Registered Funds Alert

June 2018

Table of Contents
BDCs Receive Long-Awaited2
Regulatory Relief—How Does It Workand Is It Enough?
BDCs recently won a substantial legislative
victory. In this Alert, we answer somefrequently asked questions about the newlegislation. Click here for more
Proposed Interpretation of Adviser
Duties Flies Under Radar Next
to Headline-Grabbing BrokerDealer Proposals

7

The SEC issued three significant proposals
that could alter the regulation of brokerdealers and investment advisers. In this Alert,
we focus on the proposed interpretationof investment advisers’ fiduciary duties toclients. Click here for more
The SEC’s Share Class Selection10
Self-Reporting Initiative: A Creative
Idea That Should Go Further
The SEC recently has focused on disclosure of
how investment advisers select mutual fundshare classes for their clients. In this Alert, we
discuss an SEC initiative to encourage selfreporting in this area, and highlight ways theSEC could better incentivize self-reporting.
Click here for more

New York Attorney General’s
Investigation Into Actively Managed
Mutual Funds Leads to Enhanced
Disclosure to Retail Investors

12

A recent investigation by the NYAG haspressured mutual fund firms to disclose a
new metric known as “Active Share.” In thisAlert, we summarize the NYAG’s investigative
findings and discuss the merits of this new
metric. Click here for more

The latest edition of Simpson Thacher’s Registered Funds Alert discusses
recent developments in the registered funds industry, including:answering frequently asked questions regarding the effects of a recent
legislative victory for business development companies (BDCs); analyzing

15

the SEC’s proposed interpretation of investment advisers’ fiduciary

A list of notable transactions that occurredin the first quarter of 2018, including M&A
transactions and closed-end fund initial public
offerings. Click here for more

duties to clients; suggesting ways that the SEC could better promote

Notable Transactions: Q1 2018

Simpson Thacher & Bartlett LLP

self-reporting; and explaining the new “Active Share” metric and theinvestigation that led to its development.

BDCs Receive Long-Awaited
Regulatory Relief—How Does
It Work and Is It Enough?
Business development companies (“BDCs”) recently
won a substantial legislative victory that industry
advocates have been seeking for years. The Small
Business Credit Availability Act (the “SBCA Act”)
was signed into law in March 2018 as part of anomnibus spending bill that will fund the federal
government through September 2018. The SBCA
Act loosens leverage restrictions and directs the
Securities and Exchange Commission (the “SEC”) to
reduce the limitations on security offerings that havehistorically constrained BDC offerings.
The BDC industry has been advocating for more than
five years to secure these changes, which industry
participants hope will allow BDCs to lend moremoney and allow them to compete more aggressively
in the U.S. middle-market loan space. Despite
the long buildup, the SBCA Act arrived somewhat
suddenly when it was added to the omnibus spending
bill late in the legislative process, and now industry
insiders, observers and investors alike all havequestions about the bill, its inner workings, andits practical effects. In this Alert, we address somefrequently asked questions regarding the SBCA Act.
Leverage Changes
What were the previous regulatory limits on a BDC’s
use of leverage?
BDCs have always had the ability to use leverage,
albeit limited, as part of their investment strategy.
Historically, BDCs have had greater flexibility thanother types of registered investment funds—suchas traditional closed-end funds and mutual funds—
in their use of leverage. Whereas Section 18(a) of
the Investment Company Act of 1940, as amended(the “1940 Act”), requires registered investmentcompanies to maintain 300% asset coverage forborrowings, which equates to a 1:2 debt-to-equity
ratio, Section 61(a) of the 1940 Act requires BDCs
to have 200% asset coverage, or a 1:1 leverage
ratio (registered closed-end funds have a similar
200% requirement with respect to preferred stock
issuances). In other words, a registered investmentcompany can only borrow $50 for every $100 ofequity capital on its balance sheet, while a BDC has
been permitted to borrow $100 for every $100 inequity. Despite the additional flexibility provided for
BDCs, the prior BDC leverage limit is much lower
than limits on other lenders that BDCs sometimes

