Compliance Matters Q3 2021

Oct 21, 2021

Curated for compliance officers of mutual funds and investment advisers, please find summaries and links to headlining compliance and regulatory topics from the third quarter of 2021.

It appears that Chairman Gary Gensler is hitting his regulatory stride, and rulemakings are percolating from an ambitious regulatory agenda staked out at the beginning of his term. While Commissioners have issued dueling public statements and speeches addressing ESG regulation, the SEC issued a proposed proxy rule amendment that would, among other things, address voting on ESG matters. The SEC also seeks to address digital engagement practices, and it issued guidance on principal and cross trading and has brought some interesting enforcement actions, and even Congress, FINRA, and Nasdaq have been getting in on the regulatory action. Below are highlights of the regulatory activity and related commentary on how this may impact advisers and funds.

SEC Proposed Rules

Proposed Amendments to Form N-PX and other Proxy Disclosures

The SEC is proposing to amend proxy voting disclosure rules. If passed, the amendment would impact how registered funds report their proxy votes on Form N-PX. The goal is to require categorizing each voting matter (and using structured data) so that investors can identify and compare voting records on issues that interest them. The proposal includes standardized descriptions of 17 voting categories to facilitate shareholders tracking specific voting categories such as votes related to the board of directors, extraordinary transactions, say-on-pay, shareholder rights and defenses, and environment or climate, among others. The rule also would require disclosure on how securities lending impacts voting, particularly if an investment adviser that has lent shares does not recall the shares to exercise voting rights. Under the proposal, institutional investment managers (i.e., those with discretion over $100mm in equities under section 13 of the Exchange Act) also will have to report on Form N-PX how they voted on proxies related to executive compensation (i.e., “say-on-pay” votes). This feature of the proposal would fulfill one of the remaining rulemaking mandates under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rule also would require funds to post their proxy voting records on their websites.

This proposal is designed to enhance shareholder disclosure. Some argue, however, that the proposal prioritizes ESG (environmental, social, and governmental) disclosure and exposes advisers to political pressure in their voting rather than promoting the economic interests of shareholders. These arguments likely will feature in a fierce debate about a topic, proxy voting, that ordinarily would not garner much attention. And it likely will prove only one front in a larger regulatory war over ESG’s place in investment advice. (Indeed, the Department of Labor recently proposed a rule to remove barriers, imposed under the prior presidential administration, that restricted plan fiduciaries’ consideration of non-pecuniary ESG factors when considering investment options and proxy voting for retirement plans. The proposal also should be considered in the context of a flurry of Commissioner speeches and public statements, as well as last quarter’s Divisions of Examinations risk alert, concerning ESG investing.) Thus, we expect that an otherwise fairly mundane rule proposal will attract a great deal of interest in the comment process. Comments will be due 60 days from the time the proposal is published in the Federal Register.

For more information about the SEC’s proposal, please visit the SEC’s website at the link below; DOL’s proposal also can be found in the Federal Register:

Request for Comment Concerning Digital Engagement Practices and “Gamification” of Investing

The SEC is requesting information and public comment with respect to the use of “digital engagement practices” (DEPs) by broker-dealers and investment advisers. These tools include, among other things, behavioral prompts and game-like features (referred to as “gamification”), as well as other design elements or features designed to engage with retail investors on digital platforms such as websites and mobile applications. Essentially, the SEC is reacting to gamification in trading, such as the widely-publicized run-up of so-called meme stocks and other robo-adviser marketing practices. This release is a prelude to potential rulemaking in the area. Although it may not bear directly on investment companies, fund boards and advisers should be mindful of potential regulatory scrutiny as they look for innovative ways to drive distribution. Responsive comments were due by October 1, 2021, but there likely will be continued debate on this in the context of a new report from the SEC studying the frenzy surrounding the rise of Gamestop and other meme stocks.

For more information about this release, and to view the SEC’s recent report, please visit the SEC’s website:

SEC Guidance and Alerts

Risk Alert: Principal and Cross Trading of Fixed Income Securities

In a follow-up to a 2019 risk alert on the same topic, the Division of Examinations has published a new alert on principal and agency cross trading. The new alert, which focuses on fixed-income securities, provides more detail than the previous one and, unfortunately, suggests that there are still a lot of violations. The key findings are as follows:

  • Policies and procedures must be consistent with actual practice. This includes confirming that cross trades were completed consistent with disclosures and appropriate consent (for principal transactions) has been obtained.
  • Policies and procedures often do not provide sufficient guidance to personnel to know what is required for compliance. Procedures should specify factors relevant to determining client best interest (and should provide space in reports to document that rationale). For example, when procedures specify that advisers should obtain multiple quotes, there should be corresponding guidance on which value to use when quotes differ. As determining best interest is the touchstone of a valid cross trade, advisers should memorialize the reasons for cross trading.
  • Policies and procedures are not being tested. The staff expects that some testing be done, such as having the adviser analyze trade blotters to identify unreported cross trades. This should be done at least annually.
  • Conflicts of interest should be avoided. This is largely the function of advisers’ failure to use independent prices and best execution, or adding prohibited markups. As a general rule, funds should not be engaged in any cross trades unless there is a market price. For fixed income, advisers traditionally have sought at least three independent quotes to demonstrate market prices, but Rule 2a-5’s modification of the definition of “readily available market quotations,” which impacts the cross-trading rule (17a-7), has cast doubt on that practice once compliance with Rule 2a-5 is required in September 2022.
  • Written disclosures must be clear. Form ADV requires disclosures regarding conflicts, and advisers should consider additional disclosure in advisory agreements and client communications.

As this is the second risk alert on the topic, and Rule 17a-7 is in the crosshairs (by virtue of the new valuation rule 2a-5), we would expect examiners to continue to focus on this area. Accordingly, if an adviser engages in any cross trading (or your policies at least allow it), you should be sure to review the adviser’s policies in light of this alert.

For more information, please visit the SEC’s website:

Other Legislation and Rules

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