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Blog > Regulatory Roundup: Unpacking the SEC’s Latest Updates and Insights on How to Remain Compliant

Regulatory Roundup: Unpacking the SEC’s Latest Updates and Insights on How to Remain Compliant

What to know to keep your organization compliant
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The current SEC administration continues to enact and enforce new requirements, making the ever-evolving regulatory environment more important than ever to ensure your firm is in compliance.

Read on as Michelle McGurk, a senior Arootah adviser, provides insight as to how you can bolster defenses against violations.

Private Messages and Unmonitored Channels – What We Can Learn from Citadel’s Example

Citadel is gearing up to take a strong stance against the SEC in response to the latter’s investigation into the former’s alleged use of unmonitored communications on platforms like WhatsApp. The investigation is still pending formal action, and it’s worth noting that nearly two dozen banks previously reached substantial settlements with the SEC over similar allegations, including JPMorgan Chase and Bank of America, which paid more than $2.5 billion collectively to settle allegations related to their employees’ use of unofficial channels to discuss business. Citadel’s stance challenges the idea that hedge funds should be subject to the same regulations as major Wall Street banks. The case serves as a reminder of the crucial importance of robust communication policies and the potential consequences of failing to uphold SEC compliance standards.

Key Takeaways

To enhance communication policies and steer clear of potential SEC pitfalls, investment advisers should train their staff to only use monitored methods of communication when discussing anything business related, or with customers. Additionally, advisers must utilize vigilant monitoring systems and technology to maintain sufficient and comprehensive archives, and most importantly educate employees about the related SEC requirements and dos and don’ts to ensure widespread firm compliance. It’s equally important to establish a firm culture where employees feel safe reporting potential compliance hiccups and stay up to date with evolving regulations. Regular compliance monitoring, mock-audits, internal self-examinations, ongoing employee training, whistleblower protection programs and hiring external counsel and consultants as independent resources will all add layers to an adviser’s compliance defense.

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Labor Laws and Failure to Provide Whistleblower Protections – How to avoid SEC violations of employee protections

In three separate enforcement actions announced in September 2023, the SEC issued fines totaling $10.6mm for violations of Rule 21-17(a), which included an action against D.E. Shaw & Co., a registered investment adviser. Rule 21F-17 was adopted under Dodd Frank and forbids employers from engaging in any action that obstructs an individual’s ability to directly communicate with the SEC about a possible securities violation, which would include enforcing or threatening to enforce a confidentiality agreement. The SEC has been rigorously enforcing this rule in recent years by examining confidentiality agreements, non-disparagement, covenants not to sue, and similar provisions without explicitly granting exemptions for employee whistleblower safeguards.

The SEC found that D.E. Shaw failed to include whistleblower protections in both employment agreements and separation agreements, dating back to 2011 when Rule 21F-17 was adopted, for employees who might voluntarily seek to disclose information to the SEC.  The SEC’s findings revealed that, between 2011 and 2019, D.E. Shaw barred new hires from sharing confidential information with external parties unless authorized or mandated by a legal or court order. Furthermore, the firm required departing employees to declare they had not filed complaints with any government agencies as a condition for receiving post-employment deferred compensation. Despite belatedly informing its workforce of whistleblower rights in 2017, D.E. Shaw didn’t update employee agreements until years later and didn’t revise one of their forms until after the SEC began its investigation. As a result, the SEC fined D.E. Shaw $10mm for willful Rule 21F-17(a) violations on September 29th 2023.

The SEC brought two other orders against CBRE Inc, a subsidiary of a public company, and Monolith Resources LLC, a private company. CBRE was fined $375,000 for requiring employees to declare that they hadn’t filed complaints or charges against the company, in separation agreements, impeding their communication with the SEC. Despite CBRE preserving employee rights for administrative charges and participation in government investigations, the SEC deemed this insufficient. The SEC imposed the fine against CBRE based on consideration of the company’s cooperation and comprehensive remedial actions, which included revisions of all agreements and communication with over 800 employees who signed separation agreements to ensure they educated them of their rights under Rule 21F-17.

Monolith received a $225,000 fine for failing to explicitly inform employees in separation agreements that they retained the right to receive financial awards from the SEC’s whistleblower program. These cases underscore the importance of crafting compliant separation agreements with full recognition of employee whistleblower protections.

Key Takeaways

These cases serve as a stern reminder for employers to revisit and review their employee new hire and separation agreements to ensure they explicitly and adequately carve out whistleblower protections for both current and former employees. The related enforcement actions and total penalties imposed also demonstrate how important it is for advisers to be proactive in their remediation efforts, which will not necessarily prevent a fine from the SEC but may significantly reduce the penalty amount, as was noted with the Monolith and CBRE cases.

SEC Crackdown on Electronic Communication Recordkeeping Failures

On September 29th 2023, the SEC announced charges against ten firms, including five broker-dealers, three entities serving as both broker-dealers and investment advisers, and two affiliated investment advisers for record-keeping failures. These allegations stem from their pervasive and prevalent lapses in the maintenance and preservation of electronic communications, including those on the off-channel communication platforms WhatsApp and GroupMe.

