As the world responds to COVID-19, we have identified a number of compliance and legal considerations for asset managers. We summarize a select list of these in our note below.
Like financial businesses more generally, many asset management firms have adopted far-reaching “work from home” policies. How these policies affect individual firms will vary, but firms with significant client or customer interaction or complicated operational processes (whether trading, operations or other functions) are more likely to be at risk of disruption.
In response to our informal survey, nearly all asset management firms in affected markets said that they have formally activated their business continuity policies. In due course, this action will require thoughtful consideration of how actual events tested preparedness.
Already there have been “lessons learned.” For example:
Over the past week, the U.S. Securities and Exchange Commission granted temporary relief from various filing requirements for SEC-registered investment advisers, exempt reporting advisers, investment companies and business development companies.
Read our alerts on the scope and timing of these temporary SEC regulations – one alert addresses relief specific to registered investment companies and BDCs; the other alert addresses relief specific to investment advisers. In some respects (e.g., accommodating a temporary inability to prepare and deliver financial reports or shifting required meetings from in-person to “virtual” formats), this relief largely tracks SEC relief and guidance for public reporting companies more generally. Read our alert on the temporary SEC regulations for public reporting companies.
Read the SEC’s press release on relief for certain companies affected by COVID-19. Read the SEC’s press release on guidance to promote continued shareholder engagement for companies and funds affected by COVID-19.
The U.S. Financial Institution Regulatory Authority (FINRA) temporarily suspended various requirements applicable to FINRA firms, including notifications to FINRA regarding remote offices. FINRA also published guidance specific to FINRA’s business continuity rule in light of current events. Read our alert on these FINRA regulations and guidance.
Similar to FINRA’s guidance regarding remote offices, the U.S. National Futures Association stated that it “will not pursue a disciplinary action against” a Commodity Pool Operator or Commodity Trading Adviser that permits or requires its staff to temporarily work from locations not already listed as a branch office. The NFA guidance specifically requires firms to consider the need for “alternative supervisory methods” and appropriate recordkeeping.
A Gallup survey notes that all manner of companies are communicating with the public regarding their COVID-19 responses. According to the survey, these messages tend to be tailored to the recipients, whether employees or clients/customers, and often include a personal tone alongside expert advice.
While such communications are important to the business, they also present a variety of risks:
In addition to general client and investor communications, we are aware of many funds, both SEC-registered investment companies and private funds, where there has been ongoing interaction these past weeks with the fund’s applicable governance body, whether that be a trustee, board of directors or investor body (such as a limited partner advisory committee). These types of board communications have covered:
Throughout, firms are thoughtfully balancing the desire to be a thought leader and to stay in front of clients with the related risks of inaccurate, incomplete, contradictory or selective communications.
The SEC has advised any company aware of a risk related to COVID-19 that would be material to its investors to refrain from securities transactions with the public until investors have been appropriately informed about the risk. The SEC added that companies disclosing such coronavirus-related risks should disseminate such information broadly.
When a firm maintains customer-facing functionality such as account or trading portals it is important consider how these functions can be maintained and kept fully available, notwithstanding operational stresses that can include surges in customer demand. At least one market participant has already faced well-publicized issues, including technical problems that allegedly prevented customers from trading during days in which there were significant up-and-down market movements.
Regulators in a number of countries have introduced emergency regulations banning or limiting short selling. Compliance teams should coordinate with their traders to track these developing requirements.
“Force majeure” (literally “greater force”) is a legal doctrine allowing for contract parties to assert that they are not required to meet their contract obligations because of significant external events outside the control of the parties that prevent fulfillment of the contract. To illustrate the potential scope of these kinds of provisions in a global crisis, the China Council for the Production of International Trade said that as of February 21, 2020 it had issued 3,325 “force majeure certificates” covering contracts worth more than $38 billion. We have written in detail on COVID-19 related force majeure considerations in an earlier alert. Read our previous alert.
Material adverse effect (MAE) clauses similarly allow for parties to exit or modify contracts or particular terms of contracts based on significant events arising post-signing. These may be especially relevant for private equity or direct lending funds based on their underlying acquisition/disposition or lending activity in that contracts in those contexts can have well-developed MAE terms and related market customs.
COVID-19 and force majeure also have specific implications for derivatives contracts. Read our previous alert addressing whether certain aspects of the COVID-19 outbreak could constitute a force majeure or similar event of default or termination event under various derivatives contracts including International Swaps and Derivatives Association, Inc. or other market standard master agreements.
Market volatility and trading dislocations can put pressure on any firm’s valuation and liquidity monitoring processes. This may become especially relevant in the event of market or exchange closures, as already evident in the unscheduled extensions of the Chinese Lunar New Year holidays.
Investment companies and private funds that utilize lines of credit or other financing arrangements should confirm that they continue to comply with covenants relating to asset coverage or other ratios that could result in an event of default. Read our previous alert discussing how the COVID-19 outbreak may affect both borrowers and lenders.
Firms must consider when it is appropriate to deviate from an account’s “normal” investment approach in favor of a “defensive” strategy.
Central bank stimulus efforts have driven benchmark interest rates to near or below zero in many markets.
A fund sponsor commencing or soon commencing a fund launch—and particularly a closed-end fund launch—might consider building in deferral mechanisms to the fund documents in order to enable the sponsor to achieve an initial close, but not commence the accrual of management fees and the commencement of the investment program or investment period until a later date. This might enable sponsors to reach an initial closing while providing some flexibility to assess the impact of COVID-19 on investment opportunities and capital deployment schedules.
These volatile and unsettled times have presented, and will continue to present, novel legal and compliance considerations for asset managers. In some cases, there have been proactive governmental guidance and temporary regulations. In other cases, contracts and internal policies and procedures will control. Whatever the source of guidance, measured and thoughtful attention by legal and compliance personnel should be central to an asset management firm’s COVID-19 response. Visit our COVID-19 Resource Center regularly to stay informed on the issues.
 17 C.F.R. § 270.35d-1(a)(2)-(3).
 Investment Company Names, Investment Company Act Release No. 24,828 (Jan 17, 2001), 66 Fed. Reg. 8509, 8513 (Feb. 1, 2001).