SEC Announces FY27 Examination Priorities
Summary: On October 23, the Division of Examinations announced its FY27 Examination Priorities. The Division’s press release placed a focus on asset managers, emphasizing: (1) “[i]nvestment advisers’ fiduciary obligations, conflicts of interest, investment recommendations, and compliance programs”; (2) “[r]etail investor protection, particularly regarding complex, higher-risk, and illiquid products”; and (3) “[p]rivate funds, private credit, and other complex investment strategies” as “[k]ey FY 2027 areas of focus.” In particular, the Priorities note that economic conflicts of interest will be a focus area for examiners, both substantively and as part of examiners’ assessment of a firm’s compliance program.
Takeaway: The Division has made clear that its focus will remain on asset managers in the upcoming fiscal year, with a particular emphasis on fiduciary duties and conflicts of interest. The Division’s focus on conflicts is in lockstep with priorities coming out of the Division of Enforcement, as noted by Enforcement Director Woodcock last month.
Best Practice Tip: Asset managers should prepare for examinations in the upcoming fiscal year using the Division’s Priorities as a guide. The Priorities note that never-examined or recently registered advisers, advisers that “recommend products that are difficult to trade, have unusual features, or are illiquid,” and advisers that “use certain third-party service providers” may be more likely to be chosen for examination.
SEC Brings Undisclosed Conflict of Interest and Fiduciary Duty Case
Summary: On October 30, the SEC announced settled charges with an RIA related to breaches of fiduciary duty in failing to disclose conflicts of interest. The SEC alleged that from at least February 2018 through March 2023, the RIA failed to disclose that its affiliated broker-dealer was marking up margin interest rates and receiving those amounts as compensation from its clearing firm for margin balances in its brokerage customer’s accounts. The SEC also alleged that from February 2018 through June 2020, the RIA failed to disclose conflicts of interest associated with revenue its affiliated broker-dealer received from its clearing firm based on assets the RIA’s clients invested in cash sweep money market funds. Separately, the SEC alleged that the RIA, in breach of its fiduciary duty, included a hedge clause in advisory agreements with its retail clients, which the SEC determined were misleading and inconsistent with the RIA’s own written policies and procedures.
Takeaway: While not groundbreaking, this settlement is a reminder of the SEC’s perennial focus on undisclosed conflicts of interest and aligns with Enforcement and Examination priorities.
Best Practice Tip: Advisers should regularly survey affiliate relationships for potential conflicts of interest and address conflicts through disclosures and informed consent.
Division of Enforcement Releases Section 21(a) Report
Summary: For the first time in eight years, on October 7, the SEC released a report of investigation under Section 21(a) of the Exchange Act in connection with activities of a climate-focused investor initiative, Climate Action 100+ (“CA100”) through its members. The SEC’s investigation of CA100 surrounded the organization’s practice of designating lead investors for identified issuers to sponsor certain shareholder proposals and vote in alignment with the organization’s objectives. Specifically, the SEC considered whether this type of coordinated shareholder voting power raised concerns regarding whether the shareholders formed a “group” under the beneficial ownership reporting rules.
- The report reflects that the Commission declined to pursue an enforcement action but nonetheless, “[b]ecause large asset managers, through their holdings of clients’ shares, exercise substantial voting influence across U.S. public companies, their participation in organizations, such as CA100, dedicated to aligning their members’ voting decisions raises heightened concerns.”
Takeaway: Typically, membership in an investor coalition, such as CA100, does not trigger group-formation concerns under Section 13(d) of the Exchange Act. However, the Commission’s 21(a) report emphasizes that coordination with multiple shareholders around common objectives could amount to the type of “agreement, arrangement, understanding, or concerted action” toward a common purpose necessary for group-formation. In particular, such coordination “may occur through organized engagement efforts, evaluative frameworks that the members have agreed upon, and harmonization of its members’ voting decisions on specific matters presented at an issuer’s shareholder meetings.”
Best Practice Tip: Asset managers should assess their participation in investor coalitions and whether their activities could raise group-formation concerns.
SEC Proposed Rulemaking
The SEC has devoted significant energy into rulemaking over the last month and there are numerous proposed rules that could affect asset managers.
Simpson Thacher has prepared client alerts and other pieces on a number of these proposed rules below. Advisers should engage with their regulatory teams to think through whether the proposed rules will require changes to policies, procedures, or practices.