Weekly RoundUp October 09, 2019

Financial Services Weekly News: SEC Modernizes ETF Regulation, Issues Guidance on Performance and Fee Disclosures

Editor's Note

In This Issue. The Securities and Exchange Commission (SEC) adopted a rule permitting most exchange-traded funds that satisfy a set of standardized conditions to operate without the expense and delay of obtaining exemptive relief, while its Division of Investment Management issued staff guidance summarizing observations regarding prospectus disclosure issues relating to performance and fee information. Meanwhile, federal financial regulators finalized changes to simplify the Volcker Rule and increased the asset thresholds of the management interlocks rules. These and other developments are discussed in more detail below.

Please note: The Roundup will be on hiatus due to the federal holiday observed next week. We will resume publication on October 23.

Editor's Note
Editor's Note
Editor's Note

Regulatory Developments

SEC Adopts New Rule to Modernize Regulation of ETFs

On September 26, the SEC adopted Rule 6c-11 under the Investment Company Act of 1940, as amended (1940 Act), which permits most exchange-traded funds (ETFs) that satisfy a set of standardized conditions to operate without the expense and delay of obtaining exemptive relief (ETF Rule). At the same time, the SEC issued an exemptive order granting an exemption from compliance with certain provisions of the Securities Exchange Act of 1934 and the rules thereunder, subject to certain conditions, to broker-dealers and certain other persons engaging in certain transactions in securities of ETFs relying on rule 6c-11 under the 1940 Act (the Exemptive Order). In addition, the SEC adopted: (i) certain disclosure amendments to ETF registration statements; and (ii) related amendments to Form N-CEN. One year after the effective date of the ETF Rule, the SEC is rescinding exemptive orders that previously had been granted to ETFs and ETF sponsors that may rely on the ETF Rule. Certain ETFs may not rely on the rule and, thus, would still have to rely on their existing exemptive orders, including: (i) leveraged ETFs; (ii) inverse ETFs; (iii) ETFs that are structured as unit investment trusts; (iv) share class ETFs; (v) master-feeder ETFs; (vi) exchange-traded products that are not registered under the 1940 Act (e.g., exchange-traded products that do not invest primarily in securities); and (vii) non-transparent ETFs. The ETF Rule, which modernizes the regulation of ETFs, is designed to level the playing field for most ETFs and facilitate greater competition and innovation among ETF sponsors. The ETF Rule and the Exemptive Order become effective 60 days after publication in the Federal Register.

SEC’s IM Division Issues ADI Regarding Performance and Fee Issues

On October 2, the Disclosure Review and Accounting Office of the SEC’s Division of Investment Management (Staff) issued guidance in the form of an Accounting and Disclosure Information (ADI) summarizing the Staff’s observations regarding prospectus disclosure issues relating to performance and fee information. The Staff observed inaccuracies in performance disclosure, including: (i) multiple funds that failed to reflect sales loads in their average annual returns table resulting in overstated performance; (ii) showing negative performance as positive performance (in both the bar chart and average annual return table); and (iii) transposing the performance of fund classes (e.g., showing class A performance as class B’s performance and vice versa) and transposing the performance of multiple benchmark indices. The Staff also observed inaccurate fee and expense disclosure, namely: (i) net expenses that exceeded gross expenses; (ii) fee tables that failed to reflect the appropriate amount of Acquired Fund Fees and Expenses; (iii) inaccurate expense examples where errors appeared to be arithmetic errors, the failure to reflect fee waivers for only the term of the fee waiver and the failure to include certain fee items, such as Acquired Fund Fees and Expenses; and (iv) funds that incorrectly XBRL-tagged their information by using the wrong tags, entered the data incorrectly, or associated the tagged information with the wrong fund or class in the risk/return summary section of the prospectus. The key takeaway from the ADI is the Staff’s recommendation that registrants verify the accuracy of performance and fee disclosures prior to filing them with the SEC and providing them to investors.

