Our Take: financial services regulatory update – September 6, 2024

What happened? On August 28th, Treasury’s Financial Crimes Enforcement Network (FinCEN) issued a final rule that extends certain anti-money laundering (AML) requirements to certain SEC-registered investment advisers (RIAs) and
exempt reporting advisers (ERAs). The rule delegates FinCEN’s examination authority for compliance with its requirements to the SEC.

• Who is affected? The rule applies to all RIAs and ERAs except for RIAs that:
  • Are not required to report any assets under management (AUM) to the SEC on Form ADV; or
  • Solely register with the SEC because they are:
    • “mid-sized advisers,” which are RIAs with between $25 million and $100 million AUM that are not registered or subject to examination in the state where their principal office is located;
    • “multi-state advisers,” which are RIAs with less than $100 million AUM and are required to register with 15 or more states; or
    • “pension consultants,” which are RIAs that provide investment advice to retirement plans under ERISA
• Are foreign firms subject to the rule? RIAs and ERAs located outside of the US are subject to the rule, although the final rule limits covered activities to those that take place in the US or provide services to a US person.
• What does the rule require? Investment advisers subject to the rule will be required to implement a written risk-based AML program approved by the Board. The rule notes that these programs generally contain (a) written roles and responsibilities for transaction monitoring and internal controls; (b) ongoing customer due diligence; (c) training; and (d)
  independent testing of the program. They will also be required to file Suspicious Activity Reports (SARs) and Currency Transaction Reports (CTRs) with FinCEN, respond to 314(a) requests and comply with 311 Special Measures and recordkeeping requirements.
• What’s next? The final rule will be effective January 1st, 2026 and firms will be expected to comply by January 1st, 2027.

Our Take

Long road to compliance for many. Investment advisers’ AML programs span a wide spectrum of maturity, with those that are affiliated with banks and broker-dealers or operating globally generally having more advanced programs while many others lag far behind. Some of these less-advanced firms now have significant work ahead of them to develop the governance, controls, expertise and training necessary to establish and implement effective, risk-based AML programs, even with over two years to comply. Notably, ERAs typically have limited requirements under the Adviser Act and many will need to build an AML program from the bottom up.

Investment advisers with relatively mature programs will also have significant work ahead as many programs are confined to customer due diligence and know-your-customer activities. Many of these firms will need to stand up transaction monitoring in the US and determine whether they have sufficient expertise for activities such as SAR filing, handling information requests from law enforcement and compliance with recordkeeping requirements. As many advisers’ programs are also under the umbrella of associated financial institutions, they should consider conducting a risk assessment focusing on risks specific to their business to properly tailor their AML program.

Firms that delegate to third parties will remain on the hook. Many investment advisers, especially smaller firms, will likely look to delegate certain aspects of their programs to third parties. It is important to remember that the firms will ultimately be held responsible for any deficiencies - and FinCEN has warned that it is not sufficient to rely on contractual provisions or certifications. Having strong third-party due diligence practices will be key for these firms that choose to delegate.

• What happened? The following notable events took place regarding legal challenges to regulation over the past two weeks:
  • On August 26th, a Texas federal district court rejected a challenge from the Texas Bankers Association to the CFPB’s small business lending rule, finding that the agency (a) has statutory authority under the Dodd-Frank Act to require that financial institutions collect certain information in loan applications and (b) conducted a sufficient cost-benefit analysis in developing the rule as to not act arbitrarily and capriciously.
  • On August 23rd, the Ninth Circuit Courts of Appeals decided that a California law that requires mortgage lenders to pay 2% interest to borrowers on money held in escrow accounts is not preempted by the National Bank Act. The decision follows a Supreme Court ruling issued in May regarding a separate Second Circuit interest-on-escrow lawsuit declining to set forth a bright line standard for preemption and instead directing courts to conduct a “nuanced comparative analysis” by analyzing a list of prior decisions regarding preemption.
  • The SEC did not appeal a Fifth Circuit decision striking down its private funds rule by the September 3rd deadline, with an agency spokesperson explaining that the agency decided to “focus resources on adopting and implementing other items on our rulemaking agenda."
• What’s next? The Texas Bankers Association announced its intention to appeal the small business lending rule decision to the Fifth Circuit Court of Appeals. We expect to see an appeal of the Ninth Circuit preemption decision, either to the Ninth Circuit en banc or to the Supreme Court.

Our Take

A post-Chevron regulatory agency win, but uncertainty lies ahead. The decision to uphold the CFPB’s small business lending rule shows that, despite the additional scrutiny agency actions will receive following the Supreme Court’s recent decision to overturn the longstanding Chevron precedent (see more here), there will not necessarily be a domino effect of regulations being struck down en masse. However, this particular district court’s ruling is just one data point out of what will likely be a growing number of rulings as challenges to agency authority increase, and the decision itself will be appealed to the Fifth Circuit which has consistently moved to scale back agency powers. Similarly, the Ninth Circuit’s interest-on-escrow decision will likely face appeals and may result in a conflicting outcome with the separate lawsuit before the Second Circuit. We expect to see a larger patchwork of regulatory standards as legal challenges weave through the courts, resulting in inconsistency that could remain indefinitely where cases do not reach the Supreme Court. Further, the SEC’s decision not to appeal the private funds rule decision is an early sign that agencies may have to manage their legal and resourcing strategy carefully in light of increased litigation, deciding which regulations to defend in court and whether to add resources to broaden that list.

