Category: SEC News

Real Estate Fund Information from the SEC

The Securities and Exchange Commission has been acquiring troves of data about private funds through the Form PF filing requirement. Some, including myself, have been skeptical that the SEC will figure out what to do with the data as a tool to protect investors. But, the SEC has been able to compile statistics and published a suite of new data and analyses of private fund statistics and trends. The SEC released the third quarter private fund statistics.

The number of real estate funds reporting on Form PF has increased.
The number of real estate funds reporting on Form PF has increased.

period 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3
Funds 1,802 1,800 1,801 1,806 2,056 2,093 2,091 2,108
Advisers 262 263 264 265 288 290 288 290
Net NAV ($billions) 280 280 281 319 323 323 323 323

The rise from 1802 to 2108 in advisers is a big increase. There is only a small rise of 52 from the end of 2015 to the end of the third quarter in 2016. It’s the larger multi-platform Form PF filers who file quarterly.

Pure real estate fund advisers are only filing quarterly. Given that, I didn’t expect to see much change intra-year, and that held true.

There is a wealth of information in the SEC’s report. I’m still looking for some trends.
Sources:

The SEC Is Making Room For A New Regulation

Although is questionable whether the Securities and Exchange Commission is subject to President Trump’s executive order calling for a reduction in the number of regulations, the SEC seems to be taking it to heart.

Last week, Congress started the push to roll back the Extraction Disclosure Rule. This week, the SEC is looking to roll back the pay ratio disclosure rule.

The SEC is short-handed. Acting SEC Chair Michael Piwowar asked SEC staff to reconsider implementation of the rule. The pay-ratio rule mandates companies to disclose median worker pay and compare it with CEO compensation. This product of Dodd-Frank is supposed to put pressure on corporate boards to slow pay increases for CEOs.

The argument against is that is a costly to implement and not valuable to shareholders.

Unlike the Extraction Disclosure Rule, the Pay Ratio Rule was not implemented in the window subject to the Congressional Review Act. The SEC cannot rely on Congress to repeal the rule for them.

For the SEC to make changes, it has to create a new rule-making process and open to comments on changing the rule. Repealing the rule would put the SEC at odds with the Congressional mandate in Dodd-Frank to create the rule. That seems an untenable position to take.

Since the SEC is currently subject to three vacancies, it’s unlikely that anything will happen until Jay Clayton is approved by the Senate as the new Chair. That would likely mean two votes in favor of killing or maiming the rule, to one likely opposed.

According to the President’s executive order, the SEC has identified two rules to be repealed. That means it can now roll out a new regulation. Wonder what it will be?

Sources:

The New Supreme Court Pick and Private Funds

Justice Scalia died last year and replacing his position has been held up by partisan politics ever since. President Trump has made his pick, federal appeals court judge Neil Gorsuch from the 10th Circuit, and the confirmation battle has begun.

Being very liberal on social issues, I’m disappointed that the Senate chose not consider President Obama’s pick for the vacancy. We’re now faced with a justice who is likely to cause an erosion of some of the liberal gains we have seen on social issues.

But Compliance Building is about compliance so I quickly looked for some of judge Gorsuch’s opinions involving the Securities and Exchange Commission or private funds. I didn’t find much.

In ACAP Financial v. US SEC (2015), Judge Gorsuch wrote the opinion upholding an SEC penalty levied against the appellants for failing to take sufficient steps to guard against the firm’s involvement in the unlawful trading of unregistered shares. I found the writing to be very clear and easy to read. It lacks the ponderous rhetoric of many court opinion.

The decision is an easy one to find in favor of the SEC, so it does not offer much insight. The appellants did not argue their liability, but merely disputed the remedy imposed. The remedy was one proscribed for “egregious” behavior and they argued that their behavior was not “egregious.” The judge goes on for ten pages shooting down the appellants’ arguments, none of which even come close.

Gorsuch’s 10th Circuit is responsible for the Bandimere decision that recently struck down the SEC’s current system of administrative law judges. That put the 10th Circuit in opposition to other appeals courts, setting up a potential clash at the Supreme Court. However, Judge Gorsuch was not one of the appellate judges on the Bandimere case.

Let me know if you find any other cases from Judge Gorsuch that are relevant to private funds, compliance or the SEC.