Federal Financial Regulators Finalize Changes to Simplify Volcker Rule

On October 8, the Board of Governors of the Federal Reserve System (FRB), Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Commodity Futures Trading Commission, and SEC announced that they had approved an interagency final rule to simplify compliance requirements relating to Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as the “Volcker Rule.” As previously reported in the August 21 edition of the Roundup, the final rule previously had been approved by the OCC and FDIC. Under the final rule, firms that do not have significant trading activities will have simplified and streamlined compliance requirements, while firms with significant trading activity will have more stringent compliance requirements. Community banks generally are exempt from the Volcker Rule by statute. The revisions continue to prohibit proprietary trading, while providing greater clarity and certainty for activities allowed under the law. With the changes, the agencies expect that the universe of trades that are considered prohibited proprietary trading will remain generally the same as under the agencies’ 2013 rule. The final rule has an effective date of January 1, 2020, and a compliance date of January 1, 2021.

Agencies Increase Thresholds For The Major Assets Prohibition Of The Management Interlocks Rules

On October 2, the FRB, OCC and FDIC (Agencies) adopted a final rule updating rules restricting the ability of a director or other management official to serve at more than one depository institution or depository holding company. These management interlock rules, promulgated under the Depository Institution Management Interlocks Act, originally prohibited directors or management officials from working at a depository institution or holding company with more than $2.5 billion in total assets while simultaneously working at an unaffiliated depository organization with more than $1.5 billion in total assets. As these thresholds were established in 1996, the Agencies sought to update the rules to account for changes in the U.S. banking market. The updates to these rules will increase both thresholds to $10 billion. The final rule, which was unchanged from the proposed rule announced in December 2018, will be effective upon publication in the Federal Register.

OCC Fiscal Year 2020 Bank Supervision Operating Plan Announced

On October 1, the OCC announced its Fiscal Year 2020 Bank Supervision Operating Plan (Plan) for individual national banks, federal savings associations, federal branches, agencies of foreign banking organizations, and identified service providers. The Plan, for the fiscal year beginning October 1, 2019 and ending September 30, 2020, sets forth the OCC’s supervision priorities and objectives and aligns them with “The OCC’s Strategic Plan, Fiscal years 2019-2023” and the National Risk Committee’s priorities. The Plan provides guidance for supervisory units and managers to incorporate in their individual operating plans and risk-focused bank strategies. Highlighted risk focus areas include cybersecurity and operational resiliency, Bank Secrecy Act and anti-money laundering compliance, the impact of changing interest rate outlooks, and preparation for the potential phaseout of the London Interbank Offering Rate (LIBOR) as a reference rate after 2021. The OCC will provide periodic updates regarding supervisory priorities, emerging risks, and horizontal risk assessments in the Semiannual Risk Perspective Report.

Removal of Transferred OTS Regulations Regarding Regulatory Reporting Requirements, Regulatory Reports and Audits of State Savings Associations

On October 2, the FDIC published a notice of proposed rulemaking to rescind and remove from the Federal Register certain regulations of the Office of Thrift Supervision (12 CFR 390, subpart R) related to state savings associations that had been previously transferred to the FDIC. The regulations cover regulatory reporting requirements, regulatory reports and audits of state savings associations. The proposed rule is intended to simplify the FDIC’s regulations by removing redundant and otherwise unnecessary regulations and promote parity between state savings associations and state nonmember banks by having the regulatory reporting requirements, regulatory reports and audits of both classes of institutions addressed in the same manner as FDIC rules. Comments to the proposed rule are due no later than November 1, 2019.

Enforcement & Litigation

CFPB Director Informs Congress that Agency’s Single-Director Structure is Unconstitutional

As we previously reported, the Consumer Financial Protection Bureau (CFPB) reversed course by filing a Supreme Court brief agreeing with a petitioner that the agency’s single-director structure is unconstitutional. On the same day, the CFPB’s director, Kathy Kraninger, sent letters to Congress informing it of the agency’s new position. Read the LenderLaw Watch blog post.

This week’s Roundup contributors: Jessica Craig, Chris Herbert, Mac Laban, Bill McCurdy and Jessica Park.