compete against. For example, banks and private
funds can usually incur significantly higher leverage.
How does the SBCA Act address BDC leverage
restrictions, and why does it matter?
While the default leverage limit applicable to BDCs
remains the same, the SBCA Act amended Section
61(a) of the 1940 Act to give a BDC the option toeffectively double the amount of leverage it may
utilize. If a BDC meets certain requirements, theasset coverage requirement applicable to that BDC
will be lowered from 200% to 150%, which translates
to permitting BDCs to now have up to a 2:1 leverage
ratio. Thus, a BDC may now borrow $200 for every$100 in equity capital on its balance sheet.
BDCs have historically felt that the 1:1 leverage
limitation was too restrictive and limited their ability
to provide much-needed capital to middle-market
companies. To generate the types of returns thatare attractive to investors with low leverage, BDCs
have argued that they were in effect corralled into
investing primarily in the riskiest, highest yielding
debt. Increasing the leverage limit may allow some
BDCs to deploy additional lower-risk senior capital
to borrowers and lessen their dependence on thehigher-risk junior capital and mezzanine debt inorder to obtain consistently attractive yields. For
example, an investment that yields 6% using 2:1
leverage could produce roughly the same returns as
an investment using 1:1 leverage that yields 9%.
A number of BDCs have utilized various means to
obtain effective leverage that exceeds the existing
1:1 limit without the additional leverage counting
against the 200% asset coverage requirement.
The leverage of certain joint ventures operated by
a BDC typically is not counted against the BDC’s
leverage limit if the joint venture subsidiary is notconsolidated for accounting purposes. Similarly,
BDCs may own and operate Small Business
Investment Companies as subsidiaries, and theleverage of those entities also does not counttowards that of the BDC. BDCs can also invest incollateralized debt obligations, which are themselves
leveraged.
While the newfound leverage flexibility may be aboon to certain BDCs, not all of them will fully utilize
the new leverage limit. Some may not elect to raise
their leverage limits, and almost all do not fully
utilize the leverage limits available today. According
to data from Thomson Reuters, the BDC industry as
a whole uses only about $0.69 of debt for every dollarof equity capital, which is significantly less than the
1:1 limitation.

2

BDCs use less leverage than they are legallypermitted for several reasons. Perhaps the most
relevant reason is that certain BDCs issue rated
debt securities, and ratings agencies typicallyrequire a debt-to-equity ratio of less than 0.85
as a prerequisite for an investment-grade rating.
Standard & Poor’s (“S&P”) has publicly statedits view that increased leverage in an alreadycompetitive environment may cause a net increase
for credit risk for the industry. That ratings agency
placed all BDCs it rates on “CreditWatch” withnegative implications (and lowered its outlooks tonegative on several BDCs). Fitch Ratings did nottake any immediate rating actions on BDCs, but theagency said it “generally views the potential leverageincrease as a ratings negative.”
Even if a BDC were willing to take a potential ratings
hit with respect to its future offerings, indenturesand other documents relating to its outstanding debt
may contain covenants that contractually restrict
the BDC from taking actions that negatively impact
its creditworthiness or increase its leverage pasta certain point. These covenants further impede
increases in leverage for BDCs seeking to use the newleverage limit.

to increase their leverage past the 1:1 ratio the day
after such approval is obtained.
Could a BDC seek both board approval andshareholder approval?
Yes. A BDC could have its board vote on
the increased leverage proposal, which isadministratively a far simpler task, and then also put
the matter to shareholders at a special meeting or
the next regularly scheduled annual meeting. In fact,many BDCs are doing just that. The statutory oneyear waiting period would begin whenever the board
approves the measure. If the shareholders approvethe measure at a shareholder meeting, then the BDC
would be permitted to make use of the increased
leverage the day after. If, however, the board
approves the measure but the shareholders do not,the BDC could still make use of increased leverageafter the one-year period has tolled, which will besooner than had they relied solely on obtaining
shareholder approval and experience delays in
obtaining that approval.

Are BDCs automatically able to make use of thehigher leverage ratios?
No, the increase in permissible leverage is not
automatic and the prior 1:1 limit remains the default
standard for BDCs. For a BDC to increase its leverageto the extent permitted by the SBCA Act, it mustmeet certain requirements. Specifically a BDC may
increase its permissible leverage ratio only after: (i)either (A) obtaining the approval of a majority of
the BDC’s independent directors or (B) obtaining
the approval of a majority of shareholders cast at
a special or annual meeting where a quorum ispresent; and (ii) publicly disclosing such approval
within five business days and making ongoingdisclosures about the increase, the actual amount ofleverage utilized and the principal risks associatedwith the leverage strategy. The required initial
disclosure of the approved change would be done
through a current report filing on Form 8-K (or otherannual or quarterly report) under the Securities
Exchange Act of 1934, as amended (the “ExchangeAct”), which would also be published by the BDC
electronically on its website.
The routes to approval are not equivalent. BDCs
that seek the ability to increase their leverage ratios
through the approval of their independent directors
cannot utilize the increase in leverage until one year
after the board votes. BDCs that obtain approval via
shareholder votes, on the other hand, would be able

