Editor’s letter

Citation

Davis, H.A. (2015), "Editor’s letter", Journal of Investment Compliance, Vol. 16 No. 4. https://doi.org/10.1108/JOIC-09-2015-0060

Editor’s letter

Article Type: Editor’s letter From: Journal of Investment Compliance, Volume 16, Issue 4

In the following 12 articles, leading practitioners concerned with legal and regulatory issues relevant to broker-dealers, investment banking firms, investment advisers, mutual funds, hedge funds and private equity firms provide explanation and insight on current issues including the US Department of Labor’s proposed new fiduciary standards for IRAs, the US Department of Justice’s (DOJ’s) and the US Securities and Exchange Commission’s (SEC’s) views on effective compliance programs, the US Supreme Count Omincare decision relating to opinions expressed in registration statements, changes in the Financial Industry Regulatory Authority’s (FINRA’s) equity research and research analyst conflict-of-interest rules, the SEC’s Municipalities Continuing Disclosure Cooperation Initiative, new SEC reporting requirements for registered investment companies and investment advisers, a pilot program to implement larger tick sizes in major exchanges, SEC charges related to misallocation of broken deal expenses, a proposed SEC requirement for corporations to have earnings clawback policies, frequently asked questions about new SEC money market fund rules, new BitLicense regulations, the Basel Committee for Banking Supervision’s Principles for Effective Risk Data Aggregation and Risk Reporting (BCBS 239), and a survey of anti-money laundering regulatory compliance at a selected group of banks in India.

A May 2015 speech by Assistant Attorney General Leslie R. Caldwell and an SEC settlement agreement which followed shortly thereafter underscored that the DOJ and the SEC continue to assess the efficacy of corporate compliance programs. The message of both the DOJ and the SEC is that corporations must continuously assess and tailor their compliance programs to the needs of the organization to ensure that compliance programs don’t just exist, but that they achieve the needs of the company. This article details issues every company should think about when evaluating the strength of its compliance program.

Aegis Frumento and Stephanie Korenman analyze the implications of the US Supreme Court Omnicare decision, in which a securities issuer was judged to have stated opinions in a registration statement that were misleading because they led the reader to assume certain underlying facts that turned out not to be true. In this case the issuer opined that certain contracts were legally valid arrangements when in fact those contracts violated anti-kickback laws. The authors expect that this Supreme Court decision will define new standards of ensuring that any stated opinions are backed up by well-documented facts and other background information.

In the first of two companion articles, Nathan Greene explains proposed rules recently issued by the SEC that would dramatically expand both public and non-public reporting of portfolios and other data by US registered investment companies. Among the rule’s requirements would be monthly portfolio and risk reporting as well as enhanced and standardized derivatives disclosures in fund financial statements. Given the volume and frequency of reporting, Mr Greene notes that compliance with the new rules will require considerable resources and internal coordination among a firm’s finance, operations, and legal and compliance specialists.

In his second companion article, Mr Greene explains proposed rules and amendments recently issued by the SEC that would impose more detailed reporting requirements for investment advisers that file Form ADV. He describes the SEC’s reasoning for collecting more detailed data, introduces the proposed separate account reporting requirements for SEC-registered investment advisers, explains proposed amendments to Part 1A of Form ADV, describes a proposed codification of SEC staff positions that provide for so-called “umbrella registrations” by closely related advisory firms, and details two proposed amendments to Advisers Act Rule 204-2, the books and records rule, which would require investment advisers to maintain additional materials related to the calculation and distribution of performance information.

Bruce Newman, Cherie Weldon and Andre Owens explain a joint effort by the national securities exchanges to implement a tick size pilot program. The tick size is the smallest amount (tick) by which the price of a trading instrument can move. The pilot program would widen the minimum quoting and trading increments for certain small cap stocks. It is designed to provide the SEC with empirical data regarding the impact that tick size may have on the trading of small cap stocks. Tick sizes, which in the past were fractions of a dollar, were narrowed to a penny in 2001. The tick size affects the spread, or the profit, a broker can book from trading a stock and therefore affects a broker’s interest in covering that stock. Some believe that larger tick sizes could encourage brokers to devote more resources, including analyst coverage, to small cap stocks, and therefore encourage more small companies to issue stock to list in the exchanges.

Veronica Rendón Callahan, Ellen Kaye Fleishhacker, Robert Holton, Steven Kaplan, Kevin Lavin, Michael Trager, Mark Sylvester, and Pratin Vallabhaneni explain and analyze SEC charges and a settlement with Kohlberg Kravis Roberts & Co. (KKR) related to misallocation of broken-deal expenses. KKR was found to have allocated some expenses related to deals that did not materialize to a fund but not to the fund’s co-investors, which included KKR executives and consultants, even though those co-investors shared in the fund’s investment performance. KKR was also found not to have adopted and implemented a written compliance policy or procedure governing broken deal expense allocation policies until more than two years after it registered with the SEC as an investment adviser to the fund. This enforcement action and other similar ones represents a continuing SEC focus on fee and expense misallocation.

