The following summarizes recent legal developments of note affecting the mutual fund/investment management industry.
Concerns About Pay-to-Play Violations Increase as Election Nears
The Democratic candidate for vice-president, Minnesota Governor Tim Walz, is a current state officeholder who may have influence over the selection of investment advisers and thus qualify as an "official" within the meaning of the SEC's pay-to-play rule (the "Rule") found at 17 C.F.R. § 275.206(4)-5. In addition, as November approaches, more individuals are donating to their presidential candidates of choice. Therefore, for investment advisers, compliance with the Rule is now especially salient.
The Rule. The Rule addresses so-called "pay to play" practices in the selection of investment advisers to manage the assets of U.S. state and local government entities (e.g., state pension funds, any state or local government-controlled fund, or any investment program or plan sponsored or established by a state or local government, including participant- directed plans such as 529 tuition plans and 403(b) and 457 retirement plans). The Rule effectively prohibits investment advisers who advise or seek to advise government entities, as well as certain personnel of such advisers, from making, or causing to be made, greater than de minimis political contributions to government officials with authority or influence over the hiring of investment advisers.1 There is no requirement that a donation must have been given with the intent to influence an investment decision or the selection of an investment adviser. Thus, the SEC's enforcement practices demonstrate that the SEC will bring cases regardless of whether there is evidence of an intent to influence.
Consequences of a Violation. Contributions made in violation of the Rule will result in a two-year "time out" period following the contribution date, during which the investment adviser will not be permitted to receive compensation for providing advisory services to such government entity. The SEC may seek disgorgement of fees received after a donation that violated the Rule, as well as penalties, meaning that the potential costs associated with a Rule violation are often significant (and, of course, the mere fact of an SEC investigation imposes unwanted costs).
Covered Associates. The Rule applies only to donations made by individuals who are a "covered associate" of the adviser, defined to include (i) any partner, managing member or executive officer or individual with a similar status or function, (ii) any employee who solicits a government entity for the adviser (and any person who directly or indirectly supervises such employee) and (iii) any PAC controlled by the adviser or a covered associate. The test is a functional one, and turns on the nature of a person's activities, not his or her title.
Contributions to PACs. Contributions by covered associates to a political party or political action committee ("PAC") could also trigger liability under the Rule if it is a means to do indirectly what the Rule prohibits if done directly. The SEC has issued guidance indicating that it would likely view such a contribution as triggering the Rule if "it is a means to do indirectly what the rule prohibits if done directly (for example, the contribution is earmarked or known to be provided for the benefit of a particular political official)." The SEC has emphasized that the Rule prohibits advisers and their covered associates "from coordinating or soliciting any person (including a non-natural person) or PAC to make any payment to a political party of a state or locality where the investment adviser is providing or seeking to provide investment advisory services to a government entity." Some PACs have a formal process of issuing confirmation letters when in receipt of contributions acknowledging the limited use of certain funds under the obligations imposed by the Rule.
Observations. Establishing and enforcing a political contributions compliance program that includes preclearance is critical. Advisers should regularly take steps to educate covered associates (broadly defined) about the Rule and take an over-inclusive approach to mandating that covered associates seek preclearance from compliance before making any political contribution. Advisers should also conduct regular testing of covered associate contributions using publicly available data. Other best practices include conducting regular training and, in the event of a contributions mistake, consulting with outside counsel to determine whether to apply for exemption or take any other appropriate action.
FinCEN Proposes Risk-Based Amendments to Strengthen AML/CFT Programs
On June 28, 2024, the U.S. Treasury Department's Financial Crimes Enforcement Network ("FinCEN") issued a release (the "Release") containing proposed amendments (the "Amendments") to existing regulations "to strengthen and modernize financial institutions' anti-money laundering and countering the financing of terrorism (AML/CFT) programs."
- Existing regulations subject financial institutions (which include mutual funds and broker-dealers, but not registered investment advisers) to AML/CFT program requirements. While the current regulations require that a mutual fund AML program be "reasonably designed" and include appropriate risk-based procedures for conducting ongoing customer due diligence, they do not contain explicit risk assessment requirements with respect to a mutual fund AML program more broadly.
