Investment Management Update

The staff requests input on the following questions:

• What challenges do investment advisers face in complying with the Custody Rule with respect to digital assets? What considerations specific to the custody of digital assets should the staff evaluate when considering any amendments to the Custody Rule? For example, are there disclosures or records other than account statements that would similarly address the investor protection concerns underlying the Custody Rule’s requirement to deliver account statements?
• To what extent are investment advisers construing digital assets as “funds,” “securities” or neither, for purposes of the Custody Rule? What considerations are advisers applying to reach this conclusion?
• To what extent are investment advisers including digital assets in calculating regulatory assets under management for purposes of meeting the thresholds for registering with the SEC? What considerations are included within this analysis?
• To what extent do investment advisers use state-chartered trust companies or foreign financial institutions to custody digital assets? Have these investment advisers experienced similarities/differences in custodial practices of such trust companies as compared to those of banks/broker-dealers?
• What role do internal control reports, such as System and Organization Controls (SOC) 1 and SOC 2 reports (Type 1 and 2), play in an adviser’s evaluation of potential digital asset custodians? What role should they play?
• How should concerns about misappropriation of digital assets be addressed and what are the most effective ways in which technology can be leveraged to address such concerns? How can client losses due to misappropriation of digital assets most effectively be remedied?
• What is the settlement process of peer-to-peer digital asset transactions (i.e., transactions where there is no intermediary) and what risks does this process present? What is the settlement process for intermediated transactions in digital assets, such as those that execute on trading platforms or on the over-the-counter markets, and what risks does this process present?
• To what extent do investment advisers construe digital assets as “securities” for purposes of determining whether they meet the definition of an “investment adviser” under Section 202(a)(11) of the Advisers Act? What considerations are included in such an analysis?
• To what extent can DLT be used more broadly for purposes of evidencing ownership of securities? Can DLT be useful for custody and record-keeping purposes for other types of assets, and not just digital asset securities? What, if any, concerns are there about the use of DLT with respect to custody and record keeping?

Comments can be submitted to the Division of Investment Management by emailing IMOCC@sec.gov. There is no specified deadline for comments.

See a copy of the letter.

SEC Releases No-Action Letter With Respect to Jet Charter Token

On April 3, 2019, the SEC’s Division of Corporation Finance issued a no-action letter with respect to a proposed digital asset token to be issued by TurnKey Jet, Inc. (TKJ), an air charter service.

In its letter to the SEC, TKJ explained that it faced “significant transactional costs and inefficiencies” regarding payment settlement and accepting wire transfer payments for those looking to procure charter jet services. TKJ’s business plan is to create a private, permissioned blockchain platform where charter jet users pay for a membership in the platform and then procure TKJ tokens that could be used to purchase charter jet services from carriers. The platform would also support brokers who act to connect consumers and carriers. The TKJ tokens could only be used on the platform and would not be transferable to nonmembers, and there is no assurance they could be redeemed for cash. Only TKJ would have the authority and capability to issue TKJ tokens into circulation (which it would do at a fixed price of $1 per token) or remove them from circulation upon redemption. The development of the platform and tokens would be funded by TKJ through its own capital resources and not through any token sale. The platform would be fully developed and operational at the time any tokens were sold.

In its response letter, the Division of Corporation Finance stated that it would not recommend enforcement action to the SEC if TKJ sold the tokens without registration, based on the opinion of its counsel. Among the factors the division cited were no token sale would be used to finance development; the platform would be “fully developed and operational” when the tokens were sold; and the tokens would be immediately available for purchasing air charter services, would have a fixed price and could only be used within the platform, and would be marketed solely for their functionality.

For further information regarding this no-action letter, see our April 15, 2019, client alert “Distributed Ledger: Blockchain, Digital Assets and Smart Contracts.”

Litigation

Court Rules in BlackRock’s Favor in Excessive Fee Trial

On February 8, 2019, following an eight-day bench trial, Judge Freda L. Wolfson of the U.S. District Court for the District of New Jersey ruled in favor of certain subsidiaries of BlackRock, Inc. (BlackRock) on $1.55 billion in claims brought under Section 36(b) of the 1940 Act concerning two of BlackRock’s largest mutual funds. In re BlackRock Mut. Funds Adv. Fees Litig., No. 3:14-cv-01165-FLW-TJB. Skadden represented BlackRock in the trial.

