On February 15, 2023, the U.S. Securities and Exchange Commission (SEC) proposed a new rule for registered investment advisers that would replace the current “custody rule” under the Investment Advisers Act of 1940 (Advisers Act) with a new “safeguarding rule”[1] and make corresponding amendments to the Adviser Act’s recordkeeping rule and Form ADV.

Additional information is contained in a related press release, fact sheet and proposing release. 

Among other things, the new “safeguarding” rule would:

  • significantly expand the scope of the types of client assets covered under the rule from “funds and securities” to include any client assets of which an adviser has custody (including non-securities assets, such as real estate, that are considered to be within the scope of the investment advisory relationship);
  • broadly revise the definition of “custody” to include any client assets over which an adviser exercises discretionary trading authority; and
  • require registered investment advisers to enter into a written agreement with the qualified custodian that contains terms addressing recordkeeping, client account statements, internal control reports, and the adviser’s agreed-upon level of authority to effect transactions in the account.

Although the proposed rule would include a limited exception from the surprise examination requirement (retained from the current rule) for a registered investment adviser whose custody of client assets arises solely from discretionary authority, that exception is conditional.  To rely on this exception:

  • the client assets must be maintained with a qualified custodian (e.g., securities not kept with a custodian pursuant to the “privately offered securities” exception would be disqualified from this exception) and
  • the adviser’s trading under discretionary authority is limited to client assets that settle exclusively on a “delivery-versus-payment” (DVP) basis.

Notably, by proposing to expand “custody” to include assets traded under discretionary trading authority, the proposed rule would require substantially all registered investment advisers to comply with the safeguarding rule, including its surprise examination requirement (or through delivery of annual audited financial statements in lieu of a surprise examination, as permitted under the rule).

Comments on the proposed rule are due on or before the date that is 60 days following publication in the Federal Register and may be made as described in the proposal.

Our in-depth analysis of the proposed rule will be available in the coming days.

[1] Under the proposal, the SEC would renumber the current custody rule (Rule 206(4)-2 under the Advisers Act) as new Rule 223-1 under the Advisers Act.

The Loan Market Association (LMA), the Loan Syndications and Trading Association (LSTA) and the European Leveraged Finance Association (ELFA) have published an ESG questionnaire which they hope will be an industry standard for investors undertaking ESG due diligence on prospective and incumbent asset managers.

The publishing associations hope that this will simplify the due diligence process by avoiding varied and often duplicative information requests.

There is of course a potential upside for investors too, as they are more likely to receive comparable data across asset managers which ought to make ESG analysis far more straightforward.

Whether this questionnaire will become industry standard will be largely dependent on whether investors are willing to accept it, and whether legal or regulatory requirements on investors will permit them to accept it. However, even if investors continue to have specific diligence requirements outside of the questionnaire, it would still streamline the process if this questionnaire were to form the basis of ESG due diligence going forward.

The longstanding view of the Department of Labor (the “DOL”) has been that proxy voting and other shareholder rights held by an ERISA plan are subject to ERISA’s fiduciary duties of prudence and loyalty. Previously, this view was expressed by the DOL in sub-regulatory guidance, such as interpretive and field assistance bulletins. In September of 2020, the DOL published a proposed rule (the “Proposal”) regarding an ERISA fiduciary’s duties with respect to shareholder rights. On December 16, 2020, the Department of Labor published the final regulation (the “Regulation”). Much like the Proposal, the Regulation requires that when a fiduciary decides whether and when to exercise plan shareholder rights, it must act prudently and solely in the interests of participants and beneficiaries and for the exclusive purpose of providing them benefits and defraying the reasonable expenses of administering the plan. However, in the Regulation, the DOL took an approach that is less prescriptive and more principles-based than the Proposal. Continue Reading Final ERISA Regulations Describe Fiduciary Duties Related to Plan Proxy Voting

On November 9, 2020, the Office of Compliance Inspections and Examinations (“OCIE”) of the US Securities and Exchange Commission (“SEC”) published a risk alert discussing its observations from a series of examinations that focused on SEC-registered investment advisers operating from numerous branch offices and with operations geographically dispersed from the adviser’s principal or main office. In this initiative, OCIE staff assessed, among other things, the advisers’ compliance and supervisory practices relating to advisory personnel working within the advisers’ branch offices. The following Legal Update provides a summary of OCIE’s observed deficiencies outlined in the risk alert, followed by a discussion of observed practices that seek to mitigate compliance risks.

Read our Legal Update here.