• What happened? On August 28, the SEC adopted a number of changes to the current reporting requirements of Form N-PORT impacting certain registered open-end funds, registered closed-end funds and unit investment trusts as well as changes and clarifications to the liquidity framework for open-end funds that are not money market funds (MMFs) or exchange-traded funds (ETFs).
• What are the final requirements? With the adopted amendments, the SEC is seeking to make open-end fund reporting more timely and informative by:
  • Increasing filing frequency of Form N-PORT from the current quarterly basis to monthly
  • Requiring filing Form N-PORT within 30 days of the period end rather than the current 60 days
  • Publishing N-PORT data for each month, 60 days after the end of the month
  • Requiring information about service providers used to meet liquidity risk management requirements on Form N-CEN
•  What changed from the proposal? The final amendments do not include proposed changes to liquidity classifications and requirements, including the proposal for covered open-end funds implement swing pricing. They also do not include a “hard close” at 4 pm ET after which investor orders to purchase or redeem shares would no longer be eligible for the given day’s price. Instead of the proposed liquidity requirements, the final amendments include guidance:
  • Recommending that funds review liquidity classifications of investments more frequently in response to changes in portfolio composition, such as substantially increasing the size of holdings
  • Clarifying that the definition of “cash” for liquidity classification purposes 1 means U.S. dollars and that funds need to consider conversion to U.S. dollars when classifying investments
  • Reiterating that funds investing significantly in less liquid or volatile investments should consider establishing an increased highly liquid investment minimum (HLIM)
• What’s next? The amendments take effect on November 17th, 2025. Fund groups with net assets less than $1 billion will have until May 18th, 2026 to comply with the new requirements.

Our Take

No swing pricing but funds still have work ahead. Relative to the November 2022 proposal, these final amendments omit the most onerous liquidity risk management requirements – particularly swing pricing. The industry may have expected this omission after proposed swing pricing received substantial pushback and was not included in final MMF liquidity amendments last September. However, the final open-end fund changes do not even go as far as the MMF amendments, which included a mandatory liquidity fee framework. While this means that the new requirements are not as demanding as the industry may have once feared, they will still require changes to reporting processes and systems to file Form N-PORT more frequently and quickly after each month. The accelerated timeline could necessitate greater organizational coordination and expanded use of service providers, which would in turn impact other increased regulatory reporting requirements. Funds will also need to understand and adapt to the impact of more frequent publication of the reported data and allowing stakeholders to monitor portfolio changes on a more timely basis.

^{1. SEC Rule 22e-4 provides that a fund must consider the time that it reasonably expects an investment to be “convertible to cash” (i.e., sold and settled) without significantly changing the market value of the investment.} 

These notable developments hit our radar recently:

• FFIEC issues new examiner guidance on IT risk management. On August 29th, the Federal Financial Institutions Examination Council (FFIEC) issued a new booklet to guide examiners in their assessment of financial institutions’ information technology practices. The new “Development, Acquisition, and Maintenance” booklet replaces the 2004 “Development and Acquisition” booklet and outlines principles and practices for managing the development, acquisition, and maintenance of IT systems, highlighting key risk management practices and providing an overview of IT project management, the system development life cycle (SDLC), and supply chain risk management (SCRM).
• Acting Comptroller discusses the evolution of bank supervision. On September 3rd, Acting Comptroller Michael Hsu discussed the evolution of bank supervision during a presentation at the Joint European Banking Authority and European Central Bank International Conference. Hsu offered thoughts on the nature of bank supervision, how and why it has evolved, and the steps necessary for it to remain effective.
• Fed requests comment on discount window operational practices. On September 5th, the Fed issued a request for public comment around the operational practices of the discount window to aid the Fed in making improvements in the efficiency and ease of access to the discount window and intraday credit. The comment period will close 90 days after publication in the Federal Register.
• FFIEC announces the sunset of cybersecurity assessment tool. On August 29th, the FFIEC announced that the agencies will sunset the cybersecurity assessment tool (CAT) on August 31st, 2025. Several new and updated government and industry resources have become available for financial institutions to leverage to better manage cybersecurity risks than the CAT. The FFIEC plans to discuss these resources during a banker webinar this fall.
• Barr to preview revised Basel III proposal. On September 10th, Fed Vice Chair for Supervision Michael Barr will preview the regulators’ revised proposal for changes to bank capital standards (known as Basel III) and explain next steps at the Hutchins Center on Fiscal & Monetary Policy. The Fed promised to make “broad and material” changes to the original July 2023 proposal, which received pushback from banks and some members of Congress.