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 & Co’s quarterly recap of the latest developments at a variety of regulatory agencies likely to impact our clients.
PCAOB
Spotlight Issued for Auditors and Audit Committees
In August, the PCAOB issued a spotlight that serves as a resource for audit committee members to consider as they continue their ongoing engagement and discussion with their auditors. This resource outlines questions in various areas, including fraud and other risks, audit execution, auditor independence, IPOs and mergers and acquisitions, audit firms’ quality control systems and technology.
Impact: While the spotlight was directed to conversations between audit committees and auditors, committees should also address many of the topics with management to further their understanding of how these items impact the financial reporting process and related internal controls.
SEC
Adoption of Amendments to Modernize Fund Shareholder Reports and Improve Transparency in Fund Advertisements
In late October, the SEC issued a final rule that changes the way mutual funds and ETFs report to their shareholders. The new requirements add a layered approach, requiring “concise and visually engaging” semi-annual and annual shareholder reports.
Every fund will be required to produce an individual shareholder report that contains the following, among other items:
- Fund name and class
- Ticker symbol
- Statement of material changes
- Expense example
- Management’s discussion of fund performance
- Fund statistics, including net assets, total number of portfolio holdings, portfolio turnover and total advisory fees paid
Furthermore, the report described above will need to be produced for each unique fund in a fund family (each series of a registrant is required to report separately) and for each share class individually.
Other amendments within the new rule include:
- Historical information included within the NCSR filings is still required and will be filed with the SEC, as well as available electronically. In addition, open-end funds will now be required to tag the information using Inline eXtensible Business Reporting Language (XBRL).
- Open-end funds are now mandated to mail paper copies of shareholder reports to investors, unless the investor has consented to electronic delivery.
- All fee and expense information in advertisements must be consistent with the expense information provided in the prospectus fee table.
The rule becomes effective 60 days after being published in the federal register. However, for most of the requirements, funds will have 18 months from the effective date to become compliant.
Impact: This rule has been two years in the making and substantially changes the content and volume of shareholder reporting. The goal is to allow retail shareholders to better understand and compare the performance of their various fund investments.
Proposed New Oversight Requirements for Certain Services Outsourced by Investment Advisers
Also in October, the SEC issued a proposal that would require investment advisers to perform a minimum amount of due diligence on potential vendors before hiring them to perform certain services. In addition to the requirement to perform initial due diligence, if made effective, the proposal would also require advisers to perform ongoing due diligence to help ensure vendors are meeting certain performance standards.
Covered services under the proposal are defined as those that:
- Are necessary to provide advisory services in compliance with federal securities laws; and
- If not performed (or performed negligently), would be reasonably likely to cause a material negative impact on the adviser’s clients or on the adviser’s ability to provide investment advisory services.
Clerical, ministerial, utility and general office functions are types of services specifically excluded in the proposal.
The comment period for the proposal is open through December 27, 2022.
Impact: While there are many operational reasons an investment adviser would outsource services, there is a risk that investors could be harmed in doing so. This proposal seeks to reduce that risk by requiring advisers to perform a reasonable amount of diligence prior to engaging outside vendors. It is likely that many advisers are already complying with such requirements, and, therefore, this proposal would not have a significant impact on their business.
Proposed Enhancements to Open-End Fund Liquidity Framework
Most open-end mutual funds are required to classify their investments into four categories, based on the underlying liquidity of each issuance. In early November, the SEC proposed amendments to its liquidity reporting rules, with the goal of enhancing liquidity classifications by requiring minimum standards to be used in the analysis. The SEC hopes that implementing these rules will protect investors in stressed market conditions by providing more transparency in liquidity reporting.
Also included in the proposed amendments is the required use of swing pricing. Swing pricing is a mechanism through which a fund would adjust its NAV per share so the costs a fund incurs in meeting subscription and redemption requests would be passed on to the shareholders engaged in that activity. To help ensure operational feasibility of swing pricing, the commission also included the requirement of a “hard close” in the proposed amendments, allowing funds to only accept shareholder orders until the timing of that fund’s daily pricing (typically 4 p.m. EST).
The comment period for the proposal is open for 60 days after publication in the federal register.
Impact: The proposal stems from investor response and market volatility at the onset of the COVID 19 pandemic. While there will always be, in most cases, an inherent mismatch in structural liquidity of a fund and potential shareholder redemptions, the proposal aims to minimize those instances and provide more protection for investors. Similarly, the swing pricing amendments use proposed cost apportionment to protect investors who elect to remain in a fund. Both proposals seem to carry a somewhat significant increased burden to fund administrators.
Contact Julie Lowry at jlowry@cohenco.com or a member of your service team to discuss this topic further.
Cohen & Co 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.