Sources:

Add One, Take Two Away

Prior to his inauguration, President Trump promised a 75% reduction in regulations. I was left scratching my head about what he meant. Did he want the Code of Federal Regulation to be 75% shorter? How do you decide where one regulation begins and another starts? What about statutes enacted by Congress that specifically mandate the promulgation of new regulations? Isn’t repealing a regulation itself a new rule-making?

President Trump followed up on the promise and issued a new executive order. Whenever an agency publicly proposes a new regulation, it must identify at least two existing regulations to be repealed.

Additionally, the order requires the net incremental cost for fiscal 2017 to “be no greater than zero.” The cost of new regulations should be offset by existing rules that will be rescinded. I assume this add one, take away two is being put in place to achieve his 75% promise.

It looks like Dodd-Frank is the biggest target. I’m not sure the executive order will do it. Dodd-Frank mandated many new regulations. Repealing those regulations would seem to require an act of Congress.

I focus on the Securities and Exchange Commission, so I decided to take a closer look at the executive order. First up is what was meant by regulation.

“For purposes of this order the term “regulation” or “rule” means an agency statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy or to describe
the procedure or practice requirements of an agency…”

Wow.

I think this executive order could affect not only the promulgation of new rules, but could also affect staff guidance. I think a rule-making is general applicability and guidance is particular applicability. That could affect information updates and staff guidance. Could it even affect no-action letters? I think you can read it that way. Ultimately, it will be the SEC commissioners interpretation of the executive order that matters.

Of course, there is the argument that the SEC is an independent agency and not subject to the executive order. The order itself states that it applies to each “executive department or agency.”

Regardless of whether the order applies, President Trump has lesser power to fire the commissioners on the SEC so they may chose to ignore the executive order. Or they may embrace the concept and begin de-regulating.

Sources:

The New Administration’s Pick for the Chair of the SEC

Wall Street lawyer Jay Clayton is slotted to head the U.S. Securities and Exchange Commission in the Trump administration.

This is a big change from Chair White whose background was in prosecution. Chair White had a long list of prosecutions from serving a decade as the U.S. Attorney for the Southern District of New York. (She is the only woman to have held that position.) Then served another decade as a litigator in private practice.

Mr. Clayton has a wide-ranging corporate practice spanning mergers and acquisitions, IPOs, corporate governance, and investment advice. He is respected lawyer and will likely do a great job with the SEC.

But he is a very different kind of lawyer than Ms. White. He is a deal lawyer, largely working on corporate transactions and governance.

Perhaps that marks a change in the SEC from one of enforcement to one of enhancing the capital markets. Chair White was saddled with the rule-making imperatives from Dodd-Frank. With most of those in place, the SEC will have more bandwidth to focus its agenda. The appointment of Mr. Clayton seems to be an indication that the SEC may focus more on the other prongs of its mission: maintain fair, orderly, and efficient markets, and facilitate capital formation.

The front page of the Wall Street Journal laments the loss of public companies: America’s Roster of Public Companies Is Shrinking Before Our Eyes. I think most people are guessing that Mr. Clayton will try to fix that issue.

With the appointment of Mr. Clayton, that still leaves two open slots to be filled. No word on whether the stalled nominations of Lisa Fairfax and and Hester Peirce will proceed or whether there will be new candidates.

The Latest Word on the SEC’s Administrative Judges

There have been several challenges to the constitutionality of the in-house administrative judges at the Securities and Exchange Commission. The problem is that the judges are appointed by an internal panel instead of by the President or the SEC Commissioners. The SEC has fended off attacks. Now there is break in wall. The 10th Circuit found the use to be unconstitutional.

The Constitutional question is whether the SEC’s ALJs are “Officers of the United States,” including principal and inferior officers, who must be appointed under the Appointments Clause. U.S. Const. art. II, § 2, cl. 2.

For some reason, the SEC does not appoint the ALJ’s directly. If it did so, it could probably erase this problem going forward. I assume the legal advice is that the change would put past cases into jeopardy.

In August, the U.S. Court of Appeals for the D.C. Circuit in Raymond J. Lucia Cos. v. SEC, accepting the SEC’s argument that ALJs are mere “employees,” and not officers at all. This seemed to be the accepted stance when the US Supreme Court in September denied hearing the appeal of Lynn Tilton in her case arguing on roughly the same issue.

The 10th Circuit Court of Appeals came to the opposite conclusion last week in  Bandimere v. SEC. The Bandimere may differ slightly from prior cases. Unlike some of the other attacks, Mr. Bandimere raised the constitutional question before the SEC, which rejected it. The 10th Circuit put the other attacks in the bucket of collateral lawsuits attempting to enjoin the administrative enforcement actions.

