The Markets July 13, 2023

IAA: SEC Marketing Rule Still Top Concern for Compliance Teams

Investment advisories rank the marketing rule as the ‘hottest’ topic for the third year in a row, followed by cybersecurity and electronic communications monitoring.

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The Securities and Exchange Commission’s marketing rule continues to dominate conversation among investment advisory firms, according to this year’s Investment Management Compliance Testing Survey conducted by the Investment Adviser Association.

This is the third year in a row that the rule regulating how advisers present clients with investment advice and offerings has ranked as the “hottest” area for compliance divisions, according to the IAA. The SEC started enforcing the new marketing rule in November 2022 and, as recently as June, issued a risk alert on how regulators will be reviewing compliance exams regarding the rule.

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“The persistent dominance of the SEC’s Marketing Rule as the primary worry for investment adviser compliance officers underscores the critical need for proactive adaptation,” Carlo di Florio, global advisory leader at the ACA Group, which partners with IAA on the report, said in a statement.

The survey, which is in its 18th year, gathered responses from 581 adviser firm compliance divisions, more than half (58%) of which said they also work in other areas of the business.

The SEC marketing rule has been a focus area for advisories, because it seeks to ensure that any communication mentioning investment performance directed to one or more persons is an advertisement subject to the Investment Advisers Act of 1940. This increased scrutiny has meant more resources being put toward marketing materials and presentations, even spurring knock-on offerings from third parties. On Wednesday, financial technology firm CapIntel released a “proposal generation builder” that creates investment presentations that comply with the rule.

Besides the marketing rule, investment advisers listed cybersecurity as the second hottest topic at 52% of respondents, followed by electronic communications surveillance at 35%. Monitoring and storing electronic communications for a defined period is another key area for the SEC. Last year, the regulator charged 16 Wall Street firms with failing to preserve electronic communications for the designated time period.

“The close contenders, cybersecurity and electronic communications, demand proactive measures to safeguard client data and maintain regulatory compliance,” di Florio said. “Only through proactive efforts can advisers thrive amidst these pressing challenges.”

Respondents also noted that SEC exams directed at their firms have tended to focus on the highest three areas of concern. When asked about the top areas of increased SEC testing, advisers responded with: advertising (69%), cybersecurity (65%), electronic communications (57%), vendor due diligence (44%) and ESG (40%).

“These top areas are in line with SEC rulemaking and enforcement focus areas reflecting a proactive industry, a continuing trend over the last several years,” the IAA wrote in the report. “Also, the majority of respondents did not decrease testing in any area, other than decreased COVID-19-related testing.”

Other findings from the report included:

  • 49% of advisers are working in an office at the same levels they were pre-COVID;

  • 58% of respondents are either undergoing an SEC exam or have been examined in the past five years; and

  • 64% of investment advisers have conducted or intend to conduct mock SEC exams, while 82% reported that mock exams have helped them prepare for an actual SEC exam.

The IAA partners with compliance consultants ACA Group and Yuter Compliance Consulting on the annual survey.

Compliance July 12, 2023

SEC Changes Liquidity Fee, Gate Structure for MMFs

MMFs must be significantly more liquid in 2024 under new rule updates adopted this week.

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The Securities and Exchange Commission adopted rule updates during a hearing on Wednesday which amend liquidity management requirements for money market funds governed by the Investment Company Act of 1940.

The new rule requires MMFs to keep 25% of their assets in daily liquid assets, up from 10%, and at least 50% in weekly liquid assets, up from 30%.

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Jamie Gershkow, a partner in Stradley Ronon, explains that MMFs which fall below these limits cannot acquire new assets until they satisfy these requirements.

A new liquidity fee will also be imposed on certain redemptions from institutional prime and tax-exempt MMFs. If daily net outflows exceed 5% of the fund’s value, then the fund must impose a liquidity fee on new redemptions. Gershkow explains that this fee must be a good faith estimate of the costs associated with continuing to satisfy redemptions. Imposing the fee is mandatory and intended to mitigate panic sales that could dilute a fund’s value for the remaining investors.

Gershkow explains that the SEC is targeting prime and tax-exempt MMFs because these funds were especially strained by outflows at the beginning of the pandemic.

The rule was motivated primarily by large outflows from MMFs in early 2020 during the beginning of the pandemic. William Birdthistle, the director of the SEC’s Division of Investment Management, explained that investors moved from MMFs to cash and Treasurys and the Federal Reserve had to establish an emergency liquidity program whereby it loaned money to MMFs at favorable rates so they could meet their redemptions.

The amendments also remove some elements of a 2014 rule which was also designed to improve MMF liquidity management. Under the 2014 rule, when a fund’s daily or weekly liquid assets fell below the regulatory thresholds, those funds were enabled to impose fees or “gates,” meaning a pause in redemptions. The new rules disconnected fees and gates from a specific liquidity threshold.

Jessica Wachter, the director of the SEC’s division of economic and risk analysis, explained during Wednesday’s hearing that the older rules had created perverse incentives: When investors anticipated a gate or fee being triggered, they actually began to sell more aggressively to ensure their access to cash. The 2014 rule therefore aggravated panic selling when it was intended to mitigate it.

The new final rule, which passed by a 3-2 vote, dropped a controversial swing pricing mechanism from the original 2021 proposal. The MMF swing pricing proposal is distinct from the proposal to implement swing pricing on mutual funds with a floating NAV, which is still pending.

Gershkow says mutual funds and MMFs are different products, so the SEC’s decision to abandon swing pricing for MMFs does not automatically mean it will be discarded from the mutual fund liquidity management proposal.

The Investment Company Institute gave mixed feedback in a statement: “The SEC has missed the mark by forcing money market funds to adopt an expensive and complex mandatory fee on investors. There is no precedent for such a fee framework.”

The statement continued, “The removal of the tie between minimum liquidity thresholds and fees and gates is a positive step—one we have long supported. We also supported a reasonable increase in daily and weekly liquid asset requirements, although the Commission has adopted an excessive threshold. We do applaud the Commission’s recognition that swing pricing is not an appropriate regulatory tool.”

The rule updates will take effect one year after its entry into the federal register, estimated to be August 2024.

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