- The Amendments, if adopted, would alter the existing regulations to require that mutual funds' AML/CFT programs are consistent with each fund's risk profile and include certain risk assessment requirements described below.
- This IM Update item focuses on the Amendments' potential impact on mutual funds, a term defined by FinCEN in existing regulations (and used in this IM Update) to include open-end ETFs.2
Adding CFT to AML Program Regulations. The Amendments would amend applicable regulations to add a new definition of "AML/CFT program." However, the Release states that the "inclusion of 'CFT' in the [AML] program rules is not anticipated to establish new obligations." Instead, the undefined term "AML program" is replaced by the new term AML/CFT program.
Risk Assessment AML/CFT Program Requirements. The Amendments would require a reasonably designed mutual fund AML/CFT program to focus attention and resources in a manner consistent with the mutual fund's risk profile, considering higher-risk and lower-risk customers and activities. Specifically, in addition to existing requirements, the Amendments indicate that a reasonably designed mutual fund AML/CFT program would need to establish a risk assessment process that serves as the basis for the mutual fund's AML/CFT program. The risk assessment process would be required to identify, evaluate and document the mutual fund's money laundering, terrorist financing, and other illicit finance activity risks, including consideration of the following factors:
- A mutual fund's business activities, including products, services, distribution channels, customers, intermediaries and geographic locations;
- The suspicious activity reports (i.e., SARs) and cash transaction reports (i.e., CTRs, if the fund permits cash share purchases) filed by a mutual fund; and
- The "AML/CFT Priorities" (described below) that FinCEN issues and updates from time to time.
In addition, the Amendments would require a reasonably designed mutual fund AML/CFT program to update a mutual fund's risk assessment on a periodic basis, including, at a minimum, when there are material changes to the mutual fund's money laundering, terrorist financing, or other illicit finance activity risks.
AML/CFT Officer Designation and Employee Training Based on Risk Assessments. Existing AML program requirements specify that a reasonably designed mutual fund AML program must include a designated person or persons responsible for implementing and monitoring the operations and internal controls of the program.3 The Amendments would additionally require that the designated person or persons (the "AML/CFT officer") is "qualified."
- The Release states that being qualified as an AML/CFT officer will depend, in part, on the financial institution's AML/CFT risk profile, as informed by the results of the risk assessment process.
- Among other attributes, the Release notes that a qualified AML/CFT officer would have "sufficient knowledge and understanding of the financial institution as informed by the risk assessment process, U.S. AML/CFT laws and regulations, and how those laws and regulations apply to the financial institution and its activities."
Similarly, while existing AML program requirements specify that a reasonably designed mutual fund AML program must provide "ongoing training for appropriate persons,"4 the Amendments would require an "ongoing employee training program" that is also risk-assessment based. The Release states that the change in the specific text of the training requirement is for consistency with the BSA and is not intended to have a substantive impact on the training requirements. The Release further elaborates that the training program under the Amendments "would be focused on areas of risk as identified by the risk assessment process and whose periodicity of training would be dependent on a financial institution's risk profile."
Independent Testing Requirement. Existing AML program requirements specify that a reasonably designed mutual fund AML program must include independent testing for compliance to be conducted by the mutual fund's personnel or by a qualified outside party.5 The Amendments would modify the existing regulation to require that a reasonably designed AML/CFT program include independent, periodic AML/CFT program testing that is conducted by qualified personnel of the mutual fund or by a qualified outside party.
Definition of AML/CFT Priorities. The Amendments would amend applicable regulations to add a new definition of "AML/CFT Priorities." The term would mean the most recent statement of AML/CFT Priorities issued by FinCEN (most recently, in 2021).6 FinCEN is required to update the priorities at least once every four years. The Release states that the proposed definition "would not itself establish new obligations" but that the Amendment's requirements for incorporating AML/CFT Priorities as part of a risk assessment process would impose new obligations.
Deadline for Public Comments. The Release provides that written comments on the Amendments must be submitted to FinCEN on or before September 3, 2024.
Regulatory Priorities Corner
Upcoming Compliance Dates
The following is a reminder of the upcoming compliance dates of significant SEC rulemakings.
