Thursday, May 21, 2015

SEC Proposes New Disclosure by Investment Companies and Investment Advisers

By Jacquelyn Lumb

The SEC commissioners yesterday unanimously approved proposals to increase the transparency and modernize the reporting requirements for investment companies and investment advisers. In opening remarks, Chair Mary Jo White noted that the SEC oversees more than 28,000 funds and investment advisers, with assets of registered funds exceeding $18 trillion and assets managed by registered investment advisers exceeding $62 trillion. Given the advancement of new product structures and investment strategies, White last December outlined a number of initiatives to address the risks that may arise from evolving portfolio compositions and fund operations. The proposed reforms will help the SEC identify and monitor evolving risks that could threaten the stability of the U.S. financial system, according to White, and will complement the efforts of the Financial Stability Oversight Council with respect to systemic risks.

New forms, enhanced disclosure. The Investment Company Act reforms would include a new Form N-PORT, which registered funds other than money market funds would file monthly to report portfolio-wide and position-level holdings. The disclosure would include data relating to the pricing of securities and the terms of derivatives contracts. Funds also would be required to disclose information about repurchase agreements, securities lending activities, and counterparty exposures. New disclosure about discrete portfolio-level and position-level risk measures would provide transparency about funds’ exposure to changes in market conditions.

Form N-PORT would be available to the public, so the SEC will consider rescinding Form N-Q on which funds currently report their portfolio holdings for their first and third quarters.

Registered funds would report annually on a new Form N-CEN which would replace current Form N-SAR. The disclosure requirements would be updated and streamlined to include more information about exchange-traded funds and securities lending. The reports would be filed within 60 days of the end of the funds’ fiscal years rather than semi-annually as currently required for most funds.

The portfolio and census information would be disclosed in a structured data format to make it more efficient to aggregate and analyze. The proposal would also standardize the disclosure in the financial statements included in fund registration statements and shareholder reports.

Website posting of reports. Under the proposal, mutual funds and other registered investment companies would have the option of providing shareholder reports and the past year’s quarterly portfolio holdings on their websites. Shareholders would continue to have the option to receive paper copies of the shareholder reports. Aguilar suggested that the SEC should proceed with this option with caution, given its experience with the e-proxy rules and based on investor research, which has shown a decline in retail investor participation in the proxy voting process after the adoption of the electronic filing rules.

Investment adviser amendments. The proposed investment adviser amendments would include changes to Form ADV to require additional information about advisers’ risk profiles. The new disclosure requirements reflect issues the staff has identified since the last changes to Form ADV in 2011. In particular, the SEC would require aggregate information about assets held and the use of borrowings and derivatives in separately managed accounts. White noted that 73 percent of registered investment advisers manage a wide variety of client assets in separately managed accounts, through which they provide individualized investment advice and direct ownership of the securities and other assets in the accounts. She said the SEC must have the ability to assess the potential risks in these arrangements.

Umbrella arrangements. The SEC also proposes to codify staff guidance that permits certain umbrella registration filing arrangements. The guidance has allowed advisers to private funds that are separate legal entities to organize as a group of related advisers under a single umbrella and operate as a single advisory business. They may file a single Form ADV as long as certain conditions are met.

Books and records. The proposal also would amend Rule 204-2 to require advisers to maintain records on their calculations of performance. Advisers currently must maintain this information if it is distributed to 10 or more persons, but under the proposal it would require the information to be kept if it is distributed to anyone. Advisers also would be required to maintain communications with respect to the performance or rate of return of accounts and securities recommendations.

Commissioners’ remarks. Commissioner Daniel Gallagher said he particularly appreciated the inclusion of a scaled compliance period to give smaller funds more time to comply with the rules, if adopted.

Commissioner Michael Piwowar, while supporting both proposals, raised two concerns. First, funds would have to include in Form N-PORT and N-CEN the legal identifier assigned or recognized by the Global LEI Regulatory Oversight Committee, he explained, which could result in the SEC helping to establish a monopoly for the provision of legal identifiers.

Second, he was concerned about the requirement to disclose in Form N-PORT, in connection with derivative instruments, the components of an underlying reference index if it is not already publicly disclosed on a website. Some index providers may not be willing to make this disclosure public, he explained, which could negatively impact funds that make these investments and the index providers.

The comment period on both proposals will be open for 60 days.

Additional initiatives. White noted that the staff is also developing recommendations to enhance the management and disclosure of liquidity risk by mutual funds and ETFs, and to update their liquidity standards. In addition, the staff is considering requirements for the use of derivatives by funds which may include limits to the leverage the derivatives may create. The staff also may recommend new requirements for stress testing by large investment advisers and large funds, and provisions for transition plans in the event of a major disruption of an adviser’s operations.

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