Ropes & Gray’s Investment Management Update August – September 2024

The following summarizes recent legal developments of note affecting the mutual fund/investment management industry.

Judge Blocks Missouri Anti-ESG Rules; Missouri Withdraws Subsequent Appeal

Background. In a 2023 Ropes & Gray Investment Management Update, we described a lawsuit by the Securities Industry and Financial Markets Association (“SIFMA”) in the U.S. District Court for the Western District of Missouri naming the State of Missouri and its Attorney General as defendants. SIFMA’s complaint sought declaratory and injunctive relief regarding two Missouri Securities Division rules (the “Investment Adviser Rule” and the “Broker-Dealer Rule” and, together, the “Rules”) that went into effect on July 30, 2023.

• The Rules make it a dishonest or unethical business practice in Missouri for a firm, before providing investment advice to any client, to fail to disclose to the client that the firm “incorporates a social objective or other nonfinancial objective” into the investment advice it provides.
• The Rules additionally require a broker-dealer or investment adviser to obtain from each client (i) a written consent to the broker-dealer or investment adviser incorporating a social objective or other nonfinancial objective into any discretionary investment decision and (ii) a written acknowledgement that incorporating a social objective or other nonfinancial objective into investment decisions means that the decision is not solely focused on maximizing a financial return.

Following discovery, the Court issued an order on August 14, 2024 granting SIFMA’s motion for summary judgment and granting SIFMA’s request for an order permanently enjoining Missouri from enforcing the Rules.¹ SIFMA asserted four counts as a basis for its requested relief.

The Order. As summarized below, the Court agreed with each of four legal theories advanced by SIFMA.

NSMIA Preemption. The Court noted that the National Securities Markets Improvement Act of 1996 (“NSMIA”) provides in part that no state “shall establish . . . keeping records . . . for [broker-dealers] that differ from, or are in addition to, the requirements [under federal law].” The Court highlighted that the Broker-Dealer Rule requires broker-dealers to obtain a form of signed written acknowledgment and consent from the customer and to maintain the form. Therefore, the Court held, the rule is “expressly preempted by NSMIA because it requires broker-dealers to make and keep records that differ from – and are in addition to – federal requirements.”

The Court rejected the defendants’ argument that NSMIA’s savings clause insulated the Broker-Dealer Rule from preemption because the rule was an exercise of Missouri’s antifraud police power. The Court rejected this reasoning because the savings clause – codified at Section 18(c)(1) of the Securities Act and preserving state authority “to investigate and bring enforcement actions with respect to fraud or deceit, or unlawful conduct by a [broker-dealer] in connection with securities or securities transactions” – does not authorize a state “to engage in rulemaking, particularly rulemaking that mandates new legal requirements.”

With respect to the Investment Adviser Rule, the Court relied on NSMIA’s investment adviser preemption provisions (codified in Section 203A(b)(1) of the Advisers Act) to conclude that the rule was preempted. The Court noted that, under these preemption provisions, states (i) were prohibited from substantively regulating SEC-registered investment advisers and (ii) retained authority over SEC-registered advisers only “to investigate and bring enforcement actions with respect to fraud or deceit against an investment adviser or a person associated with an investment adviser; to require filings, for notice purposes only, of documents filed with the [SEC]; and to require payment of state filing, registration, and licensing fees.”

The Court held that the Investment Adviser Rule, like the Broker-Dealer Rule, was preempted because it “impermissibly imposes new and different State regulatory obligations that are not required by federal law.” The Court added that the Investment Adviser Rule was preempted because its requirements “far exceed NSMIA’s authorization for states to ‘license, register, or otherwise qualify any investment adviser representative.’”

ERISA Preemption. The Court observed that (i) Congress included an express preemption clause in ERISA “[t]o meet the goals of a comprehensive and pervasive Federal interest and the interests of uniformity with respect to interstate [employee benefit] plans” and (ii) the clause preempts any and all state laws insofar as they may now or hereafter relate to any employee benefit plan” covered by ERISA.

The Court found that the Rules “relate to” an ERISA plan. In particular, the Court held, the Rules “interfere with ERISA by restricting what investments may be recommended or selected, and by mandating disclosure and recordkeeping requirements not required by ERISA.” On this point, the Court quoted from SIFMA’s assertion (in its summary judgment brief) that “the Rules govern central matters of plan administration by purporting to alter the very core of ERISA: its comprehensive set of rules setting forth in detail how fiduciaries may and may not perform their federally assigned functions with respect to the ERISA plan.” The Court held that “by creating a non-ERISA prohibition against ERISA-compliant fiduciary advice, the Rules undermine ERISA’s exclusive enforcement scheme and are therefore preempted.”

First Amendment Violation. SIFMA asserted that the Rules violate the First Amendment protection against compelled speech because the Rules’ written consent requirements compel speech that is inaccurate and controversial and, therefore, unconstitutional.

The Court determined the appropriate level of scrutiny that it was required to employ in evaluating whether the Rules’ mandatory disclosure requirements violate the First Amendment. The Court concluded that the Rules must pass so-called “intermediate scrutiny,” which employs a four-part standard to test the constitutionality of laws burdening commercial speech, including determining “whether the regulation is no more extensive than necessary to further the government’s interest.”

