By Jaqueline M. Hummel, Managing Director

May 21, 2015

 On May 20, 2015, the SEC proposed some rule changes and amendments to forms that will require additional reporting and disclosure from investment companies and investment advisers. The bottom line is that the SEC wants to get more and better data in to analyze risk on a fund- and adviser-specific basis, as well as identify industry trends. At this point, these changes are only in the proposal stage, and there is a 60-day public comment period. Comments can be submitted electronically on the SEC’s website.

Amendments to Form ADV

Changes for Investment Advisers

The SEC is proposing amendments to Form ADV Part 1A to get more data on advisers, to improve the Commission’s ability to monitor risk. The amendments will provide the Commission with more information on separately managed accounts (including aggregate information on assets under management, investments and use of derivatives and borrowing). Additionally, the SEC is asking for information on advisers’ use of social media, branch offices and whether the adviser or some other entity is compensating the Chief Compliance Officer.

Other proposed amendments are aimed at establishing a more efficient method for the registration of multiple private fund adviser entities operating a single advisory business. There are also a few technical amendments intended to make the form easier to complete.

Separately Managed Accounts

The SEC wants to collect general information about ten broad categories of assets (e.g., exchange-traded equity securities and U.S. government/agency bonds) held in separately managed accounts. Advisers with at least $10 billion in regulatory assets under management may be required to provide this data both mid-year and year-end on an annual basis. The SEC would also like to request information about gross notional exposure, borrowings, and gross notional value of derivatives in separately managed accounts.  This reporting would be required for advisers managing at least $150 million in regulatory assets under management attributable to separately managed accounts, but all advisers to separately managed accounts would be required to provide information on the percentage of separately managed account assets held in derivatives.

The SEC is also requesting information on custodians. In the proposing release, the SEC has asked that advisers identify any custodians that hold at least ten percent of separately managed accounts regulatory assets under management, and the total amount of the adviser’s assets held at the custodian attributable to separately managed accounts.

Social Media, Additional Offices and the CCO

The SEC is proposing changes to Form ADV Part 1A, requesting that advisers provide information on websites used on social media platforms, such as Twitter, Facebook and LinkedIn.

The SEC will also be asking for information not only about an adviser’s main office, but also the total number of offices it uses to conduct business.  Additional information will be required for an adviser’s 25 largest locations, including the number of employees providing advisory services and the types of activities conducted in these offices.

More disclosure is also being requested about Chief Compliance Officers.  The SEC wants to find out if a firm’s CCO is compensated or employed by any person other than the adviser (or an affiliates), and to report the name and IRS employer identification number of that other person. In the proposing release, the SEC says “Our examination staff has observed a wide spectrum of both quality and effectiveness of outsourced chief compliance officers and firms. Identifying information for those third-party service providers … would allow us to identify all advisers relying on a particular service provider and could be used to improve our ability to assess potential risks.”

Specific Data about Clients, Accounts and Wrap Programs

The proposal also includes amendments to Item 5, of the Form ADV Part 1A, to provide more detail about a firm’s advisory business.  The SEC is requesting changes to the form to disclose:

• The actual number of clients and amount of regulatory assets under management attributable to each category of clients (currently only ranges are disclosed);
• The number of clients that an adviser provides advisory services to, but does not include in its regulatory assets under management;
• Whether an adviser reports assets in Form ADV Part 2A differently from regulatory assets under management reported in Part 1A;
• The regulatory assets under management attributable to all separately managed accounts that managed in parallel to a registered investment company;
• The adviser’s the total regulatory assets under management attributable to acting as a sponsor and/or portfolio manager of a wrap fee program, as well as SEC file number and CRD number for those wrap fee

Umbrella Registration

The SEC’s proposal also provides a better process for “umbrella registration”, for a filing adviser and one or more relying advisers, as allowed under the 2012 ABA letter. The SEC has limited this type of registration to a private fund adviser operating as a single business through multiple legal entities.  A new Schedule R would be added to the Form ADV Part 1A that would have to be filed for each relying adviser to provide identifying and ownership information.

The remaining amendments are technical in nature, and are meant to clarify areas where there have been frequent questions from filers.

Amendments to Investment Advisers Act Rules

The SEC is also proposing amendments to the books and records rules under the Advisers Act. Currently, advisers are only required to maintain records demonstrating the calculation of the performance or rate of return in any communication that is circulated to ten or more persons.

The Commissions is seeking to remove the “ten or more persons” condition and replace it with “any person.” According to the SEC, “[t]he veracity of performance information is important regardless of whether it is a personalized client communication or in an advertisement sent to ten or more persons.”

The SEC wants to amend Rule 204-2(a)(7) to require advisers to maintain originals of all written communications received and copies of written communications that relate to the performance or rate of return of any or all managed accounts or securities recommendations. Apparently this change is in response to In the Matter of Michael R. Pelosi, where the SEC brought a case against a portfolio manager for providing false and misleading portfolio performance returns in quarterly and annual letters to his clients. The case was ultimately dismissed, because there was insufficient evidence relating to the calculation of the performance data, either by the portfolio manager or his firm. Had this revised rule been in place, the SEC could have charged the portfolio manager and his firm with a failure to maintain required books and records, even if the fraud charge could not be proven.

There were also a few technical amendments to rules under the Advisers Act, and the withdrawal of transition Rule 203A-5. Basically these amendments would remove transition provisions where the transition process is complete.

Form N-Port

Changes for Investment Companies

Under the heading of “investment company reporting modernization,” the SEC is proposing two new disclosure documents from registered investment companies, Form N-PORT, a monthly portfolio reporting form, and Form N-CEN, a new annual reporting form. Form N-Port (which will replace Form N-Q) will require registered investment companies (except money market funds) to provide portfolio-wide and position-level holdings data to the SEC on a monthly basis.

Form N-PORT will have to be filed by registered investment companies (excluding money market funds and SBICs) and ETFs organized as unit investment trusts. The data on the Form N-PORT will be used primarily by the SEC, but only quarter-end reports will be made available to the public.   Additional information required includes:

• A fund’s complete portfolio holdings in XML format as of the end of the preceding month;
• A fund’s total assets, total liabilities, and net assets;
• Monthly return data;
• Data on inflows and outflows;
• Details of derivatives held by the fund, including net realized gain (or loss) and net change in unrealized appreciation (or depreciation); identification of counterparties, “delta”, and categories (e.g., forward, future, option).
• Details of repurchase agreements, reverse repurchase agreements, counterparty exposure, and over-the-counter derivative transactions;
• Risk metric calculations to measure a fund’s exposure and sensitivity to changing market conditions, such as changes in asset prices, interest rates, or credit spreads;
• Disclosure of a fund’s securities lending counterparties and aggregate value of all securities on loan;
• Disclosure of assets categorized as Level 1, 2 or 3 in the fair value hierarchy under GAAP. 

Changes to Regulation S-X

Regulation S-X describes the form and content of financial statements required in registration statements and shareholder reports. The SEC’s proposed amendments to Regulation S-X include:

• Standardized disclosures regarding the fund’s investments in derivatives (open futures contracts, open forward foreign currency contracts, swap contracts, written and purchased option contracts);
• Identification of illiquid investments;
• Disclosures related to fair value pricing of investments that are not readily marketable; and
• Information relating to a fund’s securities lending activities (including income and fees paid in connection with securities lending, and the monthly average of portfolio securities on loan).

The SEC has also proposed allowing mutual funds and other registered investment companies to provide shareholder reports via website, as well as the funds’ quarterly portfolio holdings for the past year. Currently, investors have to affirmatively request electronic delivery; otherwise funds must mail hard copies of shareholder reports. The proposed rule would allow investors to continue to receive paper copies via mail.

New Form N-CEN

The SEC is also proposing a new form, Form N-CEN, to replace Form N-SAR. This new form will be filed in XML format on an annual basis. All registered investment companies that currently file Form N-SAR will be required to file this new form. The form will be used to collect information about funds, including basic census-type information (such as fund name, filings number, address, website, location of books and records, fund directors, CCO), including:

• Information on any fund proxy votes during the reporting period;
• Disclosure about any material legal matters;
• Information about fidelity bond and errors and omissions insurance policy;
• Disclosure of any financial support received by the fund;
• Disclosure of any reliance on SEC exemptive orders ;
• Information about underwriters and independent public accountants;
• Information about accounting and valuation items (similar to that currently required by Form N-SAR);
• Disclosure relating to whether the independent account issued an unqualified opinion, and any material weaknesses found;
• Information on any NAV errors that led to payments to shareholders.  

Form N-CEN will also be requesting information on specific fund classes, fund performance and tracking error (for index funds), investment in certain foreign corporations and securities lending.