While this two-stage approval approach is permitted
under the SBCA Act, it could put the board in
the unenviable position of feeling compelled toreconsider relying on the new leverage limit if the
proposal is later rejected by the BDC’s shareholders.
Boards will need to satisfy themselves that,
notwithstanding a negative vote (or a failure
to achieve quorum), the increase in leverage is
supported by prospects for improved performance(and does not result in a disproportionate increase infees captured by the adviser).
Could a newly formed BDC authorize increased
leverage through a sole shareholder vote?
Yes. While nothing in the SBCA Act permits a newly
formed BDC to automatically begin operations witha 150% asset coverage ratio, there is also nothing
in the SBCA Act that would prevent a sole initialshareholder from voting to approve the ability to3rely on the reduced asset coverage requirement.
A new BDC would then either include appropriate
disclosure in its registration statement regarding
its ability to rely on the 150% asset coverage limit
or file a Form 8-K within five days if its registration
statement is already effective.
Do the SBCA Act’s approval provisions overrule any
fundamental policy to the contrary?
If a BDC has an existing fundamental policy limiting
its use of leverage and then attempts to increase its
permissible use of leverage pursuant to the SBCA
Act, it is unclear whether merely obtaining board
approval would be sufficient. Section 13(a)(3) of the1940 Act requires shareholder approval to deviate
from an existing fundamental policy, but not to adopt
a new one that encompasses the old. The SBCA Act’s
approval procedures do not speak to fundamental
policies in general, and so its approval procedures
could be read as necessary, but not always sufficient,levels of approval. The question would then bewhether the BDC’s board allowing the BDC to utilize
the increased leverage limit would be “deviating”
from a BDC’s existing fundamental policy. Such aquestion can only be answered with reference tothe specific policy in question. For example, for a
BDC that has a fundamental policy that is tied tocompliance with statutory limits, or a fundamental
policy to use no more than a specified fraction of
the leverage it is permitted to utilize by law, it would
not be deviating from that fundamental policy
if it continued to abide by the same proportional
limitation after changing its leverage ceiling. If,
however, the fundamental policy specifies that the
BDC will not fall below a certain specified asset
coverage ratio (or exceed a certain debt-to-equity
ratio), then such an existing fundamental policy
would contravene the changes contemplated by the
SBCA Act. In that case, it would appear that the BDC
would need to receive shareholder approval to effectsuch a change.1
There is potentially an argument based on statutory
interpretation that would suggest that Congress
intended to create a limited exception to the rules
regarding fundamental policies, but it is unclear
whether the SEC ultimately would agree. Generally
speaking, where there is a clear contradiction
between an existing law and a new law, the newlaw is read to take precedence on matters where
1. Consider, for example, that when the SEC adopted Rule 35d-1, which ineffect required certain funds to change their fundamental investment
policies to require portfolios to be invested at least 80% in investments
implied by the name of the fund to avoid misleading investors, the SEC
noted that funds required to make changes to fundamental policies might
be required to obtain shareholder approval if a preexisting fundamental
policy conflicted with the new rule requirement. See https://www.sec.
gov/divisions/investment/guidance/rule35d-1faq.htm#P23_1077.

the two conflict. For example, in 1996, Congressenacted Section 12(d)(1)(G), which provides that thelimitations on funds owning other funds contained
elsewhere in Section 12 do not apply if, among otherthings, the acquired and acquiring companies arepart of the same fund group. It did not, however,
explicitly make reference to the prohibitions
under Section 17 that are also implicated by thosetransactions. The SEC stated in that case that since
Section 12(d)(1)(G) was created to obviate the needfor certain fund structures to obtain exemptive
relief, continuing to require them to obtain relief
for the related Section 17 matters would frustrate
the purpose of Congress’s actions, so no specificrelief with respect to Section 17 would be required
for transactions relying on 12(d)(1)(G). Here, thatargument is less clear. A BDC would have to make theargument that Congress, in enumerating the specificapproval procedures with respect to the leverage
ratio changes, intended to put aside other additional
mechanisms of shareholder protection with respect
to the leverage issue. If that were the case, then therequirement that any BDC with a fundamental policy
restricting leverage must still obtain shareholder
approval before deviating from that fundamental
policy would frustrate Congress’s intent.
Are there any other protections for existing BDC
shareholders with respect to the leverage changes?
As mentioned above, if a BDC elects to increase its
maximum leverage ratio by obtaining the votes ofa majority of its independent directors, a one-year
waiting period is required before the BDC can begin
to utilize the increased leverage. The one-year period
is intended to allow shareholders who disagree with
the increase in leverage to sell their stake in the BDC.
In addition, if an unlisted BDC approves an increase
in its leverage ceiling, it is required to offer its
existing shareholders some form of liquidity.
Regardless of whether a BDC approves the leveragechange through a board vote or a shareholder vote,
if its common shares are not listed on a national
exchange, the BDC must extend to each personthat is a shareholder as of the date of the approval
the opportunity to sell the BDC shares held by thatshareholder as of the approval date.
If a shareholder accepts the offer, the BDC would
be required to repurchase 25% of that shareholder’seligible shares each quarter of the four calendar
quarters following the quarter in which the leveragechange was approved. While most non-traded BDCs
have some mechanism for offering shareholders
periodic liquidity, many private BDCs do not, andthe only planned liquidity events are dissolution or afuture listing at some point in the future. Having to4