The Court concluded that the Rules cannot survive intermediate scrutiny because the Rules are more extensive than necessary to further the government’s interest. The Court noted that the parties dispute whether the governmental interest was to prevent “fraud and deceit in the complex areas of securities and investing” and/or to protect against “liberal priorities that are in conflict with investors’ interests.” Regardless of which of the parties was correct, the Court held the Rules are “more extensive than necessary” and, therefore, did not survive intermediate scrutiny. Specifically, the Court concluded:

• To the extent the Rules were intended to prevent fraud and deceit, “the written content requirement is not narrowly tailored.” For example, the Court observed, “the Rules could have been more narrowly and carefully worded to avoid being inaccurate and/or misleading” and
• To the extent the Rules were geared toward addressing a policy debate, defendants had a “less coercive method of publicizing their views on social investing.” For example, the Court stated the defendants “could have embarked on a public-information campaign to advance their desired message without burdening a speaker with unwanted speech.”

Unconstitutional Vagueness. The Court explained that under the federal courts’ void-for-vagueness doctrine, “a law is unconstitutional if it fails to provide a person of ordinary intelligence fair notice of what is prohibited, or is so standardless that it authorizes or encourages seriously discriminatory enforcement.” The Court concluded that the Rules were, in fact, unconstitutionally vague and adopted SIFMA’s reasoning:

[T]he Rules fail to adequately define “nonfinancial objective.” They state “[n]onfinancial objective,” means the material fact to consider criteria in the investment or commitment of customer funds for the purpose of seeking to obtain an effect other than the maximization of financial return to the customer [citations to the Rules]. The Rules leave many concepts in this definition unexplained. Read one way, this definition could be construed to apply when recommending a conservative investment strategy that is consistent with a client’s conservative risk tolerance because such an approach will not maximize financial return. Defendants have provided no written guidance on the Rules . . . such as what is meant by “maximization of financial return,” which is not a recognized phrase in the securities laws. Taken at face value, this phrase plausibly could be read to refer to those investment strategies that provide the highest potential returns on the amounts invested, even when such strategies are the riskiest.

Subsequent Events. On August 28, 2024, SIFMA filed a motion with the Court for an award of attorney’s fees and related expenses, which the Court has discretion to grant.² SIFMA requested approximately $1.3 million. On September 13, 2024, the defendants filed an appeal to the U.S. Court of Appeals for the Eighth Circuit. On September 30, 2024, the Court accepted a joint stipulation by SIFMA and the defendants in which the defendants agreed to voluntarily dismiss their appeal with prejudice, to pay SIFMA $500,000 for attorney’s fees, and to permanently waive any right to appeal or collaterally attack the Court’s August 14, 2024 summary judgment order.

FDIC Proposes to Amend its Regulations under the Change in Bank Control Act

On July 30, 2024, the Federal Deposit Insurance Corporation (the “FDIC”) issued a notice of proposed rulemaking (the “NPR”) that would amend the FDIC’s existing regulations under the federal Change in Bank Control Act (the “CBCA”).

Under current regulations, unless an exemption is available, a registered fund complex must file a notice with the FDIC at least 60 days before it acquires in aggregate 10 percent or more of any class of the voting securities of an FDIC-supervised institution.

• An exemption applies when any investor, including a fund complex, acquires voting securities of a depository institution holding company for which the Federal Reserve Board reviews a notice pursuant to the CBCA.
• If the NPR’s amendments (the “Proposed Amendments”) are adopted as proposed, the Amendments would eliminate this exemption.

Background. The CBCA generally prohibits any person, acting directly or indirectly, or in concert with other persons, from acquiring control of an insured depository institution (an “IDI”), unless the person has provided the appropriate federal banking agency (the “AFBA”) prior written notice of the proposed transaction and the AFBA has not disapproved the transaction within 60 days. The FDIC is the AFBA for certain IDIs.

The CBCA defines “control’’ as “the power, directly or indirectly, [i] to direct the management or policies of an insured depository institution or [ii] to vote 25 per centum or more of any class of voting securities of an insured depository institution.”

• Subpart E of the FDIC’s rules and regulations implement the CBCA³ and set forth the FDIC’s filing requirements and processing procedures for pre-acquisition notices filed pursuant to the CBCA. Specifically, Subpart E requires notice to the FDIC before any person, acting directly or indirectly, alone or in concert with others, acquires control of a covered institution, unless the acquisition is exempt.
• The CBCA does not describe what constitutes the power “to direct the management or policies of” a covered institution but federal banking agencies have determined that a shareholder who owns or controls a significant block of voting securities generally will have influence in a banking organization. Consistent with the regulations of other federal banking agencies,⁴ Subpart E contains a rebuttable presumption that an acquisition of voting securities of a covered institution constitutes control and triggers the notice requirement if, immediately after the transaction, the acquiring person will own, control, or hold the power to vote 10 percent or more of any class of voting securities of the covered institution.
• An acquiring person may rebut this presumption of control in writing. Generally, unless an exemption is available, for transactions above the regulatory threshold of 10 percent but below the CBCA’s 25 percent threshold, an acquiring person would file a notice with the FDIC to rebut the presumption of control. To rebut the presumption of control, the acquiring person would highlight elements that demonstrate that it will not have the power, directly or indirectly, to direct the management or policies of the covered institution. These factors may include, for example, commitments by the acquiring person not to seek representation on the board of directors of the covered institution, not to take certain actions to influence the policies of the institution, or not to acquire further voting securities above a certain threshold.
• The documents memorializing the actions the acquiring person will take or refrain from taking to rebut the presumption of control are “passivity agreements” or “passivity commitments” (“Passivity Agreements”). The FDIC usually is a party to a Passivity Agreement regarding FDIC-supervised institutions and, currently, four Passivity Agreements with three asset management companies exist and are available on the FDIC website.⁵