BlackRock is the first trial decision on the so-called “subadvisory” or “reverse manager of managers” theory in excessive fee litigation and is one of the largest mutual fund cases ever. The court applied the Gartenberg standard, adopted by the U.S. Supreme Court in Jones v. Harris Associates L.P., 559 U.S. 335 (2010), and determined that the shareholder plaintiffs failed to demonstrate at trial that the fee charged by BlackRock was “so disproportionate that it could not be one that was negotiated at arms’ length.” The BlackRock decision further underscores the importance of an independent, conscientious, well-informed fund board, and a robust Section 15(c) process during which information regarding the Gartenberg factors is clearly and thoughtfully outlined for the board.

On March 8, 2019, the plaintiffs provided notice that they are appealing both the February 8, 2019, post-trial order and the June 13, 2018, order partially granting the defendants’ motion for summary judgment.

For a detailed discussion of this case, see our February 19, 2019, client alert “Court Rules in BlackRock’s Favor in Excessive Fee Trial, One of Largest Mutual Fund Cases Ever.”

Robare v. SEC

On April 30, 2019, the U.S. Court of Appeals for the District of Columbia Circuit (D.C. Circuit) issued an important decision regarding the disclosure obligations of investment advisers. The court held that The Robare Group, Ltd. (Robare), an investment advisory firm, and its principals acted negligently in violation of Section 206(2) of the Advisers Act. The court concluded, however, that Robare’s and its principals’ negligent failure to disclose conflicts under Section 206(2) cannot support a finding of willfulness under Section 207 of the Advisers Act. Many feel this latter conclusion is a significant departure from precedent.

Background

Robare is an independent investment adviser located in Houston, Texas. In 2004, Robare entered into a “revenue sharing arrangement” with Fidelity Investments (Fidelity), through which Fidelity paid Robare when its clients invested in certain funds offered on Fidelity’s online platform.

The SEC’s Division of Enforcement initiated administrative and cease-and-desist proceedings against Robare and its principals in September 2014, alleging that Robare and its principals had failed for many years to disclose the compensation they receive through their arrangements with Fidelity and the conflicts of interest arising from such compensation to their clients and to the SEC, in violation of Sections 206(1), 206(2) and 207 of the Advisers Act. Section 206 proscribes fraudulent conduct by investment advisers. While a violation of Section 206(1) requires proof of scienter, proof of simple negligence is sufficient for a Section 206(2) violation. Additionally, Section 207 provides that “[i]t shall be unlawful for any person willfully to make any untrue statement of a material fact in any registration application or report filed with the Commission under section 203 or 204, or willfully to omit to state in any such application or report any material fact which is required to be stated therein.”

Following an evidentiary hearing, an administrative law judge dismissed the charges, concluding that the principals had not acted “with scienter or any intent to deceive, manipulate or defraud” its clients and that the division had failed to prove a negligent violation under Section 206(2) or a willful violation under Section 207.

The division sought de novo review by the SEC. The SEC concluded that the principals “failed adequately to disclose material conflicts of interest” and “in so doing they acted negligently (but without scienter) and thus violated Section 206(2) ... (but not Section 206(1)).” The SEC also determined that Robare and its principals violated Section 207 because they failed to disclose material conflicts of interest on Robare’s Form ADV.

The D.C. Circuit’s Opinion

The court upheld the SEC’s decision that Robare and its principals violated Section 206(2) by negligently failing to disclose the arrangement with Fidelity to their clients, noting that “the evidence before the Commission demonstrated that [Robare] and its principals persistently failed to disclose known conflicts of interest arising from the payment arrangement with Fidelity in a manner that would enable their clients to understand the source and nature of the conflicts.” The court agreed with the SEC that the generalized conflicts disclosure in Robare’s Form ADV, Robare’s General Information and Disclosure Brochure and Fidelity’s Brokerage Account Client Agreement did not fully describe Robare’s payment arrangements with Fidelity and failed to adequately alert clients to the potential conflicts of interest presented by the payment arrangement. Moreover, the court stated that “[b]ecause a reasonable adviser with knowledge of the conflicts would not have committed such clear, repeated breaches of its fiduciary duty, [Robare] and its principals acted negligently.”

