Private Fund Regulatory Update: Post-U.S. Government Shutdown

March 19, 2019
16 minutes

This Ropes & Gray podcast series highlights developments in Washington, D.C., affecting private funds and their legal, regulatory and compliance obligations. In this second installment, asset management partner Joel Wattenbarger and counsel David Tittsworth pick up on their conversation from January 2019, when the U.S. government was in partial shutdown, to discuss the aftermath of the shutdown and other legislative updates from Capitol Hill, as well as recent developments at the SEC, the Commodity Futures Trading Commission and the Financial Stability Oversight Council. Topics include Regulation Best Interest and related SEC initiatives; legislative updates related to capital formation, data collection and FinTech; recent developments related to the CFTC; and the FSOC’s proposed changes to how non-bank financial institutions are designated.


Joel Wattenbarger: Hello, everyone. Thank you for joining us today for the latest edition of our Ropes & Gray podcast on financial regulatory developments of interest to private fund managers. I'm Joel Wattenbarger, an asset management partner based in our New York office. And I'm joined today, as usual, by David Tittsworth, counsel based in our D.C. office. Today we'll be discussing Reg Best Interest and related developments, also touching on state fiduciary duty rule proposals. We'll give you an update on developments on Capitol Hill, a quick update on a couple of developments at the CFTC, and end with some news pretty much hot off the presses as of recording time regarding the Financial Stability Oversight Council. But before we get to any of that—David, the last time we convened for one of these podcasts, the Federal Government was in shutdown, so we're happy to note that we're done with shutdowns for this government fiscal year. Can you tell us a little bit more about sort of the status of the government shutdown as we sit here today?

David Tittsworth: Absolutely. So it may seem like old news to some of you, but after a 35-day (the longest shutdown in history) partial government shutdown, I guess to be technically correct, all of the Federal Government is up and running. There was legislation that was passed by both the House and the Senate, and signed by the President. And I think a couple things that people should just be aware of: Number one, the shutdown is over. Number two, this will take the SEC and other agencies with funding levels, with appropriations from Congress, through the end of this federal fiscal year, which means September 30, 2019. So there will not be anymore shutdowns due to lack of appropriations for the next several months. And I think, Joel, as we've talked about, the SEC lost a little time certainly in terms of some of its rule-making efforts, but as far as we can tell right now, the agency is back up and running. I believe some of our clients are being visited by examiners from OCIE, so it's back to business as usual.

Joel Wattenbarger: Great. Well, now that we are back to business as usual, the SEC, amongst other things, is presumably turning its attention to what Chairman Clayton has described as his highest priority, which is Reg Best Interest and the sort of package of related actions by the SEC that were part of a proposed rule making package last year. Given the importance of that to Chairman Clayton and the commissioners, I wanted to ask you to just give us sort of an update. Where does that stand right now? What sort of recent developments are you aware of concerning that rule-making package?

David Tittsworth: So Regulation Best Interest, Form Client Relationship Summary (or CRS) and a proposed interpretation of fiduciary duty under the Advisers Act are the three big components of this rule-making that the SEC proposed last April, in April of 2018. The answer to your question is that we do not have a definitive timeframe for when a final rule will be proposed, but there are hints that that could come sooner rather than later. In the meantime, sort of like, you know, having a dead fish on your kitchen counter, this rule-making can just continue to attract flies, as it were. And so not that these are huge developments necessarily, Joel, but for example, last month in February, the Institutional Limited Partners Association, a trade group that represents large institutional investors to private funds, wrote another letter to the SEC about Reg BI and raised all sorts of issues—asking the SEC, for example, to rescind the Heitman No-Action Letter that deals with whether you can put certain hedge clauses in advisory agreements or making SEC enforcement settlements with private fund advisers conditional on advisers not seeking indemnification from their investors. There was a whole laundry list of requests from ILPA to the SEC. I think other trade associations, certainly the American Investment Council representing private equity investors or private equity funds, has already written a letter in response to ILPA. Other trade groups are considering the same sort of thing, but again, it's just sort of exemplary of how, during one of these rule-makings, issues continue to be raised until there is a final rule. One other example is that a number of former SEC senior economists, it certainly caught my eye, going back to 1982, so several decades worth of senior economists, wrote a letter to the SEC about Reg BI saying that the economic analysis is fundamentally flawed and that the SEC has not really followed its own guidelines regarding economic analysis. So those are just two examples, Joel, of recent developments. Actually, I think you might want to talk a little bit about what's going on in the states that might be related to Reg BI.