Certain acquisitions are exempt from the FDIC’s prior notice requirements of Subpart E. These include any acquisition of voting securities of a depository institution holding company for which the Federal Reserve Board (the “FRB”) reviews a notice (the “Existing Exemption”).⁶ The Existing Exemption codifies the FDIC’s existing policy that it does not require a notice when the FRB actually reviews a notice to acquire voting securities of a depository institution holding company under the CBCA.

The Existing Exemption does not extend to FRB determinations to accept a Passivity Agreement in lieu of a notice. In these instances, the NPR notes, the FDIC has authority to evaluate the facts and circumstances to determine whether a notice is required to be filed with the FDIC for the indirect acquisition of control of an FDIC-supervised institution. However, in recent years, the FDIC typically has not determined that notices must be filed with the FDIC when the FRB accepts a Passivity Agreement in lieu of a notice.

The NPR and the Proposed Amendments. According to the NPR, recent developments involving institutional investors and FDIC-supervised institutions have prompted the FDIC to reconsider its procedures regarding transactions exempt from notice requirements and compliance with Passivity Agreements. The NPR notes that there has been an “exponential growth of index funds,” and the FDIC has observed “fund complexes [acquiring] 10 percent or more of the voting securities at FDIC-supervised institutions or their controlling affiliates and [continuing] to increase their ownership percentages at more institutions.” The NPR states that “[t]hese developments have prompted the FDIC to reconsider its policies under the CBCA and implementing regulations so that the FDIC may more appropriately assess the effects of any control exerted over the management and policies of FDIC-supervised institutions.”

Accordingly, to address these concerns, the FDIC’s Proposed Amendments would delete the Existing Exemption from Subpart E thereby permitting the FDIC “to review certain transactions under the CBCA to address the concerns and potential risks outlined [in the NPR].” The elimination of the Existing Exemption would mean that investors, including fund complexes, that propose to acquire voting securities of a depository institution holding company in transactions for which the FRB reviews a notice would no longer be automatically exempt from providing the FDIC with prior notice. According to the FDIC, this change is warranted because the original purpose of the Existing Exemption, “which was to avoid duplicate regulatory review of the same transaction by both the FRB and the FDIC, is no longer warranted in light of the widespread impacts resulting from growth in, and changes to the nature of, passive investment strategies.”

Under the FDIC’s current regulations, when the FRB accepts a passivity commitment in lieu of a notice, the FDIC evaluates the facts and circumstances of the case to determine whether a notice is required to be filed with the FDIC for the indirect acquisition of control of an FDIC supervised institution. Similarly, in cases where the FRB accepts a notice, the FDIC under the Proposed Amendments would evaluate the facts and circumstances to determine whether to require a notice to be filed with the FDIC as well. If the Proposed Amendments are adopted, the FDIC may exercise one of the following options in the case of transactions resulting in an acquiring person owning, controlling, or holding with power to vote 10 percent or more of any class of voting securities of a FDIC-supervised institution: (i) based on the facts and circumstances, require prior written notice to the FDIC under the CBCA for the indirect acquisition of control of an FDIC-supervised institution or (ii) allow the acquiring person an opportunity to rebut the presumption of control in writing. Entering into a Passivity Agreement is one option the FDIC would consider in assessing whether the presumption of control has been rebutted.

REGULATORY PRIORITIES CORNER

Upcoming Compliance Dates

The following is a reminder of the upcoming compliance dates of significant SEC rulemakings.

1. Beneficial Ownership Reporting. Beneficial owners are required to comply with the revised Schedule 13G filing deadlines on September 30, 2024. The compliance date for the structured data (XML-based language) requirements for Schedules 13D and 13G filers is December 18, 2024. The related SEC release is summarized in a Ropes & Gray Alert.
2. Short Position and Short Activity Reporting by Institutional Investment Managers. Beginning January 2, 2025, institutional investment managers that engage in short sales of “equity securities” in excess of certain thresholds are required to file new Form SHO with the SEC within 14 calendar days after the end of each calendar month. The related SEC release is summarized in a Ropes & Gray Alert.

SEC Charges Adviser with Violating Whistleblower Protection Rule

In a September 26, 2024 order, the SEC announced that it had settled an administrative proceeding with GQG Partners LLC (“GQG”), a registered investment adviser, regarding alleged violations of the whistleblower protections afforded by Rule 21F-17(a) under the Exchange Act (the “Rule”).

In pertinent part, the Rule provides “No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.”