With respect to the meaning of “willfully” under Section 207, the court “assumed (without deciding)” that the standard set forth in Wonsover v. SEC, 205 F.3d 408, 413-15 (D.C. Cir. 2000), governs this case. In Wonsover, the court stated that willfully means “intentionally committing the act which constitutes the violation” and rejected the interpretation that a person “[must] also be aware that he is violating” the federal securities laws. The SEC had argued that the principals acted willfully because they reviewed the Form ADVs before the forms were filed with the SEC and were responsible for the forms’ content. The court in Robare held that the SEC misinterpreted Wonsover. The court explained that Section 207 “does not proscribe willfully completing or filing a Form ADV that turns out to contain a material omission but instead makes it unlawful ‘willfully to omit ... any material facts’ from a Form ADV.” The SEC therefore had to find that at least one of the principals “subjectively intended to omit material information” from the Form ADVs. Because the SEC found that its principals negligently failed to disclose conflicts of interest in the Form ADV, the court determined that the SEC could not rely on the same failures as evidence of “willful” conduct for purposes of Section 207.

See the D.C. Circuit’s opinion.

SEC Takes Unexpected Disclosure Position in Deutsche Bank Case

On April 25, 2019, the SEC charged Deutsche Bank Trust Company Americas (Deutsche) with violating Section 17(a)(2) of the Securities Act, which prohibits any person in the offer or sale of securities from obtaining money or property by means of any untrue statement of material fact or any omission to state a material fact necessary in order to make statements made not misleading.

According to the SEC’s order, Deutsche, in marketing materials, requests for proposals and other related documents provided to clients, disclosed that it relies on an independent, in-house research group that uses a “multi-step due diligence process to identify, evaluate and select best-in-class asset managers.” The SEC’s order takes the position that Deutsche’s disclosures in its marketing materials and advisory agreements did not adequately disclose that Deutsche only evaluated and recommended hedge funds that would agree to share their management fees with Deutsche (referred to as “retrocessions”). On this basis, the SEC determined that Deutsche’s disclosures were materially misleading.

This is an unexpected expansion of the SEC’s position on what constitutes adequate disclosure to clients given that Deutsche’s advisory agreements contained general disclosure that Deutsche “may” receive retrocessions and that prior to acquiring any interests in a hedge fund for clients Deutsche disclosed to each client the existence and amount of the retrocession it would receive from that hedge fund. In this case, the SEC appears to have taken issue with (i) the fact that Deutsche did not further disclose that it would only recommend hedge funds that agreed to pay retrocessions and (ii) the use of “may” as opposed to more definitive language. Although the SEC’s position here was unexpected, it offers the opportunity for others to reconsider and reevaluate generalized disclosures that have historically been considered adequate and not misleading under the federal securities laws.

See the SEC’s order.

Court Enjoins Blockvest Initial Coin Offering

On February 14, 2019, Judge Gonzalo P. Curiel of the U.S. District Court for the Southern District of California granted the SEC’s motion for reconsideration in its enforcement action against Blockvest, LLC and its chairman and founder Reginald Buddy Ringgold III arising out of the defendants’ offer and sale of digital tokens. Judge Curiel had previously denied the SEC’s motion for a preliminary injunction. Upon further review, however, the court considered marketing materials on the Blockvest website and concluded that the SEC’s evidence was sufficient to give rise to a prima facie showing that defendants engaged in an unregistered securities offering under Howey. In light of this conclusion, as well as the likelihood of future violations, the court granted the SEC’s reconsideration motion and imposed a preliminary injunction from violating the Securities Act.

For further information regarding Blockvest, see our April 15, 2019, client alert “Distributed Ledger: Blockchain, Digital Assets and Smart Contracts.”

Industry Developments

Director of Division of Investment Management Delivers Keynote Address at the ICI Mutual Funds and Investment Management Conference

On March 18, 2019, Director Dalia Blass of the SEC’s Division of Investment Management delivered the keynote address at the Investment Company Institute’s Mutual Funds and Investment Management Conference. In her address, she discussed (i) the division’s 2018 agenda and accomplishments; (ii) its goals for 2019, particularly the division’s focus on proxy advisers and international policy; and (iii) asset management trends in 2019.

2018 Agenda and Accomplishments

Director Blass highlighted the division’s work in 2018 to “improve the investor experience,” noting its request for comment on how to improve investment company disclosures, the proposal to improve variable annuity disclosure through the use of summary prospectuses, and the adoption of a notice and access approach to the delivery of shareholder reports. Director Blass noted the development of the proposed “customer or client relationship summary” (Form CRS), which registered advisers, broker-dealers and dual registrants will be required to deliver to retail investors;¹ the proposed interpretative guidance under the Investment Advisers Act of 1940 (Advisers Act), which she stated “would clarify the investment adviser fiduciary duty”; and Regulation Best Interest, which she stated is “designed to enhance the standard of conduct for broker-dealers when making recommendations to their retail customers.”