deal with a forced liquidity event may dramatically
impact such private BDCs, to the point where it might
be untenable for them to enact the leverage change.
Are lenders likely to extend additional credit to BDCs
that increase their leverage?

“Securities Act”), that BDCs and registeredinvestments companies, including traditional
closed-end funds, have thus far been excluded fromusing. The changes will treat BDCs like other noninvestment company issuers that perform registeredofferings and streamline the offering process.

Generally, yes, but each BDC is situated differently.
The borrowing ability of a BDC with a wellestablished track record that invests primarily insenior loans is very different from the borrowing
ability of a newly created BDC that proposes to invest
primarily in mezzanine loans. The industry focus,
investment strategy and proven access to deals will
also impact the ability of a given BDC to borrow.
Historically, in part because BDCs have beenrequired to maintain relatively low leverage ratios,
credit rating agencies have considered BDCs to havegood credit quality and they have been viewed as
attractive borrowers by traditional banks and bondmarkets. Banks have reliably lent BDCs money atmuch lower interest rates than the rate of return
BDCs expect to earn from their investments. Bank
debt has historically been cheaper to BDCs, and so,
if as discussed above, ratings agencies and banks
revise down their view on the creditworthiness ofhigher-leveraged BDCs, such changes likely will
increase the cost of borrowing for those BDCs.
Even if traditional borrowing costs increase, it’sunlikely that most BDCs would find themselves
entirely unable to access additional credit. Because
they are statutorily required to maintain a set
asset coverage ratio, if the BDC breaks that limit,
it is required to suspend dividends and sell assets
until it is in compliance with the asset coverage
requirement. This generally protects creditors, even
if it is at the expense of shareholders. Furthermore,
all BDCs, including non-traded and private BDCs,
are required to make public disclosures akin to thoseof a public company. As a result, lenders have better
access to financial information on a quarterly basis
and can take comfort in the fact that the financials of
the BDC are subject to the scrutiny of the public and
the SEC.
Security Offerings
What does the SBCA Act change about securities
offerings by BDCs?
The SBCA Act requires the SEC to amend a numberof rules and forms so as to allow BDCs access tovarious accommodations to the rules and regulations
regarding the registration, communications andoffering processes for registered transactions
under the Securities Act of 1933, as amended (theWhat does the SBCA Act change about BDC shelfregistrations?
While BDCs have been permitted to use shelfregistration statements on Form N-2 to register
multiple offerings of securities in order to raise
capital, currently those filings do not automatically
become effective. This stands in contrast to theshelf registration process available under Form
S-3, which permits shelf registration statements of“well-known seasoned issuers” (“WKSIs”) to be
automatically effective upon filing. Automaticallyeffective registration statements provide flexibility
for WKSIs to time securities sales with optimal
market conditions without waiting for the SEC staff
to review and comment on a registration statementand declare it effective. BDCs, along with registeredinvestment companies, were expressly excluded fromthe statutory definition of a WKSI, pursuant to Rule
405 of the Securities Act.
The SBCA Act revises the definition of WKSI tomake that status available to certain BDCs. The law
removes the exclusion of BDCs from the definitionof WKSI and adds registration statements filed by
BDCs on Form N-2 to the definition of “Automatic
Shelf Registration Statement.” For those BDCs thatwill qualify as WKSIs,2 this change will dramatically