In the September 26 order, the SEC alleged the following:

Non-Disclosure Agreements

1. From November 2020 through September 2023, GQG required certain employee candidates (each a “Candidate”) to sign a non-disclosure agreement (an “NDA”) prior to employment. The NDAs typically included terms providing for termination three years from the later of (i) the last date that “Confidential Information” (defined below) was received, or (ii) the date on which all service agreements between the Candidate and GQG terminated.
2. Each NDA required the Candidate to maintain the confidentiality of all “Confidential Information” and specifically prohibited disclosure “to any person (including any governmental agency, authority or official or any third party) the fact that Confidential Information has been made available” to the Candidate. “Confidential Information” included all documents and information received by the Candidate about GQG.
3. Under the terms of each NDA, if a Candidate received a request for documents, subpoena, deposition, or other similar process of law, the NDA allowed disclosure of the fact that the Candidate possessed Confidential Information, but required the Candidate to (i) promptly notify GQG of any such request, unless prohibited by law, (ii) consult with GQG about taking steps to resist or narrow the request, and (iii) assist GQG in seeking a protective order.
4. Each NDA further provided that, if the Candidate had not received a request or subpoena or similar process of law, then disclosure would only be allowed if (i) it was required under the federal securities laws or stock exchange rules, (ii) it did not arise from a volitional action of the Candidate, (iii) the Candidate had provided written notice to GQG, unless prohibited by law, and (iv) the Candidate cooperated with GQG to limit any disclosure.
5. If GQG made a Candidate an offer of employment that was accepted, the Candidate subsequently signed a separate confidentiality agreement (“Employee Confidentiality Agreement” or “ECA”) that specifically carved out from its confidentiality provisions the reporting of possible securities law violations to the SEC.
6. In March 2021, GQG added a Whistleblower Policy to its compliance manual. The Whistleblower Policy contained a provision stating that employees “have the right to report directly to GQG’s primary regulator, [the SEC], pursuant to section 21F of the Securities Exchange Act of 1934, as amended and may do so anonymously without fear of retaliation by GQG.” However, the NDAs executed during the relevant period contained non-disclosure provisions that the SEC asserted conflicted with the ECA and the Whistleblower Policy, “creating confusion that raised an impediment to whistleblowing.”

• Certain of the NDAs contained a termination provision stating that obligations under the NDA would terminate upon the Candidate’s execution of a written agreement containing comparable confidentiality obligations, “provided that appropriate provisions of this [NDA] shall survive any such termination as reasonably necessary to effectuate the purposes of this Agreement.”
• The remaining NDAs contained a provision stating that the parties agreed that “notwithstanding the confidentiality provisions of any other agreement in effect between the parties, the terms of this [NDA] shall govern the provision of Confidential Information thereunder, except to the extent that specific confidentiality terms in such other agreement are more stringent than those set forth herein.”

Terminated Employee

7. Separately, during the same period, GQG terminated an employee (the “Former Employee”) and the parties subsequently entered into mediation regarding the termination and severance owed to the Former Employee by GQG.
8. After the Former Employee was terminated but prior to the mediation, the Former Employee’s legal counsel informed GQG that the Former Employee intended to make a submission to the SEC alleging potential violations of the securities laws by GQG. The Former Employee provided GQG with a document detailing the information he planned to submit to the SEC.
9. In response to the allegations raised by the Former Employee, GQG investigated the Former Employee’s claims and determined that they lacked merit. At the mediation, GQG described to the Former Employee and his counsel the basis for its findings that the Former Employee’s claims were unfounded.
10. At the conclusion of mediation, the parties entered into a Settlement Agreement, which expressly permitted the Former Employee to report possible securities law violations by GQG to the SEC and to participate in the SEC’s whistleblower program and receive a whistleblower award. However, the Settlement Agreement also contained representations by the Former Employee (the “Representations”) to the effect that Former Employee (i) has not initiated or sought to initiate any charge, claim, investigation or enforcement action by any governmental entity relating to GQG, or [Former Employee]’s employment with GQG, (ii) is unaware of any acts or omissions either by himself or any other GQG employee that would provide a basis for initiating any charge, claim, investigation or enforcement action by any governmental entity relating to GQG and (iii) withdraws any prior statements inconsistent with the prior representations.
11. The Representations did not appear in other separation and release agreements used by GQG during the relevant period; only that of the Former Employee, who had raised allegations of potential securities law violations.

Based upon its findings above, the SEC concluded that GQG willfully violated the Rule, which prohibits any person from taking any action to impede an individual from communicating directly with the SEC staff about a possible securities law violation.

Without admitting or denying the SEC’s findings, GQG consented to being censured and agreed to pay a civil penalty of $500,000 to the SEC.

SEC Brings Enforcement Relating to MNPI and Ad Hoc Creditors’ Committees

In a September 30, 2024 order, the SEC announced that it had settled an administrative proceeding with a registered investment adviser (the “Adviser”) regarding the Adviser’s alleged failure to establish, maintain and enforce written policies and procedures reasonably designed to prevent the misuse of material non-public information (“MNPI”) relating to its participation on ad hoc creditors’ committees.