On October 30, 2020, the U.S. Department of Labor (“DOL”) released its final regulation (“Final Rule”) relating to a fiduciary’s consideration of environmental, social and governance (“ESG”) factors when making investment decisions for plans subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). In response to the proposed rule (the “Proposal”), the DOL received several thousand comments, the vast majority of which opposed the new rule. Many plan sponsors and investment professionals voiced objection to the Proposal’s antipathy towards the consideration of ESG factors. In the Final Rule, the DOL generally softened its stance toward the consideration of economic ESG factors, but retained its opposition to the consideration of non-pecuniary ESG or other non-pecuniary factors. Continue Reading The Department of Labor’s ESG-less Final ESG Rule

ESG

On June 22, 2020, the United States Department of Labor (the “DOL”) submitted a proposed regulation (the “Proposal”) regarding the use of Environmental, Social and Governance (“ESG”) factors in selecting investments for plans subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). The Proposal generally cautions plan fiduciaries against considering ESG factors when making investment decisions, unless such factors are relevant to the plan’s pecuniary goals.

Interest in ESG-themed investments has surged in popularity in recent years. One 2020 survey showed that nearly 74% of global investors intend to increase their allocation to ESG-oriented ETFs. However, ESG-themed investments have also captured the attention of regulators, including the DOL. The Securities and Exchange Commission recently listed ESG investments in its list of examination priorities with respect to the accuracy and adequacy of disclosures in the marketing of such investments. In addition, President Trump issued an Executive Order on April 10, 2019, which included a section on ESG investments. The Executive Order required the DOL Secretary to complete a review of trends with respect to ERISA plan investment in the energy sector. Continue Reading DOL Proposed Rule Urges Caution Regarding the Use of ESG Factors When Selecting Investments for ERISA Plans

On June 2, 2020, the long-awaited carried interest proposed regulations were returned to the Office of Management and Budget (OMB) for a second round of review.  The OMB’s Office of Information and Regulatory Affairs (OIRA) previously completed its review of the proposed regulations on February 27, 2020 and the funds and alternative investments industry has been eagerly been awaiting their release ever since.  The reason for the additional round of OMB review is unknown, although the move suggests that changes to the previously-reviewed regulations may be forthcoming prior to their release.

A carried interest generally refers to a profits interest a partnership that is issued in connection with the performance of services.  The 2017 Tax Cuts and Jobs Act introduced a 3-year holding period requirement for carried interests in partnerships that engage in making and managing investments. Under the new rules, a partner generally must hold its interest for more than three years to qualify for long-term capital gain treatment.  The holding period requirement has applied for taxable years beginning after December 31, 2017.  However, practitioners and the private funds industry have been awaiting further guidance on several open questions as to how the three-year holding period applies, including in the context of REIT capital gain distributions and situations where the holding period for the partnership interest does not align with the partnership’s holding period for an underlying asset, the sale of which gives rise to carried interest. The Private Equity, Funds & Investment Management team at Mayer Brown will provide observations on the proposed regulations upon their release.

The Department of Labor’s recent pronouncement on the permissibility of investing 401(k) and other defined contribution plan assets in private equity has gotten wide-spread attention. Yet the guidance, which was issued in the form of an information letter, does not establish any new fiduciary principles, or provide any exemptions under the Employee Retirement Income Security Act of 1974 (“ERISA”). This blog discusses why the recent guidance is so significant and what it does and does not do. Continue Reading DOL Issues Guidance about Private Equity Investments in 401(k) Plans

On April 21, 2020, the US Securities and Exchange Commission proposed new rule 2a-5 under the Investment Company Act of 1940, as amended (the “Investment Company Act”), which is intended to address valuation practices and the role of the board of directors with respect to the fair value of the investments of an investment company or business development company registered under the Investment Company Act (each, a “fund”). Specifically, proposed rule 2a-5 would establish requirements in connection with the determination of fair value in good faith of fund investments for purposes of Section 2(a)(41) of the Investment Company Act, as well as permit a fund’s board of directors to assign this fair value determination to the fund’s investment adviser, subject to board oversight and certain other conditions.

A closer look at the key requirements under the proposal are described in the following Mayer Brown Legal Update:

SEC Proposes Valuation Rule for Registered Funds (authored by Peter McCamman, Adam Kanter, Leslie Cruz and Stephanie Monaco).

If you have any questions about the issues raised in this Legal Update or would like assistance with SEC regulatory or other related matters, please contact any of the above attorneys in our Investment Management practice.

On April 7, 2020, the U.S. Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (“OCIE”) issued two companion risk alerts on compliance with Regulation Best Interest and Form CRS. In the press release accompanying these risk alerts, OCIE stated that these alerts are intended to provide broker-dealers and investment advisers with advance information about the expected scope and content of the initial examinations for compliance with Reg. BI and Form CRS, both of which have an upcoming compliance date of June 30, 2020.

A closer look at issues raised in these risk alerts, along with certain takeaways, can be found in the following Mayer Brown Legal Update:

SEC’s OCIE Risk Alerts – Examination Focus on Compliance with Regulation Best Interest and Form CRS (authored by Marlon Paz, Stephanie Monaco, Kyle Swan with Leslie Cruz, Adam Kanter and Peter McCamman). 

If you have any questions about the issues raised in this Legal Update or would like assistance with SEC regulatory or other related matters, please contact any of the above attorneys or any member of our Broker-Dealer or Investment Management practices.