Short-Termism, the EU Shareholder Rights Directive, and Their Relevance to Shareholder Disclosure
Recent consultative processes in Europe and the United States reflect the interest being shown by regulators around the world in the problem of “short-termism” in capital markets. Seen by concerned parties as the promotion of an unhealthy obsession with short-term gains, at the expense of long-term allocations that would ultimately provide greater benefits to companies, investors and society generally, short-termism is being met with a variety of regulatory responses.
On July 18, 2019 in the United States, the SEC held a short-termism roundtable which considered, among other things, the value of quarterly reporting for companies, which may place undue importance on short-term financial results. In the EU, on July 29, ESMA closed its window for its consultation on “undue short-term pressure from the financial sector”, which sought input from market participants on topics such as investment horizons, disclosure of ESG (environmental, social and governance) factors, fair value accounting and credit default swaps. Similar initiatives are occurring elsewhere in the world, for example in Argentina where on May 29 the Ministry of Finance published its new Productive Financing Law, which endeavors to channel savings toward long-term investments and “the real economy” through capital markets.
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Such developments coincide with statements made by the International Organization of Securities Commissions (IOSCO), whose members regulate 95% of the world’s securities markets. Most recently, in June IOSCO’s Growth and Emerging Markets Committee issued guidance on ESG matters, recognizing the “increased emphasis recently on the need for longer-term investment for several reasons, including financial stability.”
We have already seen previously how short-termism concerns can affect shareholder disclosure obligations. In France for example, as we wrote in an article jointly published with the law firm Simmons & Simmons (here), as of 2016 the “Law Aiming to Reconquer the Real Economy” (aka the Loi Florange) triggered double-voting rights for registered shareholders that have held their shares for at least two years in listed companies. While the merits of the law can be debated (many have pointed out that instead of promoting a long-term view, it merely favors entrenched interests), and moreover issuers can vote to opt-out of the law and thus restore their uniform one-vote-per-share system (which many issuers have chosen to do), what is clear is that for shareholder disclosure purposes, investors on French markets need to pay close attention to the number of voting rights they hold and the number of issuer voting rights outstanding.
More recently, and more broadly across the EU, disclosure of both issuer and shareholder information is being affected by the amended Shareholder Rights Directive (“SRD II”). Addressing short-termism – its longer official title refers to “the encouragement of long-term shareholder engagement” — SRD II was in large part required to be implemented by EU countries by June 10, 2019. These provisions include requirements that asset managers and institutional investors create a “shareholder engagement policy” and publish it on their website annually, and that asset managers annually make available to their institutional investors a report on how their investments contribute to the medium-term and long-term performance of the institutional investor or of the fund.
Remaining portions of SRD II, which must be implemented by EU countries by September 3, 2020, will affect asset managers as well. To facilitate engagement between issuers and their shareholders, one such provision empowers issuers with the right of “shareholder identification.” Under this provision, each EU country must give issuers in its territory the right to identify their shareholders (such as asset managers), but retains the discretion to shield smaller shareholders from identification if it so chooses. Thus each EU country may set a threshold of shareholder ownership — but at no more than 0.5% — below which the issuer has no statutory right to identify the shareholder. What this effectively means for asset managers is that, depending on where the relevant issuer in which they invest is registered within the EU, they will be subject to identification when acquiring any shares at all, or when acquiring a certain threshold ownership level of at most 0.5%. Note also that the shareholder itself will not be required to submit a disclosure, but rather it’s the relevant intermediaries that will identify the shareholder (using the format set forth in “Table 2” of the relevant EU Commission Regulation here) upon the issuer’s request (made in the format set forth in “Table 1”). As for disclosure deadlines, intermediaries will be required (i) to transmit such issuer requests “to the next intermediary in the chain” by the close of the same business day (or if it receives the request after 4pm, by 10am on the next business day), and (ii) if applicable, to send its disclosure to the issuer by close of the following business day (or the business day after the record date, whichever is later).
This post was excerpted from CSS’s monthly Regulatory Updates newsletter, which features news on substantial shareholding, short selling and position limits from around the globe.