2. To qualify as a WKSI, a BDC must (i) have been an SEC-reporting
company for at least 12 calendar months and have filed all material
required to be filed with the SEC in a timely manner over the preceding
12 calendar months; (ii) have not had any material defaults on
indebtedness or longterm leases since the end of the last fiscal year;(iii) either have (A) a worldwide float of at least $700 million (i.e., market
value of outstanding voting and nonvoting common equity held by nonaffiliates) or (B) issued for cash during the past three years at least $1
billion in aggregate principal amount of non-convertible debt securities
in primary offerings registered under the Securities Act and; (iv) not be
an “ineligible issuer,” as that term is used in the Securities Act, or an
asset-backed issuer.
5

reduce the costs associated with starting andsupporting shelf offering programs.
What does the SBCA Act change about incorporation
by reference for BDCs?
Form S-3 allows a company to incorporate byreference the disclosure from its current and future
Exchange Act reports to satisfy the disclosure
requirements of the Form. Incorporation byreference occurs when disclosure in one filed
document is legally deemed to be included in anotherdocument. Currently, Form N-2 does not allow forperiodic reports to be incorporated by reference.
The SBCA Act requires the SEC to amend Form
N-2 to permit a BDC that has been an Exchange
Act reporting company for 12 months and has a $75
million common share public float to incorporate byreference current and future publicly filed periodic
reports into their registration statements. Thesechanges should streamline the registration process
for BDCs by making it less cumbersome to maintaina current shelf offering document and reduce thebulk of offering documents generally.
The SBCA Act also directs the SEC to amend therules under the Exchange Act to allow a BDC toincorporate previously filed financial statements into
its proxy materials under Schedule 14A, similar towhat is permitted under Form S-3.
The SBCA Act also requires the SEC to revise Rule
497 of the Securities Act to allow a BDC to file a formof prospectus that contains substantive changes fromor additions to a previously filed and effective baseprospectus similar to how non-investment company
issuers file such supplements under Rule 424(b).

Currently, BDCs are not eligible to rely on certain
safe-harbors contained under Rules 134, 163, 163A,
168 and 169 under the Securities Act, which permit
issuers to release certain factual and forward-looking
business information under certain safe harbors
from the Securities Act’s gun-jumping provisions
and other restrictions. The SBCA Act directs the SEC
to allow BDCs to utilize these rules, which should
permit BDCs to more easily communicate with themarket. Similarly, the SBCA Act directs the SEC tomodify Rules 138 and 139 which will permit brokerdealers and other providers of market researchmore flexibility to disseminate research on BDCs
and thereby further enhance communication to themarket regarding BDCs.

“

Individually and in the aggregate, the SBCA
Act’s modifications to BDC offering rules will
make it quicker and easier for BDCs to raise
capital through registered offerings.

”

These changes, in conjunction with the otheroffering-related changes discussed above, align therules governing BDC offering communications withthe more permissive rules available to operatingcompanies. Individually and in the aggregate, theSBCA Act’s modifications to BDC offering rules will
make it quicker and easier for BDCs to raise capitalthrough registered offerings.

What does the SBCA Act change about prospectus
delivery for BDCs?
The SBCA Act extends “access equals delivery”
treatment to BDCs. BDCs are currently often
required to deliver a final prospectus to eachpurchaser by printing and mailing hard copies toinvestors. “Access equals delivery” under Rule 172
under the Securities Act, which deems electronic
availability of the prospectus equivalent to physicaldelivery in certain circumstances, previously was
unavailable to BDCs. The SBCA Act requires the
SEC to adopt rules bringing parity to BDCs in thisregard, and will allow BDCs to provide a notice ofregistration in lieu of sending the final prospectus.
These changes should significantly reduce the costand burden associated with prospectus delivery.
What does the SBCA Act change about market
communication for BDCs?
6

When will BDCs be able to take advantage of theregistered offering-related changes?
The SBCA Act directs the SEC to effect the changes
described above by March 23, 2019. BDCs will not
be able to take advantage of the securities offeringchanges until the date the SEC takes the directedactions. If the SEC fails to act to revise the rules andforms as directed within the window provided by thelaw, however, the SBCA Act permits BDCs to treatsuch revisions as having been made in accordancewith the specifications set out for the SEC within
the SBCA Act, until such time as the SEC adopts the
directed revisions.
Are the SBCA Act’s reforms everything BDCs need toreach their full potential?
While the SBCA Act’s reforms are welcomed andimportant changes for the BDC industry, there areother problematic rules that BDCs need reprieve
from before they can reach their full potential.
Perhaps the clearest example of a regulatory issue
that still needs to be addressed is the requirements
governing acquired fund fees and expenses(“AFFE”). The AFFE rules require 1940 Act funds
that invest in BDCs to include the BDC’s expenses
in their own funds’ expense ratios. The applicationof this disclosure requirement to BDCs distorts andoverstates the expenses of mutual funds and otherregistered funds when those funds invest in BDCs.
The rationale for AFFE does not make much sensein the context of listed BDCs. When an acquiringfund purchases shares in a mutual fund, for instance,
those shares are purchased at the target fund’s NAV.
The NAV reflects the value of the portfolio asset
but does not effectively capture the present valueof the future management fees, and these future
management fees will represent a reduction in
the investor’s returns. The AFFE rule is supposed
to force the acquiring fund to disclose this to theinvestors by disclosing the target fund’s expense
ratios alongside their own. When an acquiring fundpurchases a listed BDC, however, it does so at the
BDC’s market price, and that price theoreticallydoes account for future expenses. Given that the
BDC’s trading price will already reflect its operating
expense structure, reflecting the operating expenses
again under the AFFE rule results in the doublecounting of the target BDC’s expenses. Accordingly,
the AFFE rule disclosure requirements result inacquiring funds significantly overstating theirown expense ratios, which of course makes BDCs
dramatically less attractive investments for mutual
funds and other registered funds.
The AFFE disclosure rules have effectively resulted
in a ban on BDCs from most indices. Since many