In the September 30 order, the SEC alleged the following:

1. The Adviser managed private funds across several investment strategies, including private credit, leveraged loans and real estate, with significant holdings in distressed debtors and similar special situations. One of the Adviser’s core strategies has been investing in distressed corporate bonds and other similar debt in the U.S., Europe and Asia.
2. As a result of its investment strategy, the Adviser regularly engaged with other credit investors and/or financial advisors – forming ad hoc committees of creditors for distressed issuers. The goal of these committees was to explore potential favorable debt restructuring opportunities prior to the issuer filing for bankruptcy, engaging in a reorganization or otherwise initiating a formal restructuring proceeding. The Adviser participated in several of these committees each year and, in some instances, took an active role in directing the committee’s activities.
3. Beginning in March 2020, the Adviser began acquiring bonds of a foreign company (the “Issuer”) whose common stock was listed on a foreign exchange. In July 2020, the Issuer announced it was exploring restructuring options due to the impacts of COVID-19. In early August 2020, certain analysts employed by the Adviser engaged in discussions with a foreign-based restructuring advisor (the “Restructuring Advisor”) about participating in an ad hoc committee composed of unsecured creditors of the Issuer for the purpose of exploring and discussing potential debt or company restructuring options.
4. The Adviser and the three other largest bondholders served as the coordinating group on behalf of the ad hoc committee. Once formed, the ad hoc committee retained the Restructuring Advisor to serve as an adviser and liaison between the committee and the Issuer to discuss potential restructurings. In connection with its role, in October 2020, the Restructuring Advisor executed a non-disclosure agreement with the Issuer, which allowed it to receive MNPI from the Issuer. Information that the Restructuring Advisor subsequently received from the Issuer included non-public information that was not otherwise available to the Adviser until the Adviser itself executed a non-disclosure agreement with the Issuer.
5. Throughout the fall of 2020, the Restructuring Advisor engaged in discussions with, and provided guidance to, the ad hoc committee both orally and in writing. In particular, the Adviser received reports, analyses, updates and other information throughout the duration of the committee. The Adviser’s analysts receiving this information communicated with a trader of the Adviser where they discussed what the Adviser’s strategy should be with respect to the Issuer, and the trader executed the investment strategy with respect to the Issuer.
6. The Adviser was aware that the Restructuring Advisor had entered into a non-disclosure agreement with the Issuer and had informed the Restructuring Advisor and other members of the ad hoc committee that it did not wish to restrict trading until it entered into a non-disclosure agreement with the Issuer. On November 5, 2020, the Adviser executed an NDA with the Issuer and, on that day, restricted all trading in securities related to the Issuer.
7. Both prior to and subsequent to entering into a non-disclosure agreement with the Issuer, the ad hoc committee and the Adviser’s analysts received written materials from the Restructuring Advisor. While the Adviser knew the Restructuring Advisor had entered into a non-disclosure agreement with the Issuer, neither the ad hoc committee nor the Adviser received any written representations regarding the Restructuring Advisor’s handling of any MNPI received from the Issuer. In addition, the Adviser did not perform any due diligence concerning the Restructuring Advisor’s handling of any MNPI.
8. The Adviser acquired a position in Issuer bonds between March 2020 and August 2020 (when it began to participate in the ad hoc committee) worth about €35m. After joining the committee and prior to entering into a non-disclosure agreement with the Issuer, the Adviser continued to build its position in Issuer bonds and accumulated an additional €94m in bonds. Beginning in October 2020, it sold over €22m of credit default swaps referencing the Issuer.

Based upon its findings above, the SEC concluded that while the Adviser had policies and procedures that provided general guidance for evaluating and handling potential MNPI, given the Adviser’s regular participation on ad hoc creditors’ committees and the nature of such committees, the Adviser failed to establish, maintain, and enforce policies and procedures that were reasonably designed to address the specific risks associated with receiving and identifying MNPI arising from the Adviser’s participation on ad hoc creditors’ committees.

• In particular, the SEC concluded that the Adviser’s policies and procedures failed (i) to address the risks relating to the potential inadvertent receipt of MNPI resulting from participating on ad hoc creditors’ committees, including interactions with financial advisors or other consultants for ad hoc committees and (ii) to include provisions covering the Adviser’s employees conducting due diligence regarding a committee financial advisor’s evaluation or handling of potential MNPI or obtaining representations from a committee financial advisor concerning its MNPI policies and procedures.

The SEC found that the Adviser violated Sections 204A and 206(4) of the Advisers Act, as well as Rule 206(4)-7 promulgated thereunder. Without admitting or denying the SEC’s findings, the Adviser consented to being censured and agreed to pay a civil penalty of $1.5 million to the SEC.

Observations. The SEC has previously brought enforcement actions for failing to have appropriate policies and procedures where there is seemingly insufficient evidence to pursue a successful insider trading case. Here, the SEC highlighted substantial trading activity by the Adviser in both bonds and credit default swaps during the time the Adviser sat on the ad hoc committee and before it entered into a non-disclosure agreement with the Issuer. For several years, the SEC has been looking at participation on ad hoc creditors’ committees, and we expect that to continue. Whether an adviser participates in such committees has been a common question in SEC exam request letters.

This matter highlights the importance of having MNPI policies and procedures that are appropriately tailored to the risks of an investment adviser’s business. In previous Risk Alerts, the SEC Division of Examinations emphasized tailoring policies and procedures to risks relating to specific sources of MNPI (such as alternative data providers and expert networks).