- Enhanced Reporting of Proxy Votes by Registered Funds. The effective date for this release's rule and form amendments was July 1, 2024. Thus, registered funds are required to file their first reports on amended Form N-PX by August 31, 2024, with these reports covering the period July 1, 2023 to June 30, 2024. Also effective as of July 1, 2024, registered funds must disclose in their registration statements that their proxy voting record is publicly available on (or through) their website and available upon request, free of charge. The related SEC release is summarized in a Ropes & Gray Alert.
- Remaining Money Market Reforms. June 11, 2024 was the compliance date for amendments to Forms N-CR, PF and N-MFP, including Form N-MFP's requirement that a money market fund's website distinguish between fund holdings that are U.S. Government agency notes that are coupon-paying and those that are "no-coupon discount" notes. The compliance date for funds required to impose mandatory liquidity fees is October 2, 2024. The related SEC release is summarized in a Ropes & Gray Alert.
- Beneficial Ownership Reporting. Beneficial owners are required to comply with the revised Schedule 13G filing deadlines on September 30, 2024. The compliance date for the structured data (XML-based language) requirements for Schedules 13D and 13G filers is December 18, 2024. The related SEC release is summarized in a Ropes & Gray Alert.
Additional Ropes & Gray Alerts and Podcasts Since Our April – May 2024 Update
July 29, 2024
On June 29, 2024, Governor Newsom signed into law amendments to a recently adopted California law intended to provide transparency with respect to founder diversity in "venture capital investments" made by "venture capital companies" meeting certain criteria. These amendments, among other things, (i) with respect to funds, reduce the scope of the law to funds that are more traditional venture capital funds and (ii) extend the first date for reporting diversity metrics to the State of California from March 1, 2025 to April 1, 2026. The amendments generally retained the substance of the law's original reporting requirements, and in-scope funds still must wait for administrative action in the form of a designated survey before they can gather required information under the law. Notably, violations of the law could result in an order requiring the payment of monetary penalties.
California Privacy Laws for Asset Managers
July 23, 2024
On this episode of Ropes & Gray's California Law for Asset Managers podcast series, asset management partner Catherine Skulan was joined by data, privacy & cybersecurity partner Ed McNicholas to discuss recent developments in California privacy law. California's privacy laws can implicate a wide range of managers – from those based in the state to those that simply have California investors. Catherine and Ed delved into the implications for asset managers of the California Consumer Privacy Act (CCPA) of 2020 and its amending legislation, the California Privacy Rights Act (CPRA), which became enforceable for violations after July 1, 2023.
Upcoming Deadline for Form SHL – Foreign Ownership of U.S. Securities
July 16, 2024
This Alert serves as a reminder of the upcoming deadline for filing the Treasury International Capital Benchmark Form SHL ("Form SHL"). Form SHL is filed every five years with the Federal Reserve Bank of New York and requires U.S. resident entities to report information regarding foreign ownership of U.S. securities. Data is reported as of June 28, 2024 and must be submitted no later than August 30, 2024.
SEC Announces Spring 2024 Regulatory Agenda
July 15, 2024
On July 8, 2024, the Office of Information and Regulatory Affairs published the semi-annual "Unified Agenda of Regulatory and Deregulatory Actions" of the various federal agencies. The Unified Agenda includes the SEC's Spring 2024 Current Agenda containing items of potential interest to our asset management clients, as well as the SEC's current timing estimates. The Current Agenda reflects only the priorities of SEC Chair Gary Gensler and does not necessarily reflect the views and priorities of any other Commissioner.
SCOTUS and the Future of the Administrative State: After Jarkesy and Loper Bright
July 12, 2024
The U.S. Supreme Court's term has ended, with major implications for federal agencies and those that are regulated by them. What did the Court cover? And what remains unaddressed? Litigation & enforcement partners Doug Hallward-Driemeier and Jeremiah Williams discussed the impact of Jarkesy and Loper Bright on federal agency authority, including the demise of the Chevron doctrine. Doug and Jeremiah bring unique insight to the topic: Doug is head of Ropes & Gray's appellate and Supreme Court practice; he has argued 19 cases before the Supreme Court and filed more than 200 briefs there. Jeremiah is a former SEC enforcement attorney who represents clients in government investigations and other regulatory matters.
