Update: Our May 21, 2020, alert provides our most recent discussion of information and guidance issued by the SEC, FINRA, MSRB and SIFMA.
As reported in prior McGuireWoods alerts (see April 6, March 26 and March 17 updates), financial services regulators have been issuing guidance and relief to assist the industry as financial services firms and public companies continue to deal with the impact COVID-19 is having on day-to-day business operations. As discussed below, this guidance and industrywide relief continues, including with respect to key extended deadlines for compliance with supervisory and other obligations.
The regulators seem to be considering the implications of COVID-19, not only for their registrants but also the downstream impacts. For example, in connection with the relief issued to business development companies (BDCs) discussed below, SEC Chairman Jay Clayton noted, “Many small and medium-sized businesses across the country are struggling due to the effect of COVID-19, and today’s temporary, targeted action will enable BDCs to provide their businesses with additional financial support during these times.”
U.S. SECURITIES AND EXCHANGE COMMISSION (SEC)
Custody Rule Relief
On April 2, 2020, the staff of the SEC’s Division of Investment Management updated its responses to questions about the Custody Rule to address COVID-19-related compliance challenges with respect to the requirement under Rule 206(4)-2 under the Investment Advisers Act of 1940 (the Custody Rule) that physical certificates for privately issued securities be maintained at a qualified custodian.
The staff stated that, where newly acquired physical certificates cannot be placed immediately with a qualified custodian due to COVID-19-related closures and restrictions, enforcement action would not be recommended for failure to maintain the physical certificate by a qualified custodian, provided certain conditions are met, including the following:
- Physical certificates are used only to effect a transfer or to otherwise facilitate a change in beneficial ownership of the security with the prior consent of the issuer or holder of the outstanding securities.
- Physical certificates are appropriately safeguarded.
- The adviser keeps a record of the custodian’s COVID-19-related closure.
BDC Relief to Support Portfolio Companies
On April 8, 2020, the SEC issued a temporary exemptive order to permit BDCs to (i) issue and sell senior securities in order to provide capital to the small and medium-sized companies in which they invest that may be struggling with the impacts of COVID-19 and related market impacts, and (ii) participate in investments in these companies alongside certain private funds that are affiliated with the BDC, in each case beyond what normally would be permitted under the Investment Company Act of 1940 (ICA). The relief under the exemptive order is available until the earlier of (i) Dec. 31, 2020, and (ii) the date by which the BDC ceases to rely on the order.
- Issuance of Senior Securities. The SEC recognized that BDCs may be limited in their ability to issue senior securities if they use the current valuation of their portfolio companies facing financial challenges due to the minimum asset coverage requirements to which the BDCs are subject under the ICA. Under the order, the SEC is permitting BDCs to use an “adjusted asset coverage ratio,” which uses portfolio companies’ Dec. 31, 2019, valuations rather than their most recent quarter valuations in determining whether it may issue senior securities, provided that, among other things: the adjusted asset coverage ratio and adjusted portfolio value are calculated in accordance with the order; the BDC makes an election to rely on the order by filing on Form 8-K; and the board of the BDC has determined the issuance of the senior securities is in the best interest of the BDC after taking into account certain factors, including, without limitation, advice from an “independent evaluator.”
- the adjusted asset coverage ratio and adjusted portfolio value are calculated in accordance with the order;
- the BDC makes an election to rely on the order by filing on Form 8-K; and
- the board of the BDC has determined the issuance of the senior securities is in the best interest of the BDC after taking into account certain factors, including, without limitation, advice from an “independent evaluator.”
- Co-Investments. Rule 17d-1 and other provisions under the ICA impose limitations on a BDC’s ability to enter into co-investment transactions with its affiliates. Under the order, a BDC that previously received an order from the SEC permitting co-investment transactions in portfolio companies with certain affiliated persons may make follow-on investments with such affiliated persons, provided that, among other things: any such transaction is otherwise effected in accordance with the terms and conditions of the existing co-investment order; and the board and a required majority review the proposed follow-on investment, both on a standalone basis and in relation to the total economic exposure of the BDC to the issue.
- any such transaction is otherwise effected in accordance with the terms and conditions of the existing co-investment order; and
- the board and a required majority review the proposed follow-on investment, both on a standalone basis and in relation to the total economic exposure of the BDC to the issue.