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Effective Compliance Policies & Procedures and Annual Reviews: Meeting the Reasonably Designed Standards
Sometimes it seems that enough is never really enough. While compliance officers have grown intimately familiar with SEC Rule 206(4)-7 over the past 15 years since the Rule became effective, deficiencies in connection with the Compliance Program Rule continue to rank among the most frequently cited issues identified in OCIE examinations of investment advisers. It seems that the bar is constantly rising.
Simply having written policies and procedures, and conducting an annual review is not enough! As CCOs, we must implement compliance policies and procedures that are “reasonably designed to prevent violations” and review their “adequacy” and the “effectiveness” of their implementation. Conspicuously, the Rule does not explicitly direct CCOs to identify and address violations; rather, the goal is prevention.
It’s a bit of a chicken-and-egg situation: if you have a violation, you have to ask whether your policies and procedures were reasonably designed to prevent the violation. According to the People’s Law Dictionary, “reasonable” means just, rational, appropriate, ordinary or usual in the circumstances. “Reasonable,” of course, is in the eye of the beholder. In this case, the beholder is the SEC.
In considering the reasonably designed standard, confirm that your compliance policies and procedures address the topics noted in the Rule’s adopting release. Also, determine what additional policies and procedures your firm may need to address conflicts and risk exposures relating to its particular operations. They need to be tailored to your firm and you must ensure they are appropriate in light of staff and other resources, such as technology. Remember that if you’re violating your own policies, this is going to be cited, so don’t set yourself up to fail.
It’s important to keep abreast of business developments in order to timely update or implement new policies and procedures. Be sure to attend and actively participate in meetings you’re invited to, and consider inviting yourself to be a guest at meetings you don’t normally participate in. These can be great opportunities to think about how the firm’s policies and procedures are functioning on a day-to-day basis. As a practical matter, when updating your compliance manual or implementing new policies and procedures, ask the people who will be performing the tasks to review and provide input.
By Rule, a review of the compliance program must occur no less than annually. In reality, most CCOs review policies and procedures continually throughout the year by performing testing and overseeing the implementation of and compliance with policies and procedures. Conducting an effective review requires questioning such as:
- Have problems with the subject matter area addressed by the policy been detected?
- Based on what has been detected, should the policy be revised or amended?
- Is there a better approach to preventing violations of the policy?
Approaches to testing should vary and the frequency of testing is generally determined by the risk associated with the function. Leverage technology to the extent possible. Determine the capabilities of existing software including reporting capabilities. Exception reports can automate certain reviews, for example, to flag for violations of investment guidelines. As a reminder, when testing the compliance policies and procedures, be sure to test the technology systems you rely upon to ensure they are functioning as intended.
While Rule 206(4)-7 does not require the Annual Review to be memorialized in a written report, it’s awfully hard to prove that the review occurred if it isn’t memorialized in some form. Some CCOs prepare a detailed report outlining the testing that occurred, results, violations and recommendations, while others prefer more of a high-level summary. Regardless of the format, the Annual Review Report should be a compilation of the ongoing compliance program reviews conducted throughout the course of the past year.
Remember: the SEC will ask for your annual reviews. Even if you take a high-level summary approach, be prepared and knowledgeable about what the review entailed, what issues were identified, and be sure you’re taking action on all recommendations. Your annual review, and the report memorializing the review, will be key in demonstrating the reasonableness and effectiveness of your compliance program.
Interested in learning more tips on Meeting the Reasonably Designed Standard? Listen to our recent ComplianceCast webinar.
Need help with your annual review? Check out our services and contact us.
7 Reasons to Attend Our Scottsdale Fall 2019 Compliance Conference
If you’ve been considering joining us in Scottsdale for our Sept. 23-25 compliance event, here are seven reasons you should take the plunge now!
- The Best Mix of Informational & Educational Speakers – We just added OCIE’s Co-National Associate Director of Investment Adviser/Investment Company Examination Program Marshall Gandy to our stellar list of presenters. He joins ex-NFL star Merril Hoge, CFTC Senior Economist George Pullen, Mayer Brown Partner Stephanie Monaco, AIG Life & Retirement CCO Mark Happe, University of Virginia Darden School of Business Professor Mary Darden and more!
