COVID-19 has impacted the operations of all businesses and financial institutions, including registered investment advisers. In many areas, the regulators have provided additional support to help market participants address their business, operations and compliance protocols in light of the pandemic. Armed with this new guidance and other industry best practices, Calfee has prepared the following tips for registered investment advisers to keep in mind as they look to navigate this tumultuous time.
Communicate With Clients, But Avoid Hyperbole
During these times of stress,
registered investment advisers often find themselves as a trusted resource and positive influence to help their clients remain optimistic. The markets have experienced significant negative shocks before and ultimately recovered, every time. That said, it can be easy to let optimism or politeness paint a more cheerful picture than actually exists. Equipped with patience and purpose, firms should be cautious not to provide any guarantees or flowery descriptions of future performance to clients despite their elevated emotions, which could help mitigate against any future risks of litigation and/or client complaints.
Review Risk Disclosures
If the aftershocks of this pandemic are
anything like the last financial crisis, advisers should be ready for quite a roller-coaster ride. In volatile markets, it’s important to take inventory of what risks are present in your own investment strategies, and perhaps more importantly, what risks you have previously disclosed to clients. Most firms should take some comfort in knowing that the disclosures it already had in its Form ADV and investment advisory agreements will typically cover volatility and distressed markets. That said, does implementation of the firm’s stated investment strategy contemplate its key professionals working remotely for an extended period of time? It’s unlikely that many advisers had previously disclosed specific risks attributable to pandemics, though most likely will moving forward. Firms should consider this a good time to start bulking up relevant client materials.
Establish Supervision That’s Appropriate for a Crisis
In a remote work setting, the ongoing monitoring of employees and escalation of compliance and other material issues as an adviser can present unique challenges. Internal reporting channels may be cut off as a result of isolated employees and the inability of individuals to connect in person.
To ensure the proper escalation of issues occurs, firms should consider building an escalation infrastructure that can function even during the execution of a business continuity plan. Some specific items firms should consider include:
- Providing key stakeholders and those holding critical information with multiple outlets and points of contact.
- Leveraging technologies like Zoom, Microsoft Teams, and Cisco WebEx to provide enhanced supervision where in-person connectivity isn’t available.
- Having a process in place for both the proper internal and external escalation of issues that may occur, including details of the supervisory chain.
- Firm leadership should look to connect with each other and their direct reports as often as they can, even daily if possible.
Finally, in regard to the proper supervision of investment adviser representatives (“IARs"), firms should remain vigilant on regulatory guidance for state licensing requirements. The COVID-19 pandemic presents uncharted territory in the duration of time that certain individuals may be forced to work from home. For those IARs whose offices may be located in a state other than their own residence, firms should start preparing for the prospect that they need to register individuals in new territories.
Keep Good Documentation of Books and Records and Information Security
Even in a crisis,
firms must continue to meet their regulatory burden of keeping accurate books and records and protecting the sensitive information of their clients.
Identification: As issues arise in the execution of a firm’s business continuity plan and in any remote work setting, firms should be explicit in the documentation of issues that arise that affect the normal course. Furthermore, firms should document the specific cybersecurity and data privacy precautions that are being taken to protect client information, particularly in light of the COVID-19 cyber alert and additional guidance from the U.S. Department of Homeland Security. Firms should be on heightened alert for pandemic frauds such as client impersonations and insider trading and should document any red flags accordingly.
Remediation: Where firms discover certain inconsistencies or irregularities in their ability to execute day-to-day operations (including issues with proper recordkeeping), firms should document in detail their attempts to fix the issue to the extent possible. The notes the firm takes will likely serve as the best protection against future deficiencies (in SEC examinations) and relief from possible enforcement.
Analysis: Never let a
good crisis go to waste. With the challenges presented by COVID-19, firms also will have unique opportunities to dramatically enhance their ability to sustain business operations in the event of future significant business disruptions, cybersecurity threats, global pandemics, etc. The good documentation and notes outlined by firm employees throughout the crisis cannot only serve to highlight the effectiveness of the firm’s business continuity plan (and compliance program), they can also serve as the best learning material to develop an impact analysis and enhance the firm’s internal controls in the future.
Consider Effects on Private Funds
Given the tumult
experienced in the public markets, private fund advisers might feel protected from many of the compliance and operational challenges facing most advisers. That said, private fund advisers face their own set of distinct challenges in light of COVID-19.
Private fund advisers relying on the “audit provision” of the Custody Rule should consider if they will be able to produce their financials in a timely fashion. Outside of COVID-19, the SEC has previously said they would not recommend enforcement if “unforeseeable circumstances” caused the adviser’s inability to provide audited financials on time, so long as the adviser had reasonably believed the fund’s audited financials would be distributed within the 120-day deadline. After an internal analysis, if a firm determines it is unlikely to distribute the audited financials on time, the firm should document in specific detail the “unforeseeable circumstances” that will not allow for proper distribution.
In addition to the above, private fund advisers should be sure to reexamine fund offering documents to consider
the following types of considerations:
- Are there any gates or suspensions triggered by high levels of redemptions?
- Do any side letters contemplate special rights or preferential redemptions in periods of crisis?
- Does the fund allow for in-kind distributions in certain situations?
- Have any ongoing capital calls been interrupted or halted as a result of potential defaults?
Finally, as private fund assets become increasingly illiquid, firms should be wary of shifting valuation methodologies. Having learned from the last financial crisis, the SEC will evaluate the basis for any crisis-related changes to internal policies and procedures with a skeptical eye, particularly shifting valuation strategies that benefit the adviser.
If Possible, Avoid the Regulatory Relief for Form PF
The deadline for registered investment advisers and exempt reporting advisers to file Form PF (for private fund advisers) is fast approaching (April 29, 2020). The SEC has issued
subsequent orders (March 13, 2020; March 25, 2020) which extend the deadline for Form PF (and related delivery requirements) if certain conditions are met, most notably to inform the SEC and its clients that the adviser will not be able to meet the previous deadline.
To the extent possible, we would recommend advisers complete their regulatory filings in a timely fashion, thus removing any potential cause for alarm by clients or setting off any red flags with the SEC regarding the adviser’s own operations and compliance program (and business continuity plan).
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Updated on March 31, 2020 at 8:00 p.m. ET.