The outbreak of the coronavirus (COVID-19) continues to impact markets and business operations in unprecedented ways, which presents risks and opportunities to investment advisers and fund managers. This client alert provides:
- A summary of the temporary relief granted by the Securities and Exchange Commission (SEC) to date, including exemption from certain in-person requirements and extensions of several filing and delivery deadlines; and
- A summary of priority areas for focus and attention for investment advisers and fund managers in the current crisis.
I. SEC Temporary Relief Granted
On Friday, March 13, 2020, the SEC issued two orders providing temporary relief to investment advisers and investment companies from certain filing, disclosure delivery and governance requirements. Each of these grants of relief is conditioned on, among other things, whether a firm experiences actual COVID-19-related issues requiring the relief and notice of such to the Division of Investment Management (except in the case of in-person board meeting relief).
- Investment Company Act Relief1
- In-Person Board Approvals—Until June 15, board approvals requiring in-person meetings may be made in a meeting via “any means of communication that allows all directors participating to hear each other simultaneously during the meeting.” This relief applies to renewals of contracts (including material changes), plans or arrangements under Section 15(c) or Rules 12b-1 or 15a-4(b)(2), as well as the selection of a fund’s independent public accountant pursuant to Section 32(a). This relief applies to board meetings held between March 4 and June 15, 2020.
- Forms N-CEN and N-PORT—From March 13 until April 30, a 45-day filing extension for registered funds filing Form N-CEN and Form N-PORT.
- Annual and Semiannual Reports—From March 13 until April 30, a 45-day extension for registered funds on the required transmittal of annual and semi-annual reports to unitholders.
- Form N-23C-2—From March 13 until June 15, relief from the 30-day notice requirements for closed-end funds and BDCs for calls or redemption of fund units.
- Prospectus Delivery—From March 13 until April 30, a 45-day extension of the prospectus delivery requirement for share purchases of registered funds, provided a) that the purchase of shares to the investor was not an initial purchase by the investor and b) the fund’s website has a link to the current prospectus and states the reasons why delivery cannot be made.
- Investment Advisers Act Relief2
- Form ADV—From March 13 until April 30, a) for registered advisers, a 45-day extension to file amendments to Form ADV and, under Rule 204-3(b)(2) and (b)(4) related to the delivery of Form ADV Part 2, to existing clients; and b) for exempt reporting advisers, a similar extension to file reports on Form ADV under the requirements under Rule 204-4.
- Form PF—From March 13 until April 30, for registered advisers, a 45-day extension to file Form PF as required by Section 204(b) and Rule 204.
II. Priority Areas for Ongoing Focus and Attention
- Business Continuity Procedures (BCP)—While the SEC never adopted its 2016 proposed rule3 that would have required registered investment advisers to adopt comprehensive BCPs, there is a clear expectation that firms maintain robust BCPs. Indeed, BCPs are already a focus for SEC examinations and the SEC Staff’s focus is likely to increase in light of the COVID-19 events. Firms should closely examine the effectiveness of their current BCPs for pandemic-induced disruptions in operations and markets. If real-time adjustments or deviations are necessary, document the reasons for those deviations and update the firm’s written BCPs as promptly as possible.
- Liquidity Risk Management—Liquidity management is a priority in disrupted markets, particularly for daily liquid funds. Firms should review their liquidity stress test models and assumptions (i.e., redemption scenarios) against current market realities. Certain less liquid asset classes may need to be reevaluated against registered funds’ liquidity classification buckets. Some asset classes (e.g., senior bank loans) may experience significant liquidity disruptions, which can result in the need to activate lines of credit or, in the case of private funds, the need to implement redemption gates. Fund managers should implement liquidity risk management measures reasonably designed to ensure that all clients are treated fairly, and that available liquidity is not afforded only to the clients that run for the exit first.
- Valuation, Pricing Vendor Oversight and Fair-Value Decision Making—Firms need to pay particular attention to valuation and related policies and procedures for less liquid, thinly traded or hard-to-value securities. Oversight of pricing vendors should be a real priority, especially pricing vendors providing evaluated bond prices. If a fund manager knows that a vendor’s evaluated price for a bond is not accurate, the manager has an obligation to challenge the vendor’s price and, in appropriate circumstances, make a fair-value determination to override the vendor’s price. As is always the case with valuation overrides, it is important to maintain a clear record of the rationale for that decision. SEC examinations following the crisis are likely to focus on this area.
- Side-by-Side Management, Trade Allocation and Cross-Trades—Investment advisers need to pay close attention to the conflicts of interest that are inherent in managing proprietary money alongside client accounts and potential conflicts of interests associated with managing client accounts of different size or significance. Fairly allocating available market liquidity to all selling client accounts is paramount, given the potential for such decisions to be second-guessed by clients and regulators in hindsight. Unusual deviations from or exceptions to a firm’s trade allocation policy and procedures deserve prompt attention from compliance and legal personnel. Also pay particular attention to any unusual cross-trading activity as well as compliance with the firm’s cross-trade policy and procedures.
- Counterparty Credit Monitoring—It is important for investment firms to proactively monitor their trading counterparties for credit deterioration and downgrades. Although the advent of derivatives clearinghouses and other protections resulting from the Dodd-Frank market reforms have decreased counterparty risk in some ways, those reforms have not eliminated the risk of counterparty defaults. In the context of institutional mandates, investment advisers should pay close attention to counterparty credit restrictions in investment management agreements and proactively manage within those restrictions to avoid client disputes and potential liability for counterparty failures.
- Breaches of Investment Guidelines Resulting From Market Moves and Downgrades—It is important that investment advisers closely monitor downgrades or changes to ensure that their client portfolios remain in compliance with required investment guidelines in this changing market environment. To the extent that proactive steps can be taken to avoid breaches, they should be taken. If a breach is a “passive” one resulting from market movement or downgrades, prompt action should be taken to remedy the breach. In the institutional context, it is important that managers communicate to their clients the steps they are taking in this regard.
- Monitoring of Service Providers—Firms need to closely monitor the ability of operational service providers such as custodians, administrators, and outsourced middle-office, back-office and risk management providers to continue to perform. As many service providers implement mandatory remote work practices, service levels may come under stress. Pay particular attention to service providers performing regulatorily required functions such as accounting agents, administrators that strike daily NAVs for mutual funds and ETFs, and fulfillment vendors for delivery of prospectuses for registered funds (but see above regarding temporary relief from prospectus delivery requirements).
- Updating Risk Disclosures—Fund managers should confirm that their existing investment risk disclosures accurately reflect the investment risks that a fund is experiencing, or update them as appropriate. In particular, firms should identify risks previously described in a prospectus or offering documents in hypothetical terms that have manifested or that have recently become a “principal investment risk” but to date have not been described as such. Recent SEC enforcement actions regarding risk factor disclosures in the corporate context4 highlight the need to update disclosure when material changes have occurred. Some mutual fund families have filed “temporary” prospectus stickers noting that the current COVID-19 crisis may impair a fund’s ability to meet its investment objective.
- Communications With Distribution Partners—Many mutual fund and ETF distribution agreements contain provisions requiring fund managers to alert the distribution partners to material changes in a fund’s investment process or operation. In certain cases, a fund’s adviser (and principal distributor) can have contractual liability for investor losses if a distribution partner is not made aware of material developments. Fund managers need to understand and manage their obligations to inform distribution partners of material changes in a fund’s operations or investment process.
We will provide further updates on the process for claiming the SEC filing extensions noted above, and we will continue to monitor events and provide updates as warranted.