The 10th Circuit, based on Freytag v. Commissioner of Internal Revenue, 501 U.S. 868 (1991), concluded that the SEC ALJ who presided over an administrative enforcement action against Mr. Bandimere was an inferior officer who was not constitutionally appointed. The Freytag analysis has three parts to determine if an ALJ is an “inferior officer”:

(1) the position of the SEC ALJ was “established by Law,”;

(2) “the duties, salary, and means of appointment . . . are specified by statute,”.; and

(3) SEC ALJs “exercise significant discretion” in “carrying out . . . important functions,” .

The Bandimere decision rejected the argument in the Lucia case that ALJs do not have final decision-making power. They have enough power to make them an “inferior officer.”

I would place a bet that the SEC will appeal this case to the Supreme Court. Given the split in the circuit courts of appeal, it makes the case more likely to be heard.

Sources:

Bold and Unrelenting SEC Enforcement

We are in a time of transition at the Securities and Exchange Commission. There are two vacancies on the Commission and Chair Mary Jo White has announced her departure. Although there are changes coming to the highest level of the SEC, the vast majority of the SEC personnel are staying in place and continuing their efforts to protect investors.

mary-jo-white

Chair White gave a speech to the NYU Program on Corporate Compliance and Enforcement and the NYU Pollack Center for Law and Business about the SEC’s enforcement program.

During Chair White’s confirmation hearings, she pledged to would pursue a “bold and unrelenting” enforcement agenda as SEC Chair. That was combined with a change in the way enforcement approached cases.

Investigate to Litigate – The SEC staff is coached to conduct all investigations with litigation in mind. During investigations, staff will focus on acquiring admissible and persuasive evidence

Use of Data Analytics to Uncover and Investigate Misconduct – These efforts have resulted in at least nine insider trading cases originating solely from leads generated by these types of tools, many others in the pipeline, and dozens of other cases being expanded using these tools to identify additional unlawful trading

Using Whistleblowers to Detect Misconduct – The SEC recently surpassed the $100 million mark for awards to whistleblowers, and tips in fiscal year 2016 surpassed 4,200, rising over 40 percent from 2012, the first fiscal year the program was in place.

Focusing on Individuals – Holding individuals liable for wrongdoing is a core pillar of any strong enforcement program.

The SEC’s Admissions Policy – In a first for a civil financial regulator, we announced in June 2013 that the SEC would begin to require admissions as a condition for settlement in certain types of cases, including cases with harm to large numbers of investors or significant risk of harm to the market, where the settling party engaged in egregious conduct or obstructed Commission investigations, or where admissions would significantly enhance the deterrent message of the action.

Impact of SEC Enforcement Activity – We have also, however, increasingly brought cases – including those involving negligent actions – that harm investors in other important ways that can be remedied through changes in industry practices in response to our actions, thus benefiting huge segments of investors beyond those harmed in a specific case.

In this last area, Chair White highlights the effect of enforcement on private equity.

“Over the past three years, we have brought 11 actions against private equity advisers for undisclosed fees and expenses, impermissible shifting and misallocation of expenses, and failure to adequately disclose conflicts of interests to clients. Our strong sense from exams and industry discussions is that, through the Commission’s focus on these problematic practices, we have helped to transform the level of transparency of fees, expenses, and conflicts of interest, and have prompted very meaningful change for the benefit of investors.”

Sources:

When Does A Stock Picking Contest Turn Into a Derivative

Forcerank’s premise was simple: “fantasy sports for stocks”.

Forcerank runs mobile phone games where players predict the order in which stocks would perform relative to each other.  In its original form, if a player did well he or she won points and could some receive a cash prize. Forcerank kept 10 percent of the entry fees.

The gaming is a ruse to collect data. Forcerank iss looking to obtain data about market expectations that it hopes to sell to hedge funds and other investors.

forcerank

It seems clear to me that Forcerank was concerned about the gambling aspect of the app. There was a provision in the rules the stated the Forcerank contest was a “skill based” contest. If it were not skill-based (i.e luck) then it would be gambling. You pay an entry fee and if you win you get a prize. If winning is based on luck it’s gambling.

The Securities and Exchange Commission looked at the Forcerank contest in a different light.

Dodd-Frank gave the SEC new powers to regulate security-based swaps.