institutional investors use indices to guide theirinvestment strategies (including tracking an index),
the AFFE disclosure rules made it problematicfor the operators of indices to continue including
BDCs. In 2014 the MSCI, Russell and S&P indices
all removed BDCs from their respective indicesprimarily because of the AFFE rule disclosure
requirement.3 The trend of steady growth in thenumber of public BDCs for more than a decadeprior to 2014 flattened following the change, as has
institutional ownership of BDCs. However helpful
the SBCA Act is, if Congress and the SEC truly want
to see BDCs live up to their full potential, their work
is not yet done—addressing the AFFE roadblock
would be a great next step.

Proposed Interpretation ofAdviser Duties Flies Under
Radar Next to HeadlineGrabbing Broker-Dealer
Proposals
The SEC issued three highly anticipated andsignificant proposals earlier this year that havethe potential to significantly alter the regulationof broker-dealers and investment advisers. These
proposals address enhanced standards of conduct
for broker-dealers and propose an interpretation
clarifying the fiduciary duty owed by investment
advisers. In the aftermath of the United States
Court of Appeals for the Fifth Circuit’s decision tovacate the Department of Labor’s “fiduciary rule,”
the SEC’s proposals have been widely followed bybroker-dealers and advisers looking for clarity as
to the scope of their duties and liabilities. During
the open meeting to consider these proposals, theSEC’s commissioners expressed a healthy range ofviews and concerns, but in voting four to one in favorof submitting the proposals for public comment
the commissioners signaled to broker-dealers andadvisers that they recognize the uncertainties
surrounding fiduciary standards and are willing totake substantial steps towards transparency.
The first proposal, “Proposed Interpretation
Regarding Standard of Conduct for Investment
Advisers; Request for Comment on Enhancing
Investment Adviser Regulation,” interprets the
SEC’s views of the fiduciary duties advisers owe
their clients and requests comments on whether
3. See, e.g, https://www.fitchratings.com/gws/en/fitchwire/
fitchwirearticle/Removal-of-BDCs?pr_id=823651(discussing therationales for removing BDCs from indices and its potential effects on
those BDCs).
7

the SEC should propose rules to impose certain
licensing, continuing education, and other FINRAlike obligations on advisers. The second proposal,“Regulation Best Interest,” would require a brokerdealer to act in a retail customer’s best interest
when it makes securities recommendations—i.e., theproposed regulation is designed to prohibit a brokerdealer from putting its financial interests ahead of
its retail customers. The third proposal, “Form CRS
Relationship Summary; Amendments to Form ADV;
Required Disclosures in Retail Communications andRestrictions on the use of Certain Names or Titles,”would mandate that advisers and broker-dealers
provide retail customers with summary information
about the nature of the client relationship, and would
restrict certain broker-dealers from using the terms“adviser” or “advisor” as part of their name or title
when dealing with retail customers.
This Alert focuses on the SEC’s interpretation ofadvisers’ standard of care, but the importance ofthe proposals relating to broker-dealer duties anddisclosure applicable to retail investors cannot be
overstated in light of the SEC’s effort to enhance thequality and transparency of retail investor relations.
Standard of Conduct for Investment Advisers
The SEC’s proposed interpretation reaffirms andclarifies certain standards of conduct applicable toadvisers under the Investment Advisers Act of 1940(the “Advisers Act”). The federal fiduciary standard
for advisers under the Advisers Act comprises two
broad duties: the duty of care and the duty of loyalty.
The identity of fiduciaries and the scope of their
responsibilities are sometimes open to debate. The
Department of Labor’s attempted fiduciary rule did
not succeed in establishing clear fiduciary standards,
but, with a few exceptions, the SEC’s proposal does.
Our thoughts on the SEC’s interpretation of advisers’
duty of care and duty of loyalty are summarized
below, including a key criticism related to the SEC’s
apparent view regarding how advisers allocate
investments across multiple eligible client accounts.