SEC Brings Action Against a BDC Regarding Custody of Uncertificated Securities

In a September 23, 2024 order, the SEC announced that it had settled an administrative proceeding with SuRo Capital Corp. (“SuRo”) regarding SuRo’s alleged failure to custody uncertificated securities in compliance with the custody requirements of Section 17(f) of the 1940 Act and rules thereunder. SuRo is a publicly traded closed-end fund that, in April 2011, elected to be regulated as a business development company (a “BDC”) under the 1940 Act.

Under Section 17(f) of the 1940 Act, a registered investment company, including a closed-end company that has elected to be regulated as a BDC, must place and maintain its securities and similar investments in the custody of (i) a bank meeting the qualifications set forth in Section 26(a) of the 1940 Act (a “qualified bank”), (ii) a member of a national securities exchange, subject to SEC rules, or (iii) itself, subject to SEC rules (“self-custody”).

In the September 23 order, the SEC alleged the following:

1. During the period July 2019 through June 2022, SuRo acquired securities through direct investments in prospective portfolio companies, secondary marketplaces for private companies, and negotiations with selling stockholders. Many of these securities were not represented by a physical certificate (“Uncertificated Securities”). SuRo also acquired securities by making loans to companies.
2. SuRo’s written policy and procedures stated that it would “place and maintain its securities and similar investments” in the custody of a qualified bank (the “Custodian Bank”) in accordance with Section 17(f)(1) of the 1940 Act. SuRo’s predecessor entered into a custody agreement with the Custodian Bank in April 2011 (the “Custody Agreement”), which remained in place from at least July 2019 through June 2022.
3. SuRo elected to place and maintain all of its securities and similar investments, including Uncertificated Securities, with its board-approved Custodian Bank pursuant to the Custody Agreement.
4. The Custody Agreement defined “securities” to include “equity investments, including investments in partnership and limited liability companies” and outlined procedures for SuRo to custody Uncertificated Securities at the Custodian Bank.

• The Custody Agreement was silent about loans, but SuRo’s written policies and procedures required all of its assets to be held by its board-approved Custodian Bank.

• The Custody Agreement (i) provided that SuRo would transmit the necessary documentation such that the Custodian Bank “shall maintain a register (in book-entry form or in such other form as it shall deem necessary or desirable)” of such Uncertificated Securities and (ii) detailed the documentation required by the Custodian Bank to custody the Uncertificated Securities.

5. During this period, SuRo did not ensure that its Uncertificated Securities were placed and maintained with the Custodian Bank. Specifically, SuRo did not follow the provisions of the Custody Agreement requiring delivery to the Custodian Bank of certain documents evidencing SuRo’s acquisition of Uncertificated Securities or provide notice of portfolio holdings (or changes in those holdings) in its Uncertificated Securities to the Custodian Bank. Instead, SuRo’s Uncertificated Securities were held variously with brokers, transfer agents, and in self-custody.

The Order notes that these deficiencies were identified during a 2022 examination by the SEC’s Division of Examinations. Based upon its findings, the SEC concluded that SuRo violated (i) Section 17(f) of the 1940 Act and (ii) Rule 38a-1 under the 1940 Act (requiring SuRo to adopt and implement written policies and procedures reasonably designed to prevent violations of the federal securities laws). The SEC noted the remediation efforts promptly undertaken by SuRo:

• SuRo updated its written policies and procedures with respect to the custody of Uncertificated Securities, including requiring that (i) within two business days of making an investment in a portfolio company, SuRo would send all executed documentation of an investment in a portfolio company to the Custodian Bank and (ii) SuRo would conduct a reconciliation on a weekly basis to confirm that its portfolio securities and other assets are held in the custody of the Custodian Bank and that any transfers or withdrawals are made only in accordance with the Custody Agreement with its Custodian Bank.
• In addition, SuRo entered into an updated custody agreement with a Custodian Bank, which explicitly defined Uncertificated Securities to include loans and set out requirements for the custody of such Uncertificated Securities by the Custodian Bank.

The SEC considered these remedial acts promptly undertaken by SuRo and did not impose a civil penalty.

SEC Brings Actions for Failure to File Beneficial Ownership and Insider Transaction Reports Filings; Follows Forms 13F and 13H Actions

On September 25, 2024, the SEC issued a press release announcing that it had settled administrative proceedings with 23 firms and individuals, including a number of investment advisers, for their alleged failures to timely file Schedules 13D and 13G and Forms 3, 4, and 5 under Section 16 of the Exchange Act. Links to each of the related SEC orders appear on the same webpage as the press release. The firms and individuals agreed to pay civil penalties totaling more than $3.8 million in aggregate and ranging from $10,000 to $200,000 for individuals and from $40,000 to $750,000 for entities.

The SEC’s announcement follows the SEC’s September 17, 2024 press release announcing that it had settled administrative proceedings with 11 investment advisers for their alleged failures to timely file Forms 13F and 13H.

• Pursuant to Section 13(f) of the Exchange Act, Form 13F is the quarterly reporting form filed by institutional investment managers that exercise investment discretion over at least $100 million in Section 13(f) securities.
• Form 13H is the initial registration and updating form for entities that meet the definition of a “large trader” under Section 13(h) of the Exchange Act and Rule 13h-1 thereunder.