- An Exciting Balance of Learning, Fun & Charity – Sessions are informational yet collaborative, and we make sure to sprinkle in valuable networking breaks and delicious meals. New for this year, take part in charitable events to benefit local causes, including a free round of golf at the top-rated Gainey Ranch Golf Club!
- A Deep Focus on the Latest – Worried about recent SEC Risk Alerts or the adoption of new rules like Regulation Best Interest, and how they’ll affect your firm? We’ll deep-dive into those key topics and many more.
- Forge Valuable Connections with Peers – Our attendees continually cite the ability to share ideas with colleagues in a relaxed setting and the creation of long-lasting relationships as key benefits of their conference experience.
- Discover Innovative Products, Services & Solutions – Our exhibitors and CSS team members are happy to address questions that are specific to you firm’s needs, one-on-one.
- We’ve Extended our Pricing Discount! – Use code azearlybird for $600 off.
- The Hotel Group Rate Cutoff Is Nearing! – Hotel rates rise after August 21; make reservations before it’s too late.
At CSS, we’re always looking for ways to make sure that your conference experience goes far past sitting in a classroom. Join us using our discount code and experience all we have to offer! Still not sure? Visit the following links for additional information:
Agenda | Speakers | Travel & Accommodations | Registration
Refocusing on Position Limit Monitoring & Substantial Shareholding
In recent months, we have begun to offer roundtable events focusing on important, evolving topics within the compliance world. These breakfast briefings are designed to be collaborative exchanges, and our recent two-part series addressed challenges posed by position limits and substantial shareholding.
A select and diverse group of investment managers were invited to each session, for the purpose of diving into details about these challenges that continue to frustrate holders of shares and derivatives in markets across the world. Below I’ll highlight the topics discussed by our attendees as well as Mike Marmo, the product head for CSS’ solution for substantial shareholding and position limits (Signal), and yours truly, CSS regulatory expert for the topics covered.
Positionslimitüberwachung
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In this session on position limit compliance, Mike and I went into depth on some common tripping points we have seen asset managers contend with, such as the following:
- Precisely assessing “spot month” effective periods
- Knowing which listed products aggregate into others for holdings calculation purposes
- Understanding “diminishing balance” calculations
- Considering proper contract ratios (such as for “mini contracts” held)
- Sourcing “open interest” data that can sometimes determine a position limit
These issues found a sympathetic audience among the roundtable participants, who didn’t hesitate to recount their own experiences and insights. Regarding spot month effective dates, for example, a compliance officer for a large US-based asset manager ($30 billion+ AUM) highlighted the importance of sourcing local exchange calendars to understand non-trading days such as holidays, rather than relying on data providers that may use only one calendar (e.g. New York banking calendar) to assess spot periods for all of its various positions. The officer also traded useful information with a compliance head at another large firm ($200 billion+ AUM) about whether and when to switch its sourcing of the spot period from the relevant product’s trading calendar (e.g. “First Business Day of the Contract Month”), to a specific calendar date published by the exchange (e.g. “September 3, 2019” if September 2 happens to be a non-trading day) which is often released several weeks prior to the spot period. A similar talking point was generated about “open interest” figures for listed products, which can determine position limit levels and are sometimes published shortly before position limit effective dates.
“Diminishing balance” requirements also sparked discussion, notably given the lack of useful guidance released by some exchanges. The relevant calculation, which allows a position holder to reflect a reduced position over time during the spot month or “delivery month” period, can be complicated by product aggregation requirements, as well as by adding or disposing of contracts held.
Future developments and improvements for position limit compliance were also considered. A compliance manager from a large firm ($500 billion+ AUM), for example, introduced the topic of pre-trade evaluation using “API calls,” which would allow portfolio managers to understand prospective holdings before positions are settled.