On the division’s efforts to modernize the regulatory framework, Director Blass noted its recommendations to the SEC on ETFs, fund of funds, fund liquidity reporting and fund research reports.

Director Blass also discussed the division’s Board Outreach Initiative and its issuance of no-action letters on the affiliated transaction rules and in-person meeting requirements and engagement with fund boards to update the SEC’s valuation and auditing guidance.

Looking Ahead to 2019

Director Blass discussed the division’s goals for 2019, including continued efforts on the Investor Experience Initiative, modernization efforts and “good government” projects.

On the Investor Experience Initiative, Director Blass noted that the division is considering ideas from its request for comments on improving investment company disclosure and also studying the comments on the variable annuity disclosure proposal. She also stated that the division is continuing to prioritize delivering to the SEC its recommendations on Form CRS and the fiduciary duty interpretation and working closely with the Division of Trading and Markets to support its efforts on Regulation Best Interest.

On the division’s modernization efforts, Director Blass noted that finalizing the ETF and fund of funds rules will be a high priority.

On the Board Outreach Initiative, Director Blass noted that the division will be recommending updates to the SEC’s valuation guidance, advancing into the public comment process a proposal for BDC and CEF offering reform (see “SEC Proposes Securities Offering Reforms for Business Development Companies and Registered Closed-End Investment Companies” above) and presenting a proposal on modernizing the advertising and solicitation rules for investment advisers and a re-proposal regarding the use of derivatives by investment companies.

On the division’s “good government” projects, Director Blass stated that it will review prior staff statements to determine whether any of the prior statements should be modified, rescinded or supplemented in light of market or other developments. Additionally, she noted that the Chief Counsel’s Office has been working to improve the exemptive application process to create a more streamlined approach.

Proxy Advisers. Director Blass stated that in 2019, the division will explore ways to update current guidance to clarify how investment advisers should fulfill their fiduciary duties with respect to the proxy process. In particular, the division’s review will include the following questions: (i) how to promote voting practices that are in the best interests of advisory clients, including voting on an issuer-specific basis when appropriate; (ii) whether advisers are expected to vote every proxy; (iii) how advisers should evaluate recommendations of proxy advisers, particularly where the issuer disagrees with the factual assumptions of the recommendation; and (iv) how advisers should address conflicts of interest that a proxy adviser may have.

International Policy. Director Blass discussed two major themes for the division’s work in international policy: (i) monitoring the effects of foreign policy on regulated entities and (ii) engaging with international organizations that have shown an interest in asset management policy.

On the first theme, Director Blass noted that regulatory change in Europe can pose significant challenges for U.S. firms, especially in regard to the European Union’s Markets in Financial Instruments Directive (MiFID II). Director Blass discussed the three no-action letters released in 2018 to assist in compliance with MiFID II. She noted that the division has been engaging with a wide variety of interested parties to support additional policy initiatives, and she shared four observations. First, she stated that in considering any potential regulatory steps, the division should be mindful of the many parties and interests involved. Second, she stated that the division has looked closely at the Advisers Act. She explained that the act establishes a “principles-based regime that provides significant flexibility to accommodate relationships with both modest retail accounts and large institutional accounts.” Third, she stated the development of certain market solutions — such as fund managers using reconciliation or reimbursement processes to deliver cost transparency while addressing compliance — may make extending no-action relief unnecessary. Finally, she noted that the SEC staff encourages market participants to continue to engage with the division, including with respect to solutions to “create a permanent blanket exemption from the protections of the [Advisers] Act for providers of research to institutional asset managers.”

On the second theme, Director Blass noted that the division will continue to engage with the International Organization of Securities Commissions and the Financial Stability Board on conversations regarding the U.S. asset management markets.

See a copy of Director Blass’ speech.

The SEC recently delayed decisions on proposals to list and trade shares of the Bitwise Bitcoin ETF Trust (Bitwise ETF) and the VanEck SolidX Bitcoin Trust (VanEck ETF). On January 28, 2019, the NYSE Arca, Inc. (NYSE Arca) filed with the SEC a proposed rule change to list and trade shares of the Bitwise ETF; similarly, on January 30, 2019, following the withdrawal of its previous application, the Cboe BZX Exchange, Inc. (BZX) refiled with the SEC a proposed rule change to list and trade shares of SolidX Bitcoin Shares issued by the VanEck ETF.