Each of the 11 investment advisers allegedly failed to file Form 13F and two also allegedly failed to file Form 13H. Nine of the advisers agreed to pay civil penalties totaling more than $3.4 million in aggregate and ranging from $175,000 to $725,000. Two advisers avoided a civil penalty because they self-reported the violations to the SEC and otherwise cooperated with the SEC’s investigation.

SEC Charges Fund Adviser with Misleading Investors Regarding its Investment Strategy

In a September 19, 2024 order, the SEC announced that it had settled an administrative proceeding with Inspire Investing, LLC (“IIL”), a registered investment adviser, regarding IIL’s alleged material misstatements concerning how it managed investments for clients, which include eight ETFs, as well as separately managed accounts (the “SMAs”) managed by IIL that primarily invest in the ETFs.

In the September 19 order, the SEC alleged the following:

1. IIL offers investment advisory services and represents that it employs its “biblically responsible investing” (“BRI”) strategy when advising ETFs and the SMAs that purported to exclude investments in issuers that engage in certain enumerated business practices which IIL determined “do not align with biblical values.”
2. From at least 2019 to March 2024, IIL represented in its Form ADV Part 2A Brochure (“Brochure”) and the ETFs’ prospectuses that the ETFs and SMAs it advised would not invest in companies that “have any degree of participation in” certain enumerated activities or products that IIL determined did not align with biblical values.
3. For example, the March 2023 ETFs’ prospectuses stated that IIL’s proprietary methodology “removes from the investment universe the securities of any company that has any degree of participation in the following activities or products that do not align with biblical values,” including “Abortion Legislation,” “Abortion Procedures,” “Alcohol,” “Cannabis Retail THC,” “Embryonic Stem Cell Research,” “Gambling,” “In Vitro Fertilization,” “LGBT Promotion,” and “Tobacco” (collectively, “Prohibited Activities”).
4. The prospectuses additionally stated that IIL employs “software that analyzes publicly available data relating to the primary business activities, products and services, philanthropy, legal activities, policies and practices when assigning . . . Impact Scores to a company.”
5. On its website, IIL described its methodology as “objective” and “rules-based” and represented that it “brings together the most robust data sets from the world’s leading providers.”
6. IIL’s actual investment process deviated from what it represented to clients and ETF investors in its Brochure and the ETF prospectuses. To assess companies under the Impact Score methodology, IIL relied on manual research by a small staff of its employees and did not “introduce best-practice disciplines of data science into the collection, organization, and analysis of faith-based screening data,” as represented to investors. IIL employees’ research was primarily limited to cross-referencing company names with donor and sponsor lists of well-known national organizations that it determined were associated with Prohibited Activities. Thus, despite its representations to clients, IIL did not typically conduct research at an individual company level to determine whether a company engaged in any of the Prohibited Activities.
7. Consequently, on numerous occasions, IIL’s screening process resulted in the ETFs and SMAs investing in companies that engaged in Prohibited Activities. IIL excluded certain companies from the investment universe for engaging in Prohibited Activities, while its manual research process failed to identify and exclude other companies that engaged in similar Prohibited Activities, according to publicly available information.
8. As a result of the above, ILL made material misrepresentations to clients and investors about how it would invest and failed to adhere to the ETFs’ and SMA clients’ investment criteria.
9. ILL also failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder. ILL lacked written policies or procedures establishing a due diligence process that would support the representations made to investors and clients. It also lacked written policies and procedures setting forth a process for evaluating companies’ activities as part of its investment process, which at times resulted in inconsistent application of ILL’s investment criteria in determining that certain sponsorships, donations, or products were Prohibited Activities while other companies’ similar activities were not deemed to be Prohibited Activities.

Based upon its findings above, the SEC concluded that IIL violated (i) Section 206(2) of the Advisers Act, which makes it unlawful for an investment adviser to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client, (ii) Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder, which together make it unlawful for any investment adviser to make any untrue statement of a material fact or to omit to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading, to any investor or prospective investor in the pooled investment vehicle, or otherwise engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative with respect to any investor or prospective investor in the pooled investment vehicle, (iii) Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which together require a registered investment adviser to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder by the adviser and its supervised persons, and (iv) Section 34(b) of the 1940 Act, which makes it unlawful for any person to make any untrue statement of a material fact in any fund registration statement, application, report, account, record, or other document filed or transmitted pursuant to the 1940 Act, or to omit to state therein any fact necessary in order to prevent the statements made therein, in the light of the circumstances under which they were made, from being materially misleading.

Without admitting or denying the SEC’s findings, IIL consented to being censured and agreed to pay a civil penalty of $300,000 to the SEC.

ADDITIONAL ROPES & GRAY ALERTS AND PODCASTS SINCE OUR JUNE – JULY 2024 UPDATE

Indiana Lawsuit Against BlackRock
September 24, 2024
According to a release dated August 22, 2024, Indiana Secretary of State Diego Morales issued a Summary Cease and Desist Order (the “Order”) against BlackRock, Inc. (“BlackRock”) seeking to stop BlackRock’s alleged fraudulent actions related to its environmental, social and governance (“ESG”) funds and allocation focus. While the Order is styled as a cease and desist order, it is in effect a complaint initiating an administrative proceeding in the Indiana Securities Division (the “Securities Divisions”).