Substantial Shareholding Disclosure
Like the position limit discussion, the session on substantial shareholding struck a fairly even balance between regulatory and data concerns, while understanding that these two facets of compliance tend to overlap. Among the particular challenges Mike and I addressed in depth were the following:
- Understanding and sourcing the required “denominator”(issuer outstanding shares amount) for calculation of ownership percentage held
- Sourcing proper third-party reference data
- Looking through to constituents of index products and ETFs held
- Notification procedures
- Requirements for aggregation across funds and investment manager entities
A compliance officer from a mid-sized manager ($5 billion+ AUM) immediately sparked discussion by posing a commonly heard question: How do you keep up with the regulatory requirements in all of the jurisdictions in which you invest? The responses largely depended on the internal compliance resources available within each attendee’s firm, yet a frequent refrain was that using an outside source for compliance information and efficiencies – be it a law firm, consultant, software vendor or all of the above – is essential in tackling this challenge if you hold securities listed in multiple countries. The compliance officer pointed to obtaining accurate “shares outstanding” amounts as a particularly vexing aspect of this challenge across various jurisdictions, as it presents both a regulatory question (which source must be used?) and a data sourcing hurdle (how can we efficiently ingest this required data?), which must be answered to arrive at an accurate percentage of ownership held in a relevant issuer.
The discussion evolved into sourcing regulatory reference data, which includes information such as lists of issuers involved in a takeover bid (which can trigger threshold filing requirements as low as 1%), European securities lists for the purpose of understanding trading venues (such as ESMA’s FIRDS, and “Exempted Shares” list for short selling purposes), Hong Kong’s “Designated Securities” list, and Belgium’s list of issuer-imposed thresholds. The above-mentioned compliance officer, as well as another firm’s ($10 billion+ AUM) compliance manager, emphasized in particular the need for accurate reference data when investing in “sensitive industries.” With threshold investing limits imposed by various agencies within any given country, for investing in commonly protected industries such as telecom, mining, armaments, transport and media, holders of securities must understand which issuers fall into the relevant categories. As the latter compliance manager recounted from experience, holding a 10% stake in an airline, for example, can potentially cause the investor to itself be considered an “airline” under a strict jurisdiction’s laws. And as another compliance manager from a smaller investment manager ($200 million+ AUM) observed, such unpredictability makes it difficult even to know the regulator or agency whose rules must be followed.
That attendee from the niche firm, as well as others at the table, also traded information about how to submit disclosures, once having reached a filing threshold. A gamut of experiences was recounted: from the firm with modest holdings that may initially prefer to understand only the black-letter regulatory information (confirming that its holdings do not approach any filing thresholds), to the larger asset manager that files with regulators frequently and also wants to stay abreast of higher thresholds at which public disclosures may be required.
Taking stock
Mike and I viewed these roundtable sessions as a tremendous success, as did CSS, leaving no doubt that we’ll be conducting several more in the near future. We were glad to hear the participants’ feedback confirming this, and we look forward to more fruitful discussions. Can we still improve? Always. For example, some attendees desired even more interaction, in less scripted blocks of time. Duly noted! As always, thanks for reading, and if you’re interested in learning more about our position limit monitoring and shareholding disclosure solution, feel free to visit our Signal page or contact us directly.
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Serious Security Flaw Discovered in Three Widely Used VPNs – Update Now!
Virtual Private Networks (“VPNs”) are a secure way for employees to access firm files remotely, whether working from a home office or while travelling. They work by creating an encrypted connection from a laptop or PC to a firm’s server and allowing users to securely access and transfer files while out of the office.
Access to a VPN is typically gained by entering credentials and verifying your identity with an additional step, usually a multi-digit code or authorization through a pre-configured app.
According to two security researchers, a serious flaw was “accidently” discovered recently, which could allow hackers access to firm networks without requiring any credentials at all. “We could compromise the VPN server and corporate intranet with no authentication required, compromise all the VPN clients, and steal all secrets from the victims.” Devcore researcher Orange Tsai told TechCrunch.
In effect, they could have unfettered access to all your firm’s information – that includes data that is personal, proprietary and confidential!
According to technology news site TheInquirer.net, three major VPN providers are affected:
- FortiGate’s FortiOS
Versions 5.6.3 to 5.6.7, 6.0.0 to 6.0.4
Note: This vulnerability is only present if SSL VPN (web- or tunnel-mode) is enabled.
