A compendium of regulatory matters for Q1 2024

SEC Approves Spot Bitcoin ETPs for Listing and Trading

On January 10, 2024, the U.S. Securities and Exchange Commission (“SEC” or the “Commission”) approved listing and trading the shares of a number of spot bitcoin exchange-traded products (“ETPs”). This decision by the SEC came after the Commission disapproved approximately twenty similar spot bitcoin ETPs between 2018 and 2023. During that time, the Commission disapproved the conversion of the Grayscale Bitcoin Trust into an ETP. On appeal, this decision by the Commission was remanded back to the SEC by the U.S. Court of Appeals for the District of Columbia. The court stated that the SEC failed to adequately explain its reasoning in disapproving Grayscale’s listing and trading of their proposed spot bitcoin ETP. On remand, the SEC reconsidered its prior disapproval and approved Grayscale’s spot bitcoin ETP based on the product’s consistency with the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and whether the ETP is designed to protect investors and the public interest.

However, in approving Grayscale’s spot bitcoin ETP, the SEC emphasized in its statement that the Commission is merit neutral on companies, investments, or assets. Additionally, the SEC stated that the decision:

• Does not signal that the SEC is approving listing standards for crypto asset securities.
• Does not signal the SEC’s views on the status of crypto assets under federal securities law.
• Does not signal SEC’s views on current state of non-compliance of certain crypto asset market participants with federal securities laws.
• Does not signal the SEC approves or endorses crypto trading platforms or intermediaries.

The SEC’s priority in approving the spot bitcoin ETP is the protection of investors. The public and investors are already exposed to bitcoin through mutual funds, national securities exchanges, peer-to-peer apps, and non-compliant crypto trading platforms. In order to protect investors and the public, the SEC imposed the following requirements. First, sponsors of spot bitcoin ETPs are required to provide full, fair and truthful disclosure about the products. Second, ETPs are to be listed and traded on registered national securities exchanges. These registered exchanges have rules designed to prevent fraud and manipulation in securities markets, rules designed to address certain conflicts of interest, and rules and standards of conduct that apply to purchase and sales of approved ETPs. Third, the SEC approved ten spot bitcoin ETPs, which creates a more level playing field for issuers and promotes fairness and competition benefiting investors and the broader market. Sponsors of the spot bitcoin ETPs include Grayscale, Fidelity, Ark 21Shares, Invesco, Hashdex, Franklin Templeton, BlackRock, Bitwise, VanEck, Valkyrie, and Wisdom Tree.

For investment advisers looking to add spot bitcoin ETPs to their registered funds investment portfolio, there are some considerations that should be discussed with fund counsel and the fund’s CCO before investing. First, consider whether and to what extent an investment in spot bitcoin ETPs requires changes to the fund’s investment objective, investment strategy, and risk profile for the fund. Bitcoin and crypto asset investments may not be appropriate for all funds. Second, investment advisers must seek Board approval for any investment strategy revisions. The investment adviser must present details of the strategy change, reason for the change, expected benefits of the change, and expected operational, compliance, and performance volatility challenges to implementing the change. Third, the fund’s registration statement will need to be updated for the required disclosures, which may require a filing of a registration statement amendment pursuant to Rule 485(a) under the Securities Act of 1933, as amended, that requires SEC review and approval depending on the expected level of use of spot bitcoin ETPs. The SEC review and approval of this type of registration statement filing is subject to a 60-day review and comment period. Fourth, the investment adviser should consider tax implications of spot bitcoin ETP investments for the fund. Investment advisers should consider the impact of spot bitcoin ETP investments on the fund’s 90% Gross Income Test and the IRS Asset Diversification Tests. For the spot bitcoin ETPs, there are issues regarding the asset holdings and who holds the assets, as well as timing and availability of investment holding percentages, which could place the fund in non-compliance with the 90% Gross Income Test and the IRS Asset Diversification Tests. These issues should be discussed with fund counsel and the CCO before investing.