“

The federal fiduciary standard for advisers
under the Advisers Act comprises two broad
duties: the duty of care and the duty of loyalty.

”

Duty of Care
According to the proposal, an adviser’s duty of care
to a client includes, among other things: (i) the duty
to act and to provide advice that is in the best interestof the client; (ii) the duty to seek best execution ofa client’s transactions where the adviser has the
responsibility to select broker-dealers to executeclient trades; and (iii) the duty to provide advice andmonitoring over the course of the relationship.
(i) Duty to Provide Advice that is in the Client’s BestInterest
When providing personalized investment advice,
the duty of care requires that an adviser make areasonable inquiry into a client’s financial situation,level of financial sophistication, investment
experience and investment objectives, which theproposal refers to as the client’s “investment profile.”
Understanding a client’s investment profile allows anadviser to provide suitable advice that is consistent
with the best interests of the client. Advisers
typically engage in suitability analyses whenallocating investment opportunities amongst client
accounts. The proposal establishes a reasonablenessstandard to assess an adviser’s inquiry into
its clients’ investment profiles, the nature andextent of which turn on what is reasonable under
the circumstances, including the agreed-uponadvisory services, the complexity of the anticipatedinvestment advice and the investment profile of theclient.
The proposal notes that, when allocating
investments, advisers should consider a client’s
risk tolerance and the costs of such investments(among other things). Contrary to the belief thatswept through the industry and contributed to theproliferation of “clean shares” after the Departmentof Labor’s fiduciary rule was adopted, the SEC’s
proposal recognizes that context matters and notesthat the duty of care does not require that an adviser
recommend the lowest cost investment to its clients.
However, the proposal qualifies this statement by
explaining that the SEC’s view is that an adviser
could not reasonably believe that a security is in thebest interest of a client if it has a higher cost thana security that is otherwise identical. The proposal
notes that, if an adviser advises a client to invest in amutual fund share class that is more expensive thanother available options when the adviser is receiving
compensation that creates a potential conflict andthat may reduce the client’s return, the adviser
may violate its fiduciary duties and the antifraud
provisions of the Advisers Act if it does not, at aminimum, provide full and fair conflicts disclosure
and obtain informed consent to such conflicts. Theinterpretation recognizes that a more expensive
product’s suitability depends on a client’s investment
profile and the context in which the adviser manages
the portfolio. For example, it could be consistent
with an adviser’s fiduciary duty to advise a clientwith a high risk tolerance and significant investment
8experience to invest in a private equity fund withrelatively higher fees if other factors, such as
diversification and potential performance benefits,
support the investment as being in the client’s bestinterest.
(ii) Duty to Seek Best Execution
The proposal provides that an adviser’s duty ofcare extends to its selection of broker-dealers to
execute client trades. The proposal describes “bestexecution” to mean a client’s total cost or proceedsfrom a transaction must be the most favorable under
the circumstances. An adviser fulfills this duty by
executing transactions with the goal of maximizing
value for the client under the given circumstances,and the SEC recognizes that maximizing value
entails more than minimizing cost.
In seeking best execution, the proposal notes thatadvisers should consider the full range and qualityof a broker’s services, including the value of research
provided. Institutional advisers commonly use soft
dollar credits to execute trades with broker-dealers
in exchange for research; there is no indication the
SEC intends to reign in this practice by viewing
execution costs in a vacuum.
(iii) Duty to Act and to Provide Advice andMonitoring Over the Course of the Relationship
Asserting a perpetual nature of the duty of care,the proposal states that an adviser must provide
advice and monitoring over the course of theclient relationship at a frequency that is in the bestinterest of the client and consistent with the scopeof the agreed-upon advisory services. The proposal
highlights this duty for advisers that have ongoingclient relationships, specifically referencing advisersthat are compensated with a periodic asset-basedfee (as opposed to transaction-based fees) or thathave discretionary authority over client assets, which
generally applies to advisers to registered funds.
Duty of Loyalty
The proposal interprets the duty of loyalty broadly
to require that an adviser put its clients’ interests
ahead of its own and refrain from unfairly favoring
one client over another. To meet this duty, theproposal provides that an adviser must make fulland fair disclosure to its clients of all material facts
relating to the advisory relationship and all material
conflicts that could affect the advisory relationship.
The prominence of conflicts disclosure in theinterpretation reaffirms that an adviser’s duty to
avoid conflicts with its clients and, at a minimum,