The Commodity Exchange Act defines the term “swap”:

“[T]he term ‘swap’ [includes] any agreement, contract, or transaction—… (ii) that provides for any purchase, sale, payment, or delivery (other than a dividend on an equity security) that is dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence[.]”

That’s a very broad definition. It was a definition that the SEC applied to the Forcerank contests.

[E]ach Forcerank entry was a swap because each participant paid to enter into an agreement with Forcerank LLC that provided for the payment of points and, in certain cases, cash. Those payments were dependent upon the occurrence, or the extent of the occurrence, of an event or contingency (i.e., the player’s predictions about the price performance of individual securities being compared to actual performance and the player’s aggregate points being compared to other players). Such event or contingency was “associated with a potential financial, economic or commercial consequence” because it was calculated by measuring the change in the market price of an individual security over a period of time and comparing that change to an identical metric based on the market price of other individual securities.

I find this an interesting roadblock to stock-picking contests.

I looked at the Forcerank website and downloaded the app. There is no longer an entry fee and there are no cash prizes. That removes it from the definition of “derivative”. It also removes the incentive to enter the contest and the revenue stream from Forcerank.

Sources:

 

 

See the Changes to Form ADV

With all the regulatory changes to Form ADV coming out, I found it tough to figure out what the changes look like on the form. The Securities and Exchange Commission published a helpful redline that highlights the changes.

The SEC is not willing to stand behind the redline, noting:

This document illustrates most of the revisions to Form ADV related to adopted rule release IA-4509. This document should not be considered a complete and comprehensive list of changes to Form ADV.

I think many will find the “separately managed account” portion to be confusing. The first being the use of this term which sounds much like the term, separate account, used in the insurance industry to invest. The borrowing and derivatives reporting will be time-intensive.

Sources:

Separately Managed Accounts

The biggest change to the Form ADV is reporting on separately managed accounts. The Securities and Exchange Commission is looking for data and insight into advisers’ operations. I think the benefit to consumers is a side benefit.

Cash in the grass.

I have to admit that I was confused as I was browsing through the new changes to Form ADV. I mistook “separately managed accounts” for “separate accounts.” That left me particularly confused when the section started with the scope of the changes:

we consider advisory accounts other than those that are pooled investment vehicles (i.e., registered investment companies, business development companies and pooled investment vehicles that are not registered (including, but not limited to, private funds)) to be separately managed accounts.

Later on in the release, the SEC specifically chooses not to define “separately managed accounts.” That only exacerbated my initial confusion. Many advisers and fund managers are familiar with separate accounts, a species of investing vehicle used by insurance companies

Then the light came on and realized that the SEC had created a completely new term that compliance professionals for registered investment advisers will need to learn and understand. There are “separate accounts” and “separately managed accounts.”  To add to the confusion, a separate account could be a separately managed account. But maybe that was just me.

With Dodd-Frank giving the SEC more oversight over private funds, it realized that it was collected vast amounts of information about private funds, but much less about the bread and butter separately managed accounts. But rather than collect that information in the private manner for Form PF, the SEC is mandating additional disclosure in the public Form ADV filing.

Registered investment advisers will have to report the approximate percentage of their separately managed account assets invested in twelve asset categories:

  1. exchange-traded equity securities;
  2. non-exchange traded equity securities;
  3. U.S. government bonds;
  4. U.S. state and local bonds;
  5. sovereign bonds;
  6. corporate bonds – investment grade;
  7. corporate bonds – non-investment grade;
  8. derivatives;
  9. securities issued by registered investment companies and business development companies;
  10. securities issued by other pooled investment vehicles;
  11. cash and cash equivalents; and
  12. other

Don’t look for definitions of these terms in Form ADV. The SEC is leaving it up to advisers to determine how to categorize assets, so long as the methodology is consistently applied. If an adviser has more than $10 billion in RAUM, the information will have to be reported twice a year, instead of just an annual filing.

If an adviser has more than $500 million in RAUM, the adviser will have to disclose the use of borrowing attributable to those assets. If the adviser has more than $10 billion in RAUM, the adviser will also have to report on the use of derivatives in those accounts.

As with private funds, advisers will need to report information on the use of custodians. The new Item 5.K.(3) requires investment advisers to identify any custodian that accounts for at least 10 percent of total RAUM attributable to its separately management accounts, the custodian’s office location and the amount of RAUM held at the custodian.

Sources: