Asset Management Transatlantic Regulatory Roundup: Differences In SEC And FCA Regulation Of Fund Advisers (Podcast)

On this Ropes & Gray podcast, join asset management partners Eve Ellis and Jason Brown as they delve into key regulatory issues impacting clients with interests in both the United States and Europe. Specifically, they explore the differences in how the U.S. Securities & Exchange Commission (SEC) and the U.K. Financial Conduct Authority (FCA) supervise and regulate fund advisers. They compare and contrast the differing approaches to registration, oversight, and examination. Additionally, they highlight some of the current priorities for both the SEC and the FCA.

Show Notes:

Eve Ellis: Hello, and thank you for joining us today on this Ropes & Gray podcast—Asset Management Transatlantic Regulatory Roundup. I'm Eve Ellis, an asset management partner in our London office, specializing in private fund regulation. Joining me today is my colleague Jason Brown, an asset management partner in our Boston office, and co-head of our private fund regulatory group. Many of our clients have touchpoints in the United States and Europe, and we've designed this podcast series to help provide an overview of some of the topics and regulatory issues relevant to these clients. One of the areas we discuss regularly is the difference in how the SEC and the FCA supervise and regulate fund managers and we thought we would focus on this area in today's podcast.

Jason, at a high level, how would you describe the SEC's approach to supervision of fund managers?

Jason Brown:

• The SEC requires an adviser to meet an AUM test in order to register. There are a few exceptions to that test, but most advisers register on the basis of having at least $100M in AUM.
• Having met that requirement, an adviser can register with the SEC using Form ADV.
• Form ADV has several parts, but most advisers we work with complete Part 1A ("fill in the blank" data about the adviser), Part 2A (a narrative description of the business, including strategies, fees, risks and conflicts), and Part 2B (certain biographical and conflicts information on investment personnel). Only Parts 1A and 2A get filed with the SEC.
• By law, the SEC has up to 45 days to grant registration or bring a proceeding to deny it.
• The review of Form ADV tends to be cursory. Comments from the SEC tend to be technical in nature (forgetting to include a middle name in the listing of directors and officers) and are rare.
• In my more than 25-year career, I have never had the SEC bring a proceeding to deny registration. The only exception is when the SEC stopped granting registration for non-U.S. advisers from countries with privacy laws that conflicted with the Advisers Act recordkeeping rules (which has now been resolved for many countries).
• Typically, registrations are granted without any comment or follow up, usually in the fifth or sixth week after filing, although sometimes as early as the third week.

Eve, how does this compare with the U.K.?

Eve Ellis:

• It is certainly a longer process in the U.K. Firstly, the type of licence will dictate the process and fund advisers/managers can be approved with different regulatory permissions depending on the activities they undertake. So, unlike the U.S., there is no AUM test—if an adviser performs a regulated activity it will need to be licensed, but managers with a lower AUM may be able to benefit from a slightly lighter touch regime.
• Broadly, the authorisation process can take many months. The applications are detailed and require significant supporting documents, and the FCA will review in detail. Most authorisation processes will involve multiple rounds of questions/interactions with the FCA.
• Generally, approvals are taking anything from between 6-18 months. As such, it is a significantly longer process than getting approved as an RIA in the U.S.

Jason Brown: That is a long time—are there ways to be up and running more quickly?

Eve Ellis:

• The U.K. has a regime known as the "appointed representative regime."
• If an adviser is providing limited services, it may be able to use this route, which in practice means it shelters under the licence of an existing FCA regulated entity, known as a "principal firm." These are usually third-party service providers who charge a monthly fee, and in effect, they stand in place of the regulator for the appointed representative.
• The FCA has been reviewing this regime in detail over recent years and there is therefore more scrutiny by the FCA of principal firms. However, it remains in place and allows a new adviser to be up and running within a few months. As mentioned, you can only use this if you undertake limited activities—broadly, providing non-discretionary investment advice and arranging deals.

Jason, it sounds like the FCA are more intrusive and take longer to approve an adviser, but what about ongoing supervision?

Jason Brown:

• The SEC has an extensive examination program.
• Exams occur on an undefined periodic basis, but if I have to give an average, probably around every 4-6 years.
• Exam timing depends on the SEC's evaluation of many different factors, including the AUM, investment types (e.g., if you use derivatives and leverage), types of clients (retail vs. institutional), any interesting press out there, and how well the last exam went.
• In addition to these regular exams, there are newly registered adviser exams (a kind of "get to know you" exam that tends to be lighter), sweeps (if the SEC is interested in a particular topic (e.g., compliance with new marketing rule)), and for cause exams (often whistleblower exams).
• During an exam, the SEC will give multiple lists requesting documents and interview personnel.
• Most exams are about 6-9 months, but many go on well over a year.
• At the end, the SEC issues a deficiency letter, which lists all of the places that the SEC believes that the adviser did not follow the Advisers Act. While this document is not public, many clients/investors ask to see it in fundraising.
• If the SEC believes such deficiencies are egregious enough, they will bring an enforcement action, which results in fines, penalties, and a very public press release. The bar for that is not as high as you might have hoped. This is not just for insider trading and outright fraud, but rather more minor offenses as well, depending on a variety of circumstances.

Eve Ellis:

• The SEC exam approach is certainly a key difference between the regulators.
• A U.K. adviser wouldn't generally expect to be visited by the FCA. Instead, the FCA does thematic reviews (similarly to the SEC's sweeps), and advisers may be included within those visits and reviews.
• If the FCA sees deficiencies in these reviews, it could result in enforcement action. However, this would generally only happen if issues persisted following engagement between the FCA and the adviser.

One area where we notice a difference is how advisers interact with the regulator. The FCA is a principles-based regulator, and one of its principles is to be open and honest with the FCA and inform it of anything an adviser thinks the FCA should be aware of—known as Principle 11 notifications. For this reason, if an issue arises within the U.K. adviser or within the group, it may be necessary to proactively tell the FCA about this. I have found there is a different approach with how a U.S. adviser may handle a similar situation—is that right?

Jason Brown:

• For the most part, an adviser is not required to self-report issues to the SEC.
• In public speeches, the SEC encourages advisers to self-report when compliance matters arise, on the theory that the SEC will go easier on the adviser.
• The issue is that the SEC will still bring enforcement on many issues self-reported to it. In the final enforcement order, they will note that the fine was X, instead of something higher, because of the self-report.
• However, the damage of an enforcement action for most institutional advisers is not the fine itself, but rather the extensive and expensive process of defending the action, as well as the bad press that results.
• As a result, most advisers will not self-report when compliance issues arise, but rather handle the issue internally (investigate why it happened, improve procedures to ensure it does not happen again, and sanction individuals at the firm if necessary).

Eve Ellis:

• One other area where there are some differences is the regulatory approach to senior managers within advisers. A few years ago, the FCA extended its senior managers and certification regime to fund advisers.
• This requires anyone performing a senior management function (e.g., board member or Money Laundering Reporting Officer) to be specifically approved by the FCA before performing this role and any persons performing certified roles (investment functions and heads of business units) to be certified by the adviser as being fit and proper.
• The regime also has specific conduct rules individuals need to comply with.
• The aim of SMCR was to create accountability for individuals operating within the financial services sector. This has led to enforcement action against senior managers.

Jason, is there a similar regime/concept in the U.S.?

Jason Brown:

• The SEC does not have an approval process for senior management or any personnel at an investment adviser. Similarly, there are no examination requirements at the federal level (unlike, say, broker-dealers and advisers subject to state regulation).
• While you do have to report the disciplinary history of such persons to the SEC, it is exceedingly rare that the SEC takes any action as a result.
• I would also add that it is rare for the SEC to go after individuals personally in enforcement actions against advisers. Typically, it is the adviser entity itself that is subject to enforcement, rather than individuals. It happens in less than 5% of the enforcement actions that I have been involved with.

Linked to this, one of the areas we have discussed before, Eve, which is different, is remuneration and capital. Is it right that U.K. advisers need to hold regulatory capital and also have specific remuneration policies in place, which is not the case in the U.S.?

Eve Ellis:

• This is a key difference, and both the capital and remuneration regimes have changed quite significantly for fund advisers over recent years.
• Depending on various factors, including permission scope, AUM, and revenue levels, an adviser will need to hold an amount of regulatory capital, which is likely to be at least 1/4 of fixed overheads.
• In addition, all advisers will need to have remuneration policies in place, which, for certain advisers, will include clawback arrangements, and there is also a need to make public disclosure in relation to remuneration.

We have covered the general differences, but what is keeping the SEC busy at the moment—what are some of the key priorities?

Jason Brown:

• Texting enforcement actions
• New marketing rule
• Fees/expenses, particularly for management fee post-commitment period for closed-end funds and expense allocation across funds and co-investors
• Lines of credit, both conflicts and how related expenses get allocated

Eve, same question to you: What are some of the FCA's hot topics?

Eve Ellis:

• ESG /sustainability
• Financial crime
• Market abuse
• Private market valuations

Jason Brown: Thank you, everyone, for listening. For more information on the topics that we've discussed or other topics of interest that impact asset managers, please do visit our website, www.ropesgray.com. And, of course, if you have any queries or if we can be of any assistance on any of these topics, please do get in touch. You can also listen to this and subscribe to the podcast series wherever you regularly listen to podcasts, including Apple or Spotify. Thank you again for listening.

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