To approve a Bitcoin ETF rule change, the SEC must find that the rule meets the requirements of Exchange Act Section 6(b)(5), which requires, in relevant part, that the rules of a national securities exchange be designed “to prevent fraudulent and manipulative acts and practices” and “to protect investors and the public interest.” The main concerns of the SEC continue to be market manipulation and the measures taken by the exchanges to protect investors, including a focus on surveillance sharing agreements and an analysis of whether bitcoin is itself inherently resistant to market manipulation. There appear to be two central questions of concern to the SEC, as outlined in its earlier rejection of the Bats BZX Exchange, Inc. application to list and trade shares of the Winklevoss Bitcoin Trust:

1. Unique Resistance. Whether the bitcoin market is uniquely resistant to market manipulation and fraudulent activity; and
2. Surveillance Sharing. Whether the listing exchange has entered into a surveillance sharing agreement with a regulated market of significant size in bitcoin or derivatives on bitcoin.

The sponsor for Bitwise ETF argued in its application, as amended on May 7, 2019, that the Bitwise ETF meets these objectives, and the sponsor for VanEck ETF has made this argument as well. On May 14, 2019, the SEC announced in a filing that it was delaying its decision on the Bitwise ETF, and on May 20, 2019, the SEC announced in a filing that it was delaying its decision on the VanEck ETF. In both instances, the SEC solicited additional public comment on a variety of topics that largely reflected these apparent concerns regarding market manipulation and the measures taken by the platforms to protect its investors.

See the SEC order for Bitwise ETF and the SEC order for VanEck ETF.

On April 16, 2019, the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a risk alert, which identifies compliance issues related to Regulation S-P that the OCIE staff observed during its recent examinations of registered investment advisers and broker-dealers. The OCIE staff noted that the information in the risk alert is intended to assist advisers and broker-dealers in providing compliant privacy and opt-out notices and adopting and implementing effective policies and procedures for safeguarding customer records and information under Regulation S-P.

The risk alert explains that Regulation S-P, among other things, requires a registrant to: (i) provide a clear and conspicuous notice to its customers that accurately reflects its privacy policies and practices generally no later than when it establishes a customer relationship (Initial Privacy Notice); (ii) provide a clear and conspicuous notice to its customers that accurately reflects its privacy policies and practices not less than annually during the continuation of the customer relationship (Annual Privacy Notice, and together with the Initial Privacy Notice, Privacy Notices); and (iii) deliver a clear and conspicuous notice to its customers that accurately explains the right to opt out of some disclosures of nonpublic personal information about the customer to nonaffiliated third parties (Opt-Out Notice).

The risk alert also explains that the “safeguard rule” of Regulation S-P (Safeguard Rule) requires registrants to adopt written policies and procedures that (i) “address administrative, technical, and physical safeguards for the protection of customer records and information”; and (ii) are “reasonably designed to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of customer records and information, and protect against unauthorized access to or use of customer records or information that could result in substantial harm or inconvenience to any customer.”

Privacy and Opt-Out Notices

The OCIE staff found that registrants failed to provide Initial Privacy Notices, Annual Privacy Notices and Opt-Out Notices to their customers or such notices did not accurately reflect a firm’s policies and procedures. The staff also noted Privacy Notices that did not provide notice to customers of their right to opt out of the registrant sharing their nonpublic personal information with nonaffiliated third parties.

Lack of Policies and Procedures

The OCIE staff found that registrants did not have written policies and procedures as required under the Safeguard Rule. The staff also found written policies and procedures that contained numerous blank spaces designed to be filled in by registrants and policies that addressed the delivery and content of a Privacy Notice, but did not contain any written policies and procedures required by the Safeguard Rule.

Policies Not Implemented or Not Reasonably Designed to Safeguard Customer Records and Information

The OCIE staff found that registrants had written policies and procedures that did not appear implemented or reasonably designed to “(1) ensure the security and confidentiality of customer records and information, (2) protect against anticipated threats or hazards to the security or integrity of customer records and information, and (3) protect against unauthorized access to or use of customer records or information that could result in substantial harm or inconvenience to customers.”

The OCIE staff encouraged registrants to review their written policies and procedures, including their implementation of those policies and procedures, to ensure that they comply with Regulation S-P.

See the OCIE risk alert “Investment Adviser and Broker-Dealer Compliance Issues Related to Regulation S-P — Privacy Notices and Safeguard Policies.”