Relief From Certain Paper Submission Requirements
On April 2, 2020, staff of the Division of Trading and Markets issued a temporary staff statement providing relief with respect to certain paper submission requirements. Among other things, the staff provided relief to broker-dealers with respect to the paper filing of a notarized annual report pursuant to Securities Exchange Act of 1934 Rule 17a-5(d)(1)(i)(C).
For the period March 16, 2020, to June 30, 2020, the staff will not recommend enforcement action for failure to comply with the paper format requirements and manual signature requirements provided that, among other things:
- the filer or submitter of the impacted paper submission contacts division staff by emailing [email protected] to discuss the appropriate means of filing or submitting; and
- the signatory of an impacted paper submission retains a manually signed signature page or other document that adopts the typed signature on the electronic submission.
Further, the staff will not recommend enforcement action for failure to comply with the notarization requirement for any of the impacted paper submissions or in the electronic filings of broker-dealers’ annual reports required under paragraph (d) or Rule 17a-5 due to the SEC no later than June 30, 2020, provided that:
- the filer indicates on the document that it is relying on this relief and difficulties from COVID-19; and
- the filer notifies division staff at [email protected], or if the filer is a broker-dealer, notifies its designated examining authority in writing that it was unable to obtain notarization because of COVID-19.
Sweep Program Relief
The staff of the Division of Trading and Markets of the SEC issued a no action letter on March 30, 2020, to the Capital Steering Committee of the Securities Industry and Financial Markets Association (SIFMA). This letter provides broker-dealers flexibility to treat unsecured receivables from bank sweep accounts as an allowable asset that is not deducted from net worth for purposes of SEC Rule 15c3-1.
In instances when a broker-dealer has established a sweep program and there is a one-day lag in funds transferring between a customer’s bank account and its securities account, the staff will not recommend action under Rule 15c3-1 if the broker-dealer treats a receivable from a bank account established as part of a sweep program as an allowable asset that is not deducted from net worth for net capital purposes under 15c3-1 for one business day from the date the receivable is created. It must, however, meet certain other conditions:
- The net receivable is created through the pre-funding of a customer’s brokerage account as part of an FDIC-insured bank sweep program transaction.
- The net receivable comes from an FDIC-insured bank in which a sweep program deposit account has been established.
- The broker-dealer has a legally enforceable right to demand and receive payment of the receivable.
- The customer cannot access the FDIC-insured bank sweep account directly or without going through the broker-dealer.
SEC Requests that Advisers and Funds Email Hearing Requests
The SEC’s Division of Investment Management issued an information update asking that interested persons seeking to be heard with respect to ICA applications email the SEC at [email protected] rather than following the typical procedures, which include writing to the SEC at its physical mailing address.
FINANCIAL INDUSTRY REGULATORY AUTHORITY (FINRA)
U4 Disclosure Events
On April 13, 2020, FINRA posted a new frequently asked questions section to its COVID-19 resource page regarding Paycheck Protection Program (PPP) loans. The PPP allows eligible individuals and small businesses to obtain loans for use during the COVID-19 crisis, which are then eligible for forgiveness if certain terms are satisfied.
If a registered person or a business he or she controls obtains a PPP loan and all or part of the loan is forgiven, the question is whether the registered person will be required to report that forgiveness in response to Question 14K on a Form U4 as a “compromise with a creditor.”
FINRA’s response: Forgiveness of the loan is not disclosable as a compromise with creditors, provided the loan forgiveness is consistent with the original terms of the loan. FINRA’s guidance on Question 14K explains that a “compromise with creditors” occurs when a creditor agrees to accept less than the full amount owed, “unless such an agreement is included in the original terms of the loan (e.g., forgivable loan…).” Because a PPP loan contemplates forgiveness as part of the loan, such forgiveness would be consistent with the loan’s original terms, and therefore would not constitute a “compromise with creditors” for purposes of Form U4 Question 14K.
However, FINRA cautions that any forgiveness beyond the original terms of the loan would be considered a “compromise with creditors” and would have to be reported.