The Data Day: Recent Developments in AI Governance and State Privacy Laws
July 10, 2024
Ropes & Gray's podcast series The Data Day, brought to you by the firm's data, privacy & cybersecurity practice, focuses on the day-to-day effects that data has on all of our lives, as well as other exciting and interesting legal and regulatory developments in the world of data, and features a range of guests, including clients, regulators and colleagues. On this episode, hosts Fran Faircloth, a partner in Washington, D.C., and Edward Machin, counsel in London, discussed the latest developments keeping the data team busy, including the drive to build AI governance programs in Europe and the U.S. and the launch of a new state privacy law microsite. The microsite features an interactive map of the U.S. that captures the rapidly developing privacy laws emerging from each state.
July 1, 2024
This podcast discussed the Supreme Court's decision in Loper Bright Enterprises v. Raimondo, overturning Chevron, a cornerstone of administrative law over the past 40 years. The longstanding Chevron doctrine required courts to defer to agencies' construction of ambiguous statutes, even as to the scope of those agencies' authorities, so long as the agency's construction of the ambiguous statute was reasonable and thus a "permissible" one. Loper Bright strips agencies of this presumptive deference and invites new litigation over interpretations of statutory language that govern many areas of law and business. The decision also signals that more changes to administrative law may be on the horizon.
Certain Advisers and Funds Will Be Required to Report Uncleared Repo Transactions Under New Rule
June 26, 2024
The Treasury Department's Office of Financial Research ("OFR") recently finalized a new rule that will require daily reporting of certain transaction-level data in respect of non-centrally cleared bilateral repurchase transactions (the "Rule"). Reporting under the Rule will be made directly to OFR by certain financial companies (including certain U.S. investment advisers and the funds and clients they advise) that meet a threshold prescribed by the Rule. The approach to reporting under the new Rule is a marked departure from what market participants are accustomed to under other reporting regimes, including the swap reporting rules.
The State of State ESG Activity as an Election Looms – a 2024 Mid-Year Review
June 24, 2024
Since 2021, Ropes & Gray has been actively tracking actions that states have taken on how or whether environmental, social and governance ("ESG") factors should be applied to the investment decisions for public sector retirement systems. Against a background of increasing political tensions, states have used legislative, administrative and enforcement mechanisms to address this area.
This Alert provides a broad overview of ESG lawmaking at the state level in 2024, now that most states' legislative sessions have adjourned. The first part compares this year's activity to the level of activity over the last two years. The second part provides a summary of the measures that states have adopted in recent months.
June 18, 2024
On May 16, 2024, the SEC issued a release adopting amendments to Regulation S-P (the "Amendments") that require broker-dealers, registered investment companies and registered investment advisers to adopt written policies and procedures creating an incident response program to deal with unauthorized access to customer information, including procedures for notifying persons affected by the incident within 30 days. This Alert describes the Amendments in detail followed by Ropes & Gray's observations.
June 17, 2024
On this Ropes & Gray podcast, asset management partners Eve Ellis and Jason Brown delved into key regulatory issues impacting clients with interests in both the United States and Europe. Specifically, they explored the differences in how the U.S. Securities & Exchange Commission ("SEC") and the U.K. Financial Conduct Authority ("FCA") supervise and regulate fund advisers. They compared and contrasted the differing approaches to registration, oversight, and examination. Additionally, they highlight some of the current priorities for both the SEC and the FCA.
Footnotes
1. Covered associates who are natural persons may contribute up to $350 per election to an official for whom that covered associate is entitled to vote, and a maximum contribution of up to $150 for any other official.
2. See 31 C.F.R. § 1010.100(gg). Closed-end funds would not be affected by the Release.
3. See 31 C.F.R. § 1024.210(b)(3).
4. See 31 C.F.R. § 1024.210(b)(4).
5. See 31 C.F.R. § 1024.210(b)(2).
6. See AML/CFT Priorities (June 30, 2021), available at https://www.fincen.gov/news/news-releases/fincen-issues-first-national-amlcft-priorities-and-accompanying-statements.
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