SEC Staff Issues Accounting and Disclosure Information on Filings Under Rule 485(a) of the Securities Act

On April 2, 2019, the SEC’s Division of Investment Management issued Accounting and Disclosure Information 2019-07 (ADI) regarding the SEC staff’s review of certain filings under Rule 485(a) of the Securities Act.

Rule 485(a) provides that a post-effective amendment to a registration statement filed by a registered open-end fund can become effective as early as 60 days after filing. Additionally, the rule allows a new open-end fund that is organized as a new series of an existing registrant to file a post-effective amendment to an existing registration statement that becomes automatically effective in as early as 75 days. SEC staff action is not required to bring about effectiveness in either case.

The ADI states that while most filings seeking automatic effectiveness under Rule 485(a) do not raise unique or novel issues, filings that “raise complex issues not easily resolved because of a lack of precedent” can complicate the SEC staff’s efforts to effectively protect investors. The ADI provides examples of issues in filings that require additional review and interaction with disclosure reviewers, noting that such issues “typically involve novel investment strategies, fee structures, and/or operational policies (e.g., significant changes to policies related to purchases and redemptions by investors).”

In the ADI, the SEC staff urges registrants to contact the staff before making any filings under Rule 485(a) if such filings may “raise material questions of first impression” or “address issues in a manner inconsistent with previous precedent.” The SEC staff additionally requests that registrants respond to staff comments on a Rule 485(a) filing as a general matter no later than five business days before the filing is scheduled to become effective automatically.

See the ADI.

OCIE Risk Alert: Transfer Agent Safeguarding of Funds and Securities

On February 13, 2019, OCIE issued a risk alert based on its examinations of transfer agents that also served as paying agents over a three-year period. The risk alert highlights risks and issues associated with paying agent activities, identifies significant exam deficiencies related to the safeguarding of funds and securities by paying agents, and provides a listing of some common features of robust safeguarding policies, procedures and controls for paying agents.

As noted in the risk alert, paying agent activities vary but commonly include:

• Processing and disbursing principal, interest and dividend payments to bondholders or shareholders based on an issuer’s payment schedule;
• Administering direct stock purchase and dividend reinvestment plans;
• Handling escheatment and lost shareholder search and report filing;
• Managing interest bearing accounts or demand deposit accounts in the name of mutual funds for activities such as inflows and outflows from fund orders; and
• Making distributions for mutual funds.

The OCIE staff stated that its observations from recent examinations of paying agents generally fall into two categories: (i) the transfer agents’ safeguarding of funds and securities, as required by Rule 17Ad-12 (Safeguarding Rule) under the Exchange Act; and (ii) the transfer agents’ notification to unresponsive payees and policies and procedures for lost securityholder searches, as required by Rule 17Ad-17 (Lost Securityholder/Unresponsive Payee Rule) under the Exchange Act.

Safeguarding Rule

The risk alert provides examples of deficiencies and weaknesses that the OCIE staff observed in connection with the Safeguarding Rule, including (i) misappropriation of shareholder funds and the theft of physical certificates by transfer agents; (ii) inadequate policies, procedures and controls for the safeguarding of funds and securities, including, for example, instances in which transfer agents did not have policies and procedures for any paying agent activities or policies and procedures that address the issuance and handling of checks, the distribution of dividends, bank account reconciliation, escheatment or periodic redemption requests for limited partnerships; (iii) inadequate account reconciliation controls and procedures; and (iv) instances in which agents did not secure access to vaults, computers and areas of the firm that handle disbursement operations, creating a risk of theft, loss or destruction.

Lost Securityholder/Unresponsive Payee Rule

The risk alert also provides examples of deficiencies and weaknesses that the OCIE staff observed in connection with the Lost Securityholder/Unresponsive Payee Rule, including (i) failures by transfer agents to comply with database search requirements to identify lost securityholders using public resources; (ii) failures to send written notifications to unresponsive payees and failures to send these notifications in a timely manner; and (iii) weaknesses with the transfer agents’ Lost Securityholder/Unresponsive Payee Rule policies and procedures, including written procedures that did not require database searches, address unresponsive payee notifications, designate responsibility for performing and documenting reviews, or outline the methodology utilized to comply with the rule.

Robust Policies, Procedures and Controls

The risk alert states that during the examinations, the OCIE staff observed several transfer agents that appeared to have implemented robust written policies, procedures and controls related to the processing of funds, handling of physical certificates, lost securityholder searches and unresponsive payee notifications, and included examples of these practices for transfer agents to consider implementing.