The Securities and Exchange Commission (“SEC”) is proposing rules that would modify the registration, communications, and offering processes for business development companies (“BDCs”) and other closed-end investment companies (“CEFs”) under the Securities Act of 1933, as recently mandated by Congress. The potential benefits for those entities resulting from the proposed rules include: improved access to capital, lower cost of capital, and facilitated communications with investors. As of September 30, 2018, there were 807 affected funds, including 103 BDCs and 704 registered closed-end funds.
SEC’s Performance Measurement
On March 18, the SEC released the “SEC Fiscal Year 2020 Congressional Budget Justification and Annual Performance Plan; Fiscal Year 2018 Annual Performance Report.” Since we are already in FY 2019 (October 1, 2018 through September 30, 2019), in this report the SEC indicates to the Congress, how much it thinks it needs to accomplish its goals in the next fiscal year, FY2020 and how it performed versus its goals for FY2018, compressed into 178 pages.
Lest we and the Congress forget the role of the SEC, it is updated in the Executive Summary:
“The SEC’s broad mission covers a lot of ground. We oversee over $97 trillion in securities trading annually on U.S. equity markets and the activities of over 27,000 registered market participants, including investment advisers, mutual funds, exchange-traded funds (ETF), broker-dealers, municipal advisors, and transfer agents. We are responsible for selectively reviewing the disclosures and financial statements of almost 8,000 reporting companies, of which approximately 4,300 are exchange listed. Of the top 100 public companies in the world, 81 fall under the SEC’s reporting requirements. The SEC also engages and interacts with the investing public on a daily basis through a number of activities ranging from our investor education programs to alerts on SEC.gov. We provide critical market services through our IT systems. On a typical day, investors and other market participants access disclosure documents through the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system 41 million times. The agency also oversees 22 national securities exchanges, 10 credit rating agencies, and 7 active registered clearing agencies, as well as the Public Company Accounting Oversight Board (PCAOB), the Financial Industry Regulatory Authority (FINRA), the Municipal Securities Rulemaking Board (MSRB), the Securities Investor Protection Corporation (SIPC), and the Financial Accounting Standards Board (FASB).”
One of the SEC’s top priorities for FY2020, is to focus on the long-term interests of Main Street investors. This includes the examination program, “executed by the Office of Compliance Inspections and Examinations (OCIE), another key area where our work directly protects the interests of Main Street investors. The SEC in recent years has been leveraging data, advanced risk analytics, and human capital to successfully focus its limited resources where they can have the most benefit. These efforts have resulted in a number of significant improvements, including expanded coverage of investment advisers even as the amount of assets under management by investment professionals continues to increase. To highlight, examination coverage of investment advisers was approximately 17 percent in FY 2018, nearly double the 9 percent coverage we had just five years ago.”
Another high priority is to evaluate the SEC’s performance by enhancing our analytical capabilities and human capital development. “In FY 2018, the SEC began implementing our Technology Strategic Plan to streamline the delivery of technology, strengthen operational resiliency, and improve information available to investors and markets. The agency has made advancements in foundational areas including cybersecurity, secure cloud infrastructure, and data management. FY 2020 will be a critical year for the agency to follow through on strategic technology priorities, which include a number of multi-year initiatives.
“As of September 2018, there were 13,222 SEC-registered investment advisers reporting almost $85 trillion in regulatory assets under management. Approximately 53 percent of these advisers provide investment advice to mainstream retail investors. Approximately 36 percent provide investment advice to private funds such as hedge funds and private equity funds with gross assets of about $13.1 trillion. In addition to registered investment advisers, the SEC also receives reports from approximately 3,844 exempt reporting advisers—those who are exempt from registering with the SEC because they are venture capital fund advisers or mid-sized private fund advisers—who report managing approximately $3.3 trillion in private funds.”
In FY2018: 2,312 IAs were examined (17% of the IA population), 138 ICs were examined (15% of the IC population).
For FY2019: an estimated 1,955 IAs (15% of the IA population), and an estimated 215 ICs (11% of the IC population) will be examined, the numbers reduced due to the five-week government shut-down.
For FY2020: an estimated 2,300 IAs (16% of the IA population), and an estimated 135 ICs (15% of the IC population) will be examined.
In FY2018: 69% of IAs examined had identified deficiencies, 20% had significant deficiencies, and 6% were referred to enforcement.
For comparison, five years ago in FY2013, 80% of IA exams resulted in deficiencies, 35% had significant deficiencies, and 13% were referred to enforcement.
On March 18, Commissioner Roisman spoke to the ICI Mutual Funds and Investment Management Conference. His major topic was around proxy voting, primarily speaking to fund advisers, but if recommendations are made to modify disclosures around proxy voting, it will probably impact on all advisers who vote proxies. One of his questions was, “How are fund boards and advisers fulfilling their fiduciary duty in the context of proxy voting?”
“One example is a merger, where the deal appears better for one company (say, the target) than the other (here, the acquirer, who may be taking on a struggling business and large debt obligations). Let’s say an adviser manages two funds, one with a long position in the target that would benefit from the merger, and another, heavily invested in the acquirer, that could lose value. Shouldn’t the adviser vote both funds’ shares differently, one in favor of the transaction, and the other against? More broadly, it seems that conflicts could exist between funds with different investment objectives. Consider the preferences of a portfolio manager at a growth fund, which targets companies with high growth prospects, and an income/dividend fund, which seeks to generate an income stream for shareholders in the form of dividends or interest payments. If there is a proxy contest led by an investor to increase dividend payments, shouldn’t these funds vote differently? It would seem to me that voting these funds’ shares the same way could risk subsidizing one fund’s votes with votes of another.”
If all your clients are invested in the same strategy, this is not an issue, but if you have clients in different strategies, owning the same securities, this could be a concern, particularly since the SEC now appears to be focusing on this issue.
Things are moving again at the SEC, on-site exams are/will be shorter, but the examiners can analyze more data than ever. In addition to focusing on issues at your firm, the SEC is also focusing on the number of exams completed during the fiscal year, the number of deficiencies, major and minor, and my favorite statistic, the number of exams per examiner.
As a quick end note, please inform any individuals that you have identified on your Form ADV as the CCO, that they are in that position, preferably before the SEC starts to question them. This is a now classic example of compliance failure.