The ten firms, including Interactive Brokers, Robert W. Baird & Co., William Blair & Company, Nuveen Securities, Fifth Third Securities, and Perella Weinberg Partners, were slapped with a combined penalty of $79mm. The firms all admitted to the facts of the case and violations that extend back to at least 2019 and entail communication breakdowns, including personal text messages among employees and off-channel communications related to business recommendations and advice. The violations involved employees across multiple levels of authority, including senior management. The off-channel communications issue aligns with the previously mentioned SEC investigation of Citadel and this is clearly an area the SEC is cracking down on.

Such widespread noncompliance results in significant consequences highlighting the importance of enforcing and upholding rigorous recordkeeping standards, establishing adequate policies and procedures, and educating employees.

Key Takeaways

These recent enforcement actions provide investment advisors with critical takeaways as they work to prevent similar violations and hefty penalties. It’s essential to meticulously review and enhance communication policies, systematically archive and monitor electronic communications, and ensure records contain any off-channel conversations related to any aspect of the business.  Investment firms should also prioritize creating supervisory mechanisms to detect and prevent breaches of recordkeeping provisions. As the SEC increases their regulatory scrutiny, investment advisers must be proactive in cultivating a robust culture of compliance to steer clear of the SEC significant fines.

SEC Adopts 13F-2 Short Sale Disclosure Rule – New Reporting Requirements for Hedge Funds

On October 13th, 2023, the SEC adopted new rule 13f-2 which mandates that institutional investment advisers who exceed specific reporting thresholds must disclose short position and activity data for equity securities on Form SHO. Although broker dealers already report a snapshot of open short positions twice a month, the new short-sale disclosure rule applies to a broader set of entities including hedge funds.

Advisers are required to file Form SHO via the EDGAR system within 14 days after the end of each calendar month and should report on:

  • Securities registered under Section 12 (i.e. the same method used to determine reportable securities relevant to 13-F filings) including all discretionary accounts, when an adviser’s monthly average gross short position meets or exceeds the prescribed threshold of either (i) a gross short position in the equity security worth at least $10 million at the end of a trading day on any settlement date within the reporting calendar month, or (ii) a monthly average gross short position representing 2.5% or more of total shares outstanding.
  • Securities not registered under Section 12 but for which the adviser’s gross short position meets or exceeds a different prescribed threshold defined by a gross short position of $500,000 or more at the close of regular trading hours on any settlement date during the calendar month.

For each of these securities, advisers must report on Form SHO:

  • Their gross short position at the close of regular trading hours on the last settlement date of the calendar month, as well as whether such positions are fully hedged, partially hedged or not hedged. The SEC defines “gross short position” as the total number of shares of an equity security held in a short position, excluding any offsetting long positions or economic long positions, such as actual shares of the equity security or derivatives of that equity security.
  • Daily “net” activity in each of the reportable equity securities, which includes activity in derivatives such as option assignments and exercises, for each individual settlement date during the calendar month.

The SEC will aggregate this data by security to maintain the confidentiality of reporting managers and publish it through EDGAR on a delayed basis, within one month. This information will include the gross short position and corresponding dollar value for all reporting advisers and the “net” activity for each settlement date across all reporting advisers.

Notably, however, while 13F reporting is limited to institutional investment advisers that generally exceed a threshold investment discretion in equity securities of at least $100 million, that would not be the case for Rule 13f-2 and Form SHO which have established different reporting thresholds as noted above.

The new Rule 13f-2 and Form SHO will become effective 12 months after the adoption release, and public aggregated reporting will commence three months after that.

According to the SEC, the new short disclosure requirements will provide transparency to the market about overall short-sale activity, and help regulators distinguish between hedging activity and bets against a company.

Key Takeaways

This new SEC reporting rule signifies a change and demonstrates the increasing burden and cost investment advisers must learn to comply with additional reporting requirements. The new monthly short sale filing requirement (based on daily reporting thresholds) will require funds to efficiently and accurately consolidate and closely monitor data. This requirement underscores the critical importance of developing robust data management systems and using reputable service providers to ease the burden and mitigate related compliance risk. To effectively prepare for change, advisers should consider that data management is paramount, operational efficiency is critical, internal collaboration will help their firm establish well-structured processes, and seeking advice and guidance from compliance experts can be invaluable.

The Bottom Line

Staying informed and proactive in addressing these regulatory challenges is paramount for hedge funds. By understanding the nuances of each issue and implementing the recommended advice, leaders can navigate the evolving regulatory landscape with confidence, ensuring they remain compliant and maintain a solid reputation within the industry.

Want to learn more and ensure your organization is set up for success? Find out how Arootah’s Hedge Fund Advisory can support you.

Disclaimer: This article is for general informational purposes only and does not constitute legal, investment, financial, accounting, or tax advice, or establish an attorney-client relationship. Arootah does not warrant or guarantee the accuracy, reliability, completeness, or suitability of its content for a particular purpose. Please do not act or refrain from acting based on anything you read in our newsletter, blog, or anywhere else on our website.

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