Joel Wattenbarger: That's right. Thank you, David. And certainly, one of the trends that we've noticed developing recently are states, who I think probably fair to say are acting out of a sense that there's frustration with the pace and the course of rule-making over fiduciary duty or related standards applicable to broker dealers and potentially investment advisers at the federal level. Some states are looking to sort of rush into that vacuum from their perspective and either pass laws at the state legislative level or, in the case of at least one state, actually embark on a rule-making with respect to state securities regulators that differ in their details, but the general thrust of which would be to impose explicitly fiduciary duties on broker dealers, and potentially some sort of new fiduciary duty standard for investment advisers as well that are doing business in the states at issue. And states where we've seen these developments including Nevada, which is probably farthest along—Nevada has passed legislation, is in a rule-making process now on this topic, as well as New Jersey and Maryland. We anticipate we may see this in other states as well this year, so very interesting. When I saw this and have been asked about this by clients, one of my immediate reactions, and I know I'm not alone in this, was to sort of scratch my head and say, "At least with respect to investment advisers, is there an issue here of federal preemption?" Because I'm sure many listeners are aware, NSMIA, which was a statute passed at the federal level 20+ years ago now, is intended to preclude substantive state regulation with respect to federally registered investment advisers. And we're not going to take you on this podcast into the weeds of the specific state laws and proposals that are out there, but at least some of these laws and proposals are drafted so that there's at least some ambiguity as to how the proposed rules would apply with respect to investment advisers, including federally registered investment advisers that have some business connection to that state. We're not the only ones to have had this observation. The IAA, the Investment Adviser Association, filed a comment letter in Nevada recently to this effect. Commenting from the other direction, NASAA, the state securities regulatory group, has recently submitted a letter in Nevada supporting the new rules in Nevada and setting forth their view that the rules are not preempted by federal law. And, you know, I think I probably would agree with that position, at least with respect to aspects of the new rules, again, without getting into the details. But I think for investment advisers, there will be really a question as to how these rules will apply, if at all, particularly with respect to the activities of federally registered investment advisers. So this is one to keep an eye on. The one additional observation I'll make is just in the last day, there was a news story where Commissioner Hester Peirce, one of the SEC commissioners speaking at the conference, effectively encouraged states to wait to see how the federal process plays out with respect to the developments that David was just discussing, Reg Best Interest and then the sort of related package of regulatory initiatives, noting that she expects the package to be finalized soon, which is interesting. We'll see what “soon” means, but effectively, encouraging the states to sort of hold off on taking action that may be inconsistent with or overlap with what the SEC is doing currently at the federal level. So we'll certainly keep an eye on that and see how that plays out.

I want to move on from talking about those developments to moving to Capitol Hill and talking a little bit about what's happening from a legislative perspective with the Federal Government. So we know that in a time of divided government and heightened partisanship, it's difficult to get legislation on whether it's financial reform topics or any other topic passed on Capitol Hill, but there have been some recent developments of note and I wanted to start by asking if you, David, could give us a quick recap of the chairman of the Senate banking committee's legislative priorities as he's articulated them recently.

David Tittsworth: I'll be very quick, Joel. So Mike Crapo, a senator from Idaho who chairs the Senate Banking Committee, put out a statement just a few weeks ago saying this is essentially what his priorities for the committee's agenda in the coming Congress are. It's very vague so it's hard to take away too many specifics, but he mentions three areas that are worth mentioning. First, capital formation—so that would include matters dealing with corporate governance, proxy advisers, which has certainly been a hot issue, and reducing burdens for small businesses. The second area is data collection, privacy and security. This should not come as a shock to anybody. I think with the breaches that have been very high-profile and involving millions of consumers and the release of personally identifiable information, both in the public as well as the private sectors, it's no surprise that there is potential legislative action even in the Senate relating to data collection privacy and security. And then the third area that he mentions, a broad area, again is FinTech—so that is looking at new and innovative products and services. It certainly includes one of our favorite topics, digital payments and currency, so initial coin offerings and cryptocurrency as well as other topics. So I wouldn't hold my breath, Joel. The Senate is still where you will look to see if there are 60 votes, so some level of bipartisanship that'll be required if there's going to be any legislation. But those are some broad hints of areas that the Senate Banking Committee will be looking at during the coming months.

Joel Wattenbarger: Great. Thank you, David. I saw the statement from Senator Crapo. One other thing that jumped out to me is he did make reference to a piece of legislation from the last Congress, the JOBS and Investor Confidence Act of 2018, which obviously wasn't ultimately enacted into law, but passed the House by a substantial margin. And interesting that he referenced that legislation—that was sort of a grab bag of securities law reform provisions across a number of different areas. But one that would be notable probably to many listeners of this podcast was a provision that would expand the accredited investor definition under Reg D to pick up, amongst other things, certain persons, who by virtue of their experience or educational background and professional responsibilities, might qualify as accredited investors under this legislation, even though they didn't otherwise meet the income and net worth thresholds that folks are familiar with currently under Reg D. So that's certainly an area that we'll be tracking—that would be a piece of legislation that would certainly be of interest to folks in the private fund community.