FortiGate has released updates and provides more information about this vulnerability here.NIST has also released a Common Vulnerabilities and Exposures (“CVE”) specific to the FortiOS vulnerability. Info about CVE-2018-13379 can be found here. - Palo Alto Networks’ Global Protect Portal and GlobalProtect Gateway interfaces
GlobalProtect Portal/Gateway Interface (PAN-SA-2019-0020), PAN-OS 7.1.18 and earlier, PAN-OS 8.0.11-h1 and earlier, and PAN-OS 8.1.2 and earlier releases. PAN-OS 9.0 is not affected.
Palo Alto Networks has released updates and provides more information about this vulnerability here.NIST has also released a CVE specific to the Palo Alto vulnerability. Info about CVE-2019-1579 can be found here. - Pulse Secure
Pulse Connect Secure and Pulse Policy Secure products were affected. The company released patches in April 2019 to remedy this vulnerability. If you use either of these products ensure all updates have been installed, especially the patches released by the company in April. Pulse Secure security advisories can be found here.
If your firm allows employees to work remotely and uses VPN software to accomplish this, be sure to ask your IT vendor whether the products mentioned above are in use at your firm; if so, ensure they install the necessary updates immediately!
For more cybersecurity help, here are some helpful resources:
- Webinar – Getting Practical with Cyber, Part I: Testing & Validating Your Risk Controls
- Webinar – Getting Practical with Cyber, Part II – In the Driver’s Seat: Your Critical Role in Cyber Resiliency
- CSS Cybersecurity Solution – Shield
Ask us how we can help tailor a package to meet your needs. Fill out our form here and receive our free checklist for evaluating policies for cyber insurance coverage.
The Challenges of Compliance for State-Registered Advisers
Are you the designated chief compliance officer of a state-registered investment advisory firm? If so, you must be clocking many extra hours these days! It seems the state regulators are just as busy as the Securities and Exchange Commission. New Jersey, Massachusetts and Nevada have all introduced their own Fiduciary duty standard rules. The North American Securities Administrators Association (NASAA) introduced a model act to protect vulnerable adults. In addition, NASAA members voted to adopt an information security model rule package. All this and we haven’t even mentioned the potential implications of the SEC’s new Form CRS on your workload.
Add to that state regulators’ increased frequency of regulatory examinations and you have yourself a nearly unmanageable situation! State CCOs have to work harder on the limited budget that compliance is allotted. And while keeping ahead of the regulations, many investment advisers’ CCOs are also the primary adviser meeting clients and trying to grow their business. But growing your business may be hindered if your compliance program is not up to state standards.
Here are a few topics state CCOs should be focusing on, along with some helpful hints to further guide you in strengthening your compliance program:
- Be aware of the Senior Safe Act and provide your entire staff with training.
- Working with Senior Clients and Vulnerable Adults is a hot topic! Have policies and procedures in place covering this topic: trusted contact forms, SARs reports, etc. Familiarize yourself with the Serve Our Seniors website!
- Cybersecurity is everyone’s concern, but mostly the CCOs these days. Get to know the model NASAA information security and privacy rule and implement protocols to protect your firm. The model rule requires investment advisers to adopt policies and procedures regarding information security.
- Regulatory examinations are challenging, so prepare in advance for when the big day comes.
- Find a resource to keep on top of new regulations.
- Monitor for more than five clients in a new state (or other exceptions) – you may have triggered a new state registration and may be acting as an unregistered adviser in that state. Yikes!
- Figure out if you are keeping all the required books and records. Are you aware that NASAA amended the recordkeeping requirements for investment advisers mode rule? If not, it’s a great exercise to go through the list and ensure you know where the records are located for ease of reference.
So how does one stay ahead of all these moving parts? The reality is that a single blog post can’t address all of the many things that you need to stay ahead of as a chief compliance officer! Participation in our complimentary monthly ComplianceCasts is a great first step toward laying the building blocks of a successful compliance program. You can check out our archive here. Additionally, Ascendant, the compliance services arm of CSS, provides step-by-step compliance with the many obligations of a state-registered investment adviser. If you do not have that great partner, have a look at our service offerings and give us a call!
If you need more help on Form CRS, visit our Ultimate Guide to Form CRS page, with information about the regulation, as well as our solution.