The Securities Division alleges that BlackRock has repeatedly made false and misleading statements to Indiana investors through its assertions relating to ESG products and offerings. The Securities Division takes issue with BlackRock’s assertion to clients that they would experience better long-term financial outcomes by investing in ESG-backed funds. The Securities Division has also called out BlackRock’s commitment to using its assets under management to incorporate ESG considerations despite the fact that it markets certain funds as non-ESG funds.

Podcast: Culture & Compliance Chronicles: How Corporate Culture Drives Investment and Performance Outcomes
September 10, 2024
On this episode of Culture & Compliance Chronicles, Amanda Raad and Nitish Upadhyaya from Ropes & Gray’s Insights Lab, and Richard Bistrong of Front-Line Anti-Bribery, were joined by Stephanie Niven, a portfolio manager at Ninety One, for an engaging conversation on the significance of corporate culture as a source of competitive advantage and its role in driving sustainable investment returns. Stephanie shared her insights on the importance of diversity, equity, and inclusion in the investment space, the evolution of ESG expectations, and discussed the framework used by Ninety One to assess (not measure!) and influence corporate culture. The conversation offered a deep dive into the practical aspects of fostering a positive corporate culture and its direct impact on business performance and investment success.

Urgent QPAM Compliance Deadline: QPAMs Must Register with the DOL by September 15, 2024
September 5, 2024
The qualified professional asset manager (“QPAM”) class prohibited transaction exemption 84-14 (“the QPAM Exemption” or “PTE 84-14”) is one of the most widely used and important exemptions for asset managers. Managers of funds and separate accounts subject to ERISA are also often required to make representations regarding their QPAM status in order to enter into common transactions and trading agreements (e.g., ISDAs, purchase and sale agreements, credit agreements and investment management agreements). Even managers who do not have ERISA funds or accounts may take steps to qualify as QPAMs so as to be prepared in the event that a fund holds ERISA plan assets in the future (this is especially true for open-ended funds). In April, the U.S. Department of Labor adopted amendments to the QPAM Exemption that are having a dramatic effect on how certain managers operate.

SEC Issues Guidance on Fund Liquidity Risk Management Programs and Amends Forms N-PORT and N-CEN
September 5, 2024
On August 28, 2024, the SEC published a release (the “Release”) containing guidance based on the SEC staff’s monitoring of funds’ liquidity classifications and liquidity risk management programs mandated by Rule 22e-4 under the 1940 Act (the “Guidance”). The Guidance covers issues concerning:

• How frequently a fund should review the liquidity classifications of its investments;
• The meaning of the term “cash” under Rule 22e-4, which excludes foreign currencies, and the implications of this exclusion; and
• Relevant considerations when determining a fund’s highly liquid investment minimum (“HLIM”).

The Release also adopts amendments to Forms N-PORT and N-CEN that are consistent with the amendments proposed in the SEC’s now-postponed 2022 proposals to overhaul open-end fund liquidity risk management programs and to implement mandatory swing pricing for all open-end funds, except money market funds.

Podcast: Interval and Tender Offer Funds for Private Fund Managers
August 29, 2024
On this Ropes & Gray podcast, asset management partners Chelsea Childs and Catherine Skulan discussed considerations for private fund managers seeking to explore the expansion of their business into alternative retail products. They shared insights on the benefits of accessing a broader investor base, highlighted alternative fund types – interval funds and tender offer funds – that are more suited to private investment strategies and discussed key considerations for managers looking to break into the registered funds space.

August 2024 Asset Management ESG Review
August 19, 2024
Ropes & Gray closely monitors the rapidly evolving ESG landscape, helping asset managers and institutional investors navigate the dynamic ESG regulatory environment and keep on top of emerging ESG trends and industry best practices. This first edition of Asset Management ESG Review provides an overview of significant ESG developments over the first half of 2024, and compiles related insights from Ropes & Gray attorneys, drawing on the full breadth of the firm’s expertise. This edition covers a broad range of recent ESG topics, including U.S. and non-U.S. regulatory developments, litigation matters, legislative initiatives, and industry and trade group news.

Podcast: A Word for Our Sponsors: GP-Led Secondaries Outlook with Devon Park Advisors (Part I)
August 15, 2024
In this podcast, Deb Lussier, partner and co-leader of the sponsor solutions practice at Ropes & Gray, and Marc Migliazzo, counsel in the sponsor solutions practice, delved into the dynamic world of GP-led secondary transactions with special guest Jon Costello, founder and managing partner of Devon Park Advisors, a boutique investment bank with a core focus on continuation fund transactions. On this episode of A Word for Our Sponsors, the first in a two-part podcast series, they discussed the current market trends, the history and future of continuation fund transactions, and the perspectives of both sponsors and limited partners. This podcast provided valuable insights into the strategic considerations for executing successful GP-led secondaries and the importance of early engagement and clear communication in these deals.

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If you would like to learn more about the issues in this IM Update, please contact your usual Ropes & Gray attorney contacts.