Andrew Brady, Rolf Zaiss, and Nyron Persaud examine the proposed rules issued by the SEC pursuant to Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which, if adopted, would require national stock exchanges to establish listing standards that would require listed issuers to adopt so-called clawback policies for the recovery of excess incentive-based compensation in the event that an issuer is required to prepare an accounting restatement resulting from material noncompliance with any financial reporting requirement. The SEC’s proposed rules will, if adopted, impose additional burdens on listed issuers to adopt and comply with recovery policies for excess incentive-based compensation and adhere to new public disclosure requirements.

In Volume 16 #1, Jack Murphy, Stephen Cohen, Brenden Carroll, Aline Smith, Matthew Virag and Justin Goldberg explained problems money market funds encountered during the financial crisis, other background, and the details of the SEC’s July 2014 adoption of sweeping amendments to Rule 2a-7 and other rules that govern money market funds under the Investment Company Act of 1940. Those amendments require, among other things, “institutional” money funds to operate with floating net asset values (NAVs) permit (and, under certain circumstances, require) all money funds to impose “liquidity fees” and/or “redemption gates” when weekly liquidity levels fall below regulatory thresholds. In a follow-up article in this issue, Jack Murphy, Stephen Cohen, Brenden Carroll, Justin Goldberg, and Joshua Katz explain the background and details of SEC staff responses to selected frequently-asked questions (FAQs) about the July 2014 amendments. Those FAQs deal with, among other things, reporting of financial support to a fund by an affiliate or sponsor, website disclosure of fund valuation and valuation methods, permissible use of the amortized cost method of valuation, policies and procedures to ensure all beneficial owners of a “retail” money market fund’s shares are natural persons, qualifying both feeder and master funds as retail funds, one-time reorganizations to comply with the July 2014 amendments, operational details relating to the implementation of liquidity fees and redemption gates, and investment criteria for government money market funds.

Amy Ward Pershkow and Adam Kanter explain a recently settled administrative proceeding that the US SEC brought against a private fund manager in connection with the use of fund assets to pay for the manager’s operating expenses. The authors describe this as the latest in a string of SEC enforcement actions driving at the same issue: the need for clear and up-front disclosure regarding how fund managers are compensated and the respective expenses borne by funds and fund investors.

Gary DeWaal and Guy Dempsey analyze the New York State Department of Financial Services (NYDFS) final BitLicense regulations with respect to Bitcoin and other virtual currencies. They examine how the new regulations require all persons engaging in a virtual currency business to apply and obtain a BitLicense, and to maintain certain minimum standards and programs to help ensure customer protection, cyber-security and anti-money laundering compliance. The final regulations are the first formal attempt by any state or federal regulator in the United States to expressly regulate the virtual currency business. However, nothing in the new NYDFS provisions regulates virtual currencies themselves. It’s too early to tell whether the procedures in place for BitLicensees will discourage firms from engaging as virtual currency intermediaries or firewalling their virtual currency business activities from potential New York customers.

Based on a survey of 29 major financial institutions, including global and domestic systemically important banks, Lukas Prorokowski advises banks and other financial institutions on what they need to do to become ready and compliant with the Basel Committee for Banking Supervision’s Principles for Effective Risk Data Aggregation and Risk Reporting (BCBS 239). The introduction to BCBS 239 notes that one of the most significant lessons learned from the global financial crisis that began in 2007 was that banks’ information technology (IT) and data architectures were inadequate to support the broad management of financial risks. Many banks lacked the ability to aggregate risk exposures and identify concentrations quickly and accurately at the bank group level, across business lines and between legal entities. Some banks were unable to manage their risks properly because of weak risk data aggregation capabilities and risk reporting practices. For the purpose of BCBS 239, the term “risk data aggregation” means defining, gathering and processing risk data according to the bank’s risk reporting requirements to enable the bank to measure its performance against its risk tolerance/appetite. This includes sorting, merging or breaking down sets of data. BCBS presents a set of principles to strengthen banks’ risk data aggregation capabilities and internal risk reporting practices.

Finally, B. Viritha, V. Mariappan and Varun Venkatachalapathy report on a study they conducted with a group of banks in India to assess their level of the compliance with anti-money laundering (AML) regulations and to understand the bottlenecks in AML implementation. Results indicated that banks’ policies and procedures, including know-your-customer guidelines, reporting procedures, and customer identification procedures, were largely compliant with AML guidelines but actual day-to-day practice fell short of those policies and procedures.

Henry A. Davis