MUNICIPAL SECURITIES RULEMAKING BOARD (MSRB)
On April 9, 2020, the MSRB issued Notice 2020-09, MSRB Amends Certain Rules to Provide Regulatory Relief During COVID-19 Pandemic. The notice announced the following relief:
- Suspension of late fees owed for March 1, 2020, through July 31, 2020 (Rule A-11, fee assessments for municipal adviser professionals, for annual fees owed for MSRB FY 2020; and Rule A-12(d), late fees related to assessments under the rule; and for fees assessed under Rule A-13 on underwriting and transaction assessments).
- Extension of time to complete certain supervisory functions for a temporary period, specifically, certain annual supervisory obligations under Rule G-27 and certain supervisory and compliance obligations of municipal advisers under Rule G-44, provided that such supervisory functions are completed on or before March 31, 2021.
- Extension of time to complete certain professional qualification standards.
- Extension of the compliance date of certain rule changes that have yet to be implemented. Specifically, the Nov. 30, 2020, compliance date for the amended and restated guidance regarding the fair dealing obligations underwriters owe to issuers of municipal securities under MSRB Rule G-17, was proposed to be extended until March 31, 2021. Further, the compliance date of Nov. 30, 2020, for amendments to Form G-32 (designed to collect new data elements from underwriters related to primary offerings of municipal securities through the MSRB’s Electronic Municipal Market Access, or EMMA®, Dataport system), is proposed to be extended until March 31, 2021.
On April 2, 2020, the MSRB began publishing a weekly summary to assist market participants, policymakers and the general public with identifying disclosures submitted to EMMA by issuers of municipal securities that reference COVID-19. The disclosures provide information on how states and municipalities are grappling with the impact of COVID-19 on their revenues and ability to finance essential public services. According to the MSRB, from Jan. 1, 2020, through March 30, 2020, the EMMA system received:
- 506 COVID-19-related continuing disclosures out of a total of 43,667 continuing disclosures, and
- 125 COVID-19-related primary market disclosures out of 2,548 total primary market disclosures.
Issuers in the state of California submitted the highest number of disclosures across all states, with a total of 97 COVID-19-related primary market and continuing disclosures.
STATE REGULATORS
The North American Securities Administrators Association (NASAA) has established a COVID-19 working group to help coordinate responses to COVID-19-related issues and engage with other regulators. Please refer to the NASAA COVID-19 page for updates on specific relief issued by state and provincial securities regulators.
SIFMA
As noted in McGuireWoods’ earlier alert, SIFMA’s BCP and COVID-19 site has links to updated regulatory guidance, industry guidance, and Cybersecurity and Infrastructure Security Agency (CISA) guidance.
SIFMA President and CEO Ken Bentsen has started a series of podcasts with different guests on the COVID-19 pandemic. On March 18, he discussed industrywide business continuity planning efforts to protect personnel and maintain operational resiliency during the COVID-19 pandemic, and on April 6, he discussed the stimulus packages passed by Congress.
Additionally, SIFMA has recently taken the following actions in response to the COVID-19 pandemic.
On March 25, 2020, SIFMA submitted a letter to the SEC outlining a non-exhaustive list of issues raised by the industry and requests:
- Wet signatures
- DTCC processing of physical securities
- Regulation SHO
- Brokers relying on Rule 15c3-3(k)(2)
- Quarterly box count requirements
- Medallion processing
- Transfer agent exemptions
On March 25, 2020, SIFMA submitted recommendations for deadline extensions on behalf of its member firms to the U.S. Department of Treasury and Internal Revenue Service:
- Information returns and other filing extensions
- Form 990-T penalty and filing relief
- Responsible officer certification, qualified intermediary, withholding foreign partnership and withholding foreign trust agreements
- Temporary postponement of IRS automatic notices
- Flexibility regarding documentation requirements
- Impact on regulatory rulemaking
MOVING FORWARD
Expect regulators to continue to issue new guidance and additional relief. Deadlines in the current relief issued may need to be extended further. McGuireWoods is monitoring the developments and will provide updates to clients as information becomes available. Please let us know if you have any questions or if there is anything else we can do to support you during this challenging time.
McGuireWoods’ COVID-19 Response Team helps clients navigate urgent and evolving legal and business issues arising from the novel coronavirus pandemic. Lawyers in the firm’s 21 offices are ready to assist quickly on questions involving healthcare, labor and employment, education, real estate and more. For assistance, contact a team member or send an email to [email protected].
McGuireWoods has published additional thought leadership related to how companies across various industries can address crucial COVID-19-related business and legal issues.