Investment Industry Wire | July 2020– July 21, 2020 by Julie Lowry

The pace and intricacies of regulatory change in the investment industry are, at times, nothing short of overwhelming. Yet, organizations in this space need to have a clear understanding of evolving regulations, their timing and overall impact.

To help you stay up to date, below is Cohen & Company’s quarterly recap of the latest developments at a variety of regulatory agencies.

Securities & Exchange Commission (SEC)

Items Impacting Boards of Directors

  • In-person meetings. At the onset of COVID-19 in the United States, the SEC issued leniencies with regard to the format of board meetings, no longer requiring the meetings to be in person. The SEC initially provided the relief through June 15 but later extended it through December 31, 2020.

Impact: Although we miss seeing our clients in person, we believe most board meetings will continue to happen virtually at least until 2021.

  • Fair valuation practices. During the last quarter, the SEC proposed Rule 2a-5a: Good Faith Determinations of Fair Value under the Investment Company Act of 1940. It’s been 50 years since the SEC conducted a major overhaul on fair valuation practices and the role of the board for investment companies. This proposed rule is the culmination of SEC outreach and speculation designed to provide boards and investment advisors of registered investment companies with a consistent, modern approach for the determination of fair value when securities do not have readily available market quotations.

The proposed requirements surrounding determining fair value in good faith include:

  • Assessing and managing material risks associated with fair value determinations, including material conflicts of interest, such as the use of affiliated broker quotes;
  • Establishing, applying and testing fair value methodologies; and
  • Overseeing and evaluating pricing services used.

Previously, the board was not officially allowed to delegate the responsibility of fair value to the advisor or sub-advisor(s), and took ultimate responsibility with respect to fair value. Under the proposed rule, the board would now be allowed to assign the determination of fair value to the fund’s investment advisor, provided that:

  • The board oversees the fair value process at the advisor;
  • The board receives periodic and prompt reporting on fair value determinations from the advisor, which are to include: material valuation risks, material changes to or material deviations from approved methodologies, testing performed, resources used, pricing services used and the results of back-testing;
  • Clear responsibilities and reasonable segregation of duties exist among the advisor’s personnel; and
  • Additional documentation surrounding the delegation of such responsibilities to the advisor is retained.

If the board assigns the fair determinations to the advisor, the advisor would need to approve and adopt fair value policies and procedures, subject to board oversight under rule 38a-1. In such cases, the proposed rule would also require the advisor to establish and formalize a process for the approval, monitoring and evaluation of each pricing service provider.

The comment period on this proposal is open through July 21, 2020.

Impact: Many of the proposed requirements are currently common practice in the industry, so the proposed guidance simply formalizes what many investment companies are already doing.  If adopted, we would not expect to see significant changes for most fund companies.

>> Read more in “SEC Proposes Rule to Modernize Fund Valuation Practices”

Financial Reporting & Disclosure Considerations

  • Disclosure reminders. The SEC issued a staff statement in April to remind investment companies to consider the potential impact of COVID-19 on the investment company and its portfolio when drafting disclosures, particularly risk disclosures, within a fund’s prospectus and financial reports. The PCAOB issued similar reminders to auditors, as items to consider when completing audits during the COVID-19 pandemic.

Impact:  While the overall severity of COVID-19’s impact on the economy is unknown, it is important for funds to be conservative in their risk disclosures to shareholders; auditors must consider the impact a declining economy may have on the financial statements and potential audit risks.

  • Business acquisitions and dispositions. In May, the SEC issued final rules surrounding the filing and disclosure requirements for business acquisitions and dispositions. In doing so, the commission created new Regulation S-X Rule 6-11, which is specific to investment companies and business development companies, and outlines differences between those companies and other industries covered in the guidance. The new rule is effective January 1, 2021 (early adoption permitted). Some of the main provisions include:
    • In determining whether the financial statements of the acquired fund need to be filed with the SEC, the acquired fund would need to meet the definition of a “significant subsidiary.” A “significant subsidiary” is one that meets one of the following tests:
    1. Investment Test: The fair value of investments of the acquired fund exceeds 20% or more of the fair value of investments of the acquirer (with subsidiaries);
    2. Income Test: The absolute value of the sum of investment income, realized gain/loss, and unrealized gain/loss of the acquired fund exceeds 10% of the change in net assets from operations of the registrant and 5% of the fair value of investments (the Investment Test described above, but with a lower threshold)
    • The financial statements of the acquired fund would only need to be filed once with the SEC.
    • If acquired funds, when accumulated, exceed either test at the 50% level, financial statements of all acquired funds must be filed.
    • Instead of providing pro-forma information relating to the acquisition, investment companies now will be required to file supplemental information, including a comparative before-and-after fee table for each fund and the combined entity; a narrative description of differences in accounting policies between the registrant and the acquired fund; and, a modified schedule of investments for the acquired fund, if the acquired fund’s portfolio of investments would change materially because of investment restrictions of the registrant.

Impact: These amendments are intended to improve transparency and comparability surrounding the information provided to investors for acquisitions and dispositions, and to reduce the complexity of disclosures provided. Not only does this new rule include many updates within the guidance for investment companies, it also rectifies issues with inconsistencies that historically have existed amongst the various rules registrants have to comply with surrounding reporting and disclosure when fund acquisitions or dispositions take place.

Commodity Futures Trading Commission (CFTC) and National Futures Association (NFA)

No-Action Letter on Treatment of Loans under Paycheck Protection Program
On April 22, 2020, the CFTC issued a no-action letter relating to the treatment of loans received by futures commission merchants (FCM) and introducing brokers (IB) under the Paycheck Protection Program in meeting their net capital requirements. The no-action position allows for FCMs and IBs to add forgivable expense amounts back to their calculations of net capital, so long as the following criteria are met:

  1. The FCM or IB includes a covered loan as a liability on its balance sheet, and the amount of the add-back to net capital cannot exceed the amount of such liability;
  2. The add-back is included on line 3070 of the Statement of the Computation of the Minimum Capital Requirements with the applicable Form 1-FB; or, if filing a FOCUS Report in lieu of Form 1-FB, on line 3525 of the FOCUS report; and
  3. The FCM or IB retains documentation of the basis of the add-back amount, including a record of its computation of the forgivable expense amount, a record of costs and payments making up that amount, and a record of any estimate of the limits under 1106(d) with a basis for such estimate.

In conjunction with this announcement, the NFA released a notice to its members on April 23, 2020, indicating that any FCM or IB in compliance with the terms of the CFTC’s no-action letter outlined above will also be deemed in compliance with applicable NFA rules surrounding net capital computations and requirements under Sections 1 and 5.

Impact: Much like the SEC relief discussed earlier, this is another good example of industry organizations working to recognize the impact COVID-19 may have on constituent members and helping them realize the benefits of various government programs, while remaining compliant with regulatory requirements.

Public Company Accounting Oversight Board (PCAOB)

New Board Inspection Report Template
As many are aware, the PCAOB paused on issuing inspection reports for 2018, as they embarked on a project to change their format. Finally, the time has arrived, and with the new format in place the PCAOB has been issuing 2018 reports, along with an excerpt explaining the changes and how to understand the new template.

Impact: As a result of the finalization of the new format, we expect our firm’s final 2018 inspection report to be issued in the near term. Speak with your Cohen & Company engagement team about the status at your next opportunity.

Crypto asset questions for audit committees. In-line with its strategic objectives, the PCAOB monitors the development and implementation of emerging technologies to analyze their implications to audit quality. As a result of a recent increase in the use of crypto assets across issuers, including material crypto asset transactions observed during inspections, the PCAOB identified the need for auditors and audit committees to focus more on identifying and assessing the risks of material misstatement to financial statements related to crypto assets, and on planning and execution of an appropriate audit response. In response, the PCAOB issued a “Spotlight” in May 2020 with information for auditors and audit committees, providing sample questions audit committees may want to ask their auditors. These questions include:

  • What is the experience of the engagement partner and other senior engagement team members with crypto assets?
  • Would the firm be able to supplement the engagement team’s expertise if necessary, such as by engaging relevant specialists?
  • What is the auditor’s understanding of the technology underlying the issuer’s crypto asset-related activities?
  • Are specialized technology-based audit tools needed to identify, assess and respond to risks of material misstatement?
  • What is the auditor’s understanding of the legal and regulatory implications of the issuer’s crypto asset-related activities?
  • How does the audit firm monitor auditor independence considerations associated with audit engagements involving crypto assets?
  • What policies and procedures does the audit firm have regarding conducting and monitoring audit engagements involving crypto assets, including considering the risks associated with performing such audits?

ImpactThe PCAOB regularly issues guidance for audit committees to assist in their role of financial reporting oversight. Most times, this guidance is in response to changes in the evolution of today’s business operations environment. See other information for audit committees here.

Contact Lori Novak at or Julie Lowry at or a member of your service team to discuss these topics further.

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Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.