The one other piece of legislative development I wanted to pass on on this podcast was there was a bill that passed the house at the end of January, by a resounding vote of 413 to three, that was legislation to mandate an SEC study of insider trading law and focus in particular on 10b5-1 trading plans. And there's been a sense that those trading plans may be susceptible to abuse by corporate insiders—and so this is a bill that would effectively mandate the SEC to conduct a study, but with an eye towards presumably amendments to the rules, potentially tightening the terms on which issuers and other insiders could enter into 10b5-1 trading plans. So there's now been a companion bill introduced in the Senate by Senator Van Hollen of Maryland. It’s unclear at this point, I'd say very unclear, whether that legislation is going to move forward at all, but certainly, a number of our clients do use 10b5-1 trading plans or are familiar with those plans—and if that legislation progresses, we'll certainly keep this group updated.

So next, I wanted to move to just a quick discussion of a couple of recent developments related to the CFTC. And the first is just a note that there continues to be a fair amount of what I think I would describe as sort of background noise regarding the possibility of some sort of streamlining of the SEC and the CFTC's regulatory mandates. And the MFA, the hedge fund industry group, has been pushing the idea of a sort of primary regulator scheme so that in circumstances where a particular fund manager, say, was subject to both SEC oversight as a registered investment adviser as well as CFTC oversight as a commodity pool operator and commodity trading adviser, that one of those regulators, based on the preponderance of the firm's activity would be designated as a primary regulator. And there would be some sort of safe harbor given so that if the primary regulator gave relief or took action in a certain area, the firm would have comfort that the other regulator couldn't come in and bring some sort of enforcement action based on a disagreement between interpretations of a given rule between the two regulators. And for what it's worth, Commissioner Peirce, who we've already referenced on this podcast, and CFTC Commissioner Quintenz, have reportedly been working together on the possibility of some sort of, again, streamlining of SEC and CFTC regulatory mandate, so stay tuned on that front.

The other thing I just wanted to note briefly is that CFTC Chairman Giancarlo has already been announced that he's planning to step down in the relatively near future—exact date still to be determined. There have been some press reports about what his priorities may be in terms of the closing months of his tenure as Chair. Certainly, one area that he has publicly pushed for in the past has been reform of the SEF, the Swap Execution Facility rules. Some conflicting reports out there about the extent to which he may continue to push forward on that topic before he retires, or I should say steps down as CFTC Chair. So we'll continue to monitor that, but I expect that we'll see some further activities and further announcements from the CFTC as he moves towards stepping down his chair.

And then the last topic, and I wanted to turn to you, David, was as we record here on March 8, there's been news just within the last day concerning the Financial Stability Oversight Council, which is of I think real interest to private fund managers, particularly the larger private fund managers, and I just wanted to turn it over to you to give us a quick update there.

David Tittsworth: So I'll end on some good news. And this really goes back to the beginning of the Trump administration, when he issued an Executive Order directing the Treasury Department to do a report on the FSOC, Financial Stability Oversight Council designations that were authorized under the Dodd-Frank Act more than a decade ago and have been roundly criticized, especially by members of the asset management industry. So yesterday, FSOC, the super regulator, all the banking regulators, the SEC, the CFTC, that was created by the Dodd-Frank Act, unanimously put forward a new proposal for public comment that relates to non-bank financial company designations. In my humble opinion, all of this proposal, the 64 pages, move in the right direction. Basically, what the asset management industry, including hedge fund managers, has been arguing to policy markers is that designating non-banks significantly institutional financial institutions is really antithetical to the way that the asset management industry is constructed. Asset managers, including hedge funds, are fully substitutable by investors—it's really an agency relationship. There's been no compelling evidence that asset management activities have presented a threat to the financial stability of the United States, as well as the fact that all asset management firms are already subject to comprehensive regulatory, inspection, enforcement programs by their primary regulator, which is the SEC. So without going into any great detail, the proposal that came out yesterday will look at financial risks for non-banks on an activities-based approach, rather than a company-by-company approach. Second, they'll perform a cost benefit analysis before they designate any non-bank financial company. They'll assess the likelihood that a non-bank company's material, financial distress would actually occur before taking any action. And they'll make a number of different changes to FSOC's procedures that'll create a more efficient, effective designation process. Joel, all of these could bear, you know, further elaboration—I'd be happy to speak to anybody about the details. This is a proposed rule, 60-day comment period. I imagine our firm will be working with some interest groups in providing some comments on this, but the bottom line is this is good news. Asset managers, including hedge funds, private funds, should not be regulated as banks. Period.

Joel Wattenbarger: Well, I agree, David. And it's good to end on good news. I cannot promise that we will do so in every podcast, but thank you for that happy update. And thank you for joining me today for this insightful discussion more generally. For more information on the topics that we discussed today or other topics of interest to the asset management community, please visit our website And of course, if we can help you navigate any of the topics we discussed today, please don't hesitate to get in touch. Stay tuned for future podcasts on the latest developments in this space, and thank you for listening.

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