disclose such conflicts is a cornerstone of the dutyof loyalty. The proposal further states that advisers
need to describe conflicts with sufficient specificity
to give investors the ability to provide informed
consent. This is not a new concept, but that statement
will further empower examiners to push for more
specificity in conflicts disclosure. The proposal notesthat disclosing the mere possibility of a potential
conflict is not adequate when such conflict actuallyexists, a point which was emphasized at the SEC’s
annual Compliance Outreach Program National
Seminar in April 2018.4 As such, advisers may wish
to consider amending their Form ADV brochures
and other sources of conflicts disclosure to disclose
conflicts in definite terms rather than in the abstract.
The proposal interprets the duty of loyalty to include
a duty not to treat some clients favorably at theexpense of other clients. Thus, when allocating
investment opportunities among eligible clients, theproposal said that an adviser must treat all clients
fairly. We note that the proposal stops short of sayingthat clients must be treated “equally.” Without
further guidance as to the SEC’s definition of “fairly,”
the proposal could be interpreted to prohibit thecommon practice among advisers to allocate specificinvestment opportunities to clients with priority
rights on certain types of investments, even thoughother clients might have eligible investment profiles.
The proposal cites to an article that provides thatan adviser must not give preferential treatment tosome clients or systematically exclude eligible clientsfrom participating in specific opportunities without
providing the clients with the appropriate disclosure
regarding the treatment. The proposal further notesthat an adviser’s allocation policies must be fairand, if they present a conflict, the adviser must fully
and fairly disclose such conflict that a client can
provide informed consent.5 The proposal stops shortof deeming it permissible to exclude certain clientsfrom investments if the adviser has disclosed its
practice to do so, but by citing to this article, it may
have incorporated this position by reference.
An adviser’s conflicts disclosure should include aclear methodology for allocating investment anddisposition opportunities across multiple eligible
client accounts. It is not uncommon for such
4. The SEC has found an adviser’s disclosure inadequate because it
stated the adviser may receive compensation from a broker as a resultof facilitating client transactions through the broker and that thesearrangements may create a conflict of interest when the adviser was
actually receiving such payments and had such a conflict. See In the
Matter of The Robare Group, Ltd., et al., Investment Adviser Act Release
No. 4566 (Nov. 7, 2016).
5. This requirement is consistent with an advisers’ responsibility tomaintain policies and procedures that address allocation of investment
opportunities and disclosure, and to provide clients with sufficiently
specific facts so that the client is able to understand the adviser’s conflictsof interest and give informed consent to such conflicts or reject them.
See Investment Advisers Act Release No. 2204 (Dec. 17, 2003); General
Instructions for Part 2 of Form ADV.
9methodologies to contemplate strategic relationships
with individual clients, other third parties oraffiliates that provide for preferential “first rights”
on certain investments or categories of investments.
An otherwise eligible client may be excluded froman investment opportunity if an adviser has sucha strategic relationship. The proposal’s fairness
standard does not necessarily conflict with firstrights allocation methodologies. Advisers may
enter into strategic relationships for a variety ofreasons, including to receive referrals, reliableliquidity and reciprocal first rights. Preferential
allocations are not inherently “unfair” (when clearly
disclosed), as the benefits of strategic relationships
are generally shared among clients, but we expect
continued uncertainty on this point without further
clarification from the SEC.

The SEC’s Share Class
Selection Self-Reporting
Initiative: A Creative Idea
That Should Go Further
The SEC recently has focused on what it perceives
as disclosure violations related to how registeredinvestment advisers select mutual fund share classes
for their clients. In this Alert, we discuss a recent
initiative by the SEC to encourage self-reporting ofsuch violations and highlight ways the SEC could
better incentivize self-reporting in the future.
Continuing a theme from 2017, the SEC’s Officeof Compliance Inspections and Examinations(“OCIE”) has stated that it will continue to focus
on share class disclosure violations in its exampriorities for 2018. To that effect, the SEC Division
of Enforcement (the “Enforcement Division”)
launched a new initiative on February 12, 2018—
the Share Class Selection Disclosure Initiative(“SCSD Initiative”). The SCSD Initiative provides
a self-reporting outlet for firms that have failed toadequately disclose conflicts of interest related to theselection of mutual fund share classes that paid theadviser as a dually-registered broker-dealer, or its
related entities or individuals, compensation whena lower-cost share class for the same fund was alsoavailable to the adviser’s clients. The SEC believes
these violations are widespread and that the SCSD
Initiative is a better allocation of agency resources
than individualized enforcement actions. On May 1,
2018, the