In conclusion, the SEC approval applies only to bitcoin, considered a non-security commodity, but other ETPs for other crypto assets are expected to be approved in the future. The SEC also emphasized in its statement that bitcoin is primarily a speculative and volatile asset also used for illicit activity including ransomware, money laundering, sanction evasion, and terrorist financing. The SEC Commissioner also stated that crypto assets are investment contracts and should be subject to federal securities laws and that most crypto asset platforms and intermediaries are non-compliant with federal securities laws and often have conflicts of interest.

https://www.sec.gov/news/statement/gensler-statement-spot-bitcoin-011023

Expansion of Semi-Transparent ETF Exemptive Relief to Include Short Selling

On January 30, 2024, an ETF Trust (“ETF”) and its adviser (together, the “Applicants”) filed a request with the Commission to amend a prior exemptive order to permit the ETF to engage in short sales with the same types of investment instruments that the ETF is permitted to hold as long positions. The Commission had previously issued an order that permitted the ETF to operate a novel type of actively managed ETF that is not required to disclose its portfolio holdings daily. Instead, the ETF only needs to publish daily a portfolio reference basket of securities and cash (the “basket”) that would closely track its daily performance. However, the basket differs from the ETF’s actual portfolio. Additionally, under this prior order, the ETF may not borrow for investment purposes or hold short positions. The requested amendment to this prior order would give the ETF the ability to engage in short selling. The ability to short sell would be limited to the same long position investments the ETF is already permitted to hold.

Under the prior order, the basket needs to be constructed using the following four elements:

• The basket must use the same securities as the investment portfolio.
• There must be substantial overlap between securities in the basket and those held as investment portfolio assets.
• There must be guardrails regarding deviations from the weightings of individual securities.
• Performance must be correlated between the basket and the investment portfolio.

The requested amendment to the prior exemptive order that allows short selling is subject to the same elements of the original exemptive order listed above. In addition, the basket would be constructed in two portions with the first corresponding to long positions in the ETF and the second corresponding to short positions in the ETF. Additionally, in the aggregate, the basket will provide an arbitrage tool to allow market participants to price and hedge their positions in the ETF shares.

The original exemptive relief order and the current amendment was requested under Sections 6(c) and 17(b) of the Investment Company Act of 1940, as amended (the “1940 Act”). Relief under Section 6(c) is appropriate when the relief is in the public interest and consistent with protection of investors and purposes intended by the policy and provisions of the 1940 Act. Relief under Section 17(b) is appropriate when the proposed transactions continue to be:

• Reasonable and fair and do not involve overreaching on the part of any person concerned, and
• Consistent with both the policies of each registered investment company concerned and with the general purpose of the 1940 Act.

The applicants’ position is that the amendment to exemptive relief in this instance would be appropriate in this case under Sections 6(c) and 17(b) of the 1940 Act. To read more regarding the applicants’ legal analysis regarding the appropriateness of this amendment, please follow the link below.

sec.gov/Archives/edgar/data/1668817/000168035924000059/bluetractor40appa01302024.htm

SEC Staff Publishes FAQ on Tailored Shareholder Reports

On January 19, 2024, the staff of the SEC’s Division of Investment Management (“Staff”) prepared responses to questions related to the adoption of rule and form amendments in October 2022 to require mutual funds and exchange-traded funds (together, “funds”) to transmit concise and visually engaging annual and semi-annual reports to shareholders (collectively, “shareholder reports”) under the 1940 Act and to promote transparent and balanced presentations of fees and expenses in investment company advertisements.

The Staff’s responses to questions include topics such as “appropriate broad-based securities market index,” Form N-CSR and website availability requirements, binding individual shareholder reports of multiple funds, electronically provided shareholder reports, and compliance date and inline iXBRL issues.

The Staff may update this information occasionally to include responses to additional questions. These responses represent the views of the Staff and are not rules, regulations, or statements of the SEC, and the SEC has neither approved nor disapproved these FAQs or the answers to these FAQs. The FAQs, like all staff statements, have no legal force or effect: they do not alter or amend applicable law, and they create no new or additional obligations for any person.

SEC.gov | Tailored Shareholder Reports Frequently Asked Questions

Final rule: Tailored Shareholder Reports for Mutual Funds and Exchange-Traded Funds; Fee Information in Investment Company Advertisements (sec.gov)

SEC Announces Fall 2023 Regulatory Agenda

On December 6, 2023, the SEC released its Fall 2023 Unified Agenda of Regulatory and Deregulatory Actions, which includes planned final and proposed rulemakings. The items on the SEC’s Agenda are intended to advance its three-part mission: to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. Among other topics, final and proposed rulemakings encompass climate change disclosure (adopted on March 6, 2024), ESG investment practices disclosure, open end fund liquidity risk management programs and swing pricing, cybersecurity for funds and advisers, safeguarding advisory client assets, and outsourcing by investment advisers.

Agency Rule List – Fall 2023 (reginfo.gov)

FINRA Releases 2024 Regulatory Oversight Report

On January 9, 2024, the Financial Industry Regulatory Authority (FINRA) released its 2024 FINRA Annual Regulatory Oversight Report. The Report includes notable findings and is intended to be an evolving resource or library of information for member firms. Member firms are encouraged to consider incorporating relevant elements into their compliance programs tailored to their activities. The Report describes regulatory obligations and related considerations, findings and effective practices, and additional resources.

2024 FINRA Annual Regulatory Oversight Report | FINRA.org

SEC Charges Investment Adviser for Failing to Disclose Influencer’s Role in Fund Launch

On February 16, 2024, the SEC announced that a registered investment adviser to an exchange-traded fund has agreed to pay a $1.75 million civil penalty to settle charges that the adviser failed to properly disclose a licensing arrangement it had with the ETF’s index provider. The index provider partnered with a social media influencer to promote the ETF’s index, paying the influencer with a larger percentage of the licensing fee when the ETF’s assets under management reached certain thresholds.

The SEC’s order found that the adviser violated Section 15(c) of the 1940 Act when it failed to adequately inform the ETF’s independent trustees of the influencer’s planned involvement and compensation in connection with the initial approval and subsequent renewal of the investment advisory contract. In particular, it found that the adviser failed to disclose information about the economies of scale and profitability associated with the advisory contract when it did not disclose the sliding scale arrangement with the influencer. The order also found that the adviser failed to discuss the controversies surrounding the influencer and corresponding brand risk to the ETF and other funds in the complex.

In addition, the order found that the adviser violated: (a) Section 206(2) of the Investment Advisers Act of 1940, as amended (the “Advisers Act”) when it failed to adequately disclose details of the arrangement with the influencer to the fund board; and (b) Section 206(4) of the Adviser’s Act and Rule 206(4)-7 thereunder when it failed to adopt and implement written compliance policies and procedures reasonably designed to prevent those violations.

Without admitting or denying the SEC’s findings, the adviser agreed to an order to cease-and-desist from committing or causing violations and future violations of the above provisions, a censure, and the monetary penalty.

ic-35132.pdf (sec.gov)

SEC Announces Enforcement Results for Fiscal Year 2023

On November 14, 2023, the U.S. Securities and Exchange Commission (the “SEC”) announced that it filed 784 total enforcement actions in fiscal year 2023. These actions represented a 3% increase over fiscal year 2022, including 501 original, or “stand-alone,” enforcement actions, which represented an 8% increase over fiscal year 2022. The SEC also filed 162 “follow-on” administrative proceedings seeking to bar or suspend individuals from certain functions in the securities markets based on criminal convictions, civil injunctions, or other orders and 121 actions against issuers who were allegedly delinquent in making required filings with the SEC.

The stand-alone enforcement actions spanned the securities industry, from billion-dollar frauds to emerging investor threats involving crypto asset securities and cybersecurity, and charged violations by diverse market participants, from public companies and investment firms to gatekeepers and social media influencers. The SEC also brought numerous enforcement actions addressing conduct that undermines oversight of the securities industry, including actions to protect whistleblowers and actions to enforce recordkeeping requirements and other investor protection requirements applicable to industry participants, including broker-dealers and investment firms.

In fiscal year 2023, the SEC obtained orders for $4.949 billion in financial remedies, the second highest amount in SEC history, after the record-setting financial remedies ordered in fiscal year 2022. The financial remedies comprised $3.369 billion in disgorgement and prejudgment interest and $1.580 billion in civil penalties. Both the disgorgement and civil penalties ordered were the second highest amounts on record. The SEC also obtained orders barring 133 individuals from serving as officers and directors of public companies, the highest number of officer and director bars obtained in a decade.

In addition, the SEC distributed $930 million to harmed investors in fiscal year 2023, marking the second consecutive year with more than $900 million in distributions.

Fiscal year 2023 was a record-breaking year for the SEC’s Whistleblower Program. The SEC issued whistleblower awards totaling nearly $600 million, the most ever awarded in one year, including a record-breaking $279 million awarded to one whistleblower. The SEC received more than 18,000 whistleblower tips in fiscal year 2023, a record number and approximately 50% more than the then-record 12,300 whistleblower tips received in fiscal year 2022. The SEC received more than 40,000 tips, complaints, and referrals in total, a 13% increase over fiscal year 2022.

SEC.gov | SEC Announces Enforcement Results for Fiscal Year 2023

fy23-enforcement-statistics.pdf (sec.gov)

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