdings and transactions. The Reporting Exception provides that accounts over which access persons have “no direct or indirect influence or control” are exempt from this rule.

The guidance addresses accounts where the access person is: (i) a grantor or beneficiary of a trust managed by a third-party trustee, or (ii) gives discretionary authority over the account to a third-party manager. The terms of these accounts may vary, making it difficult to provide a black and white answer. The SEC’s recent guidance offers the following suggestions to determine whether such an account meets the Reporting Exception:

  • Obtain information about the relationship between the access person and the third-party manager or trustee. Personal relationships with the manager or trustee may suggest that that the access person does have some influence or control over the account’s activities;
  • Request and assess account holdings and investments for any sign of trading in securities that indicate the use of the firm’s non-public information, e.g., to front-run client accounts. Compliance should also look for any issuers on the firm’s restricted and watch lists;
  • Periodically obtain signed certifications by the access persons and third party manager or trustee. The certification should include representations to the effect that the third party manager or trustee manages the account without the direct or indirect influence or control of the access person.

Carefully reviewing account details at the outset will assist compliance officers in determining whether an account initially qualifies for the Reporting Exception. Thereafter, compliance officers should periodically review the accounts and obtain certifications to ensure the account remains qualified for the exception. Because the terms of these accounts can vary widely, compliance teams should consult their outside legal counsel or consultant with any questions.

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 16thAmendment 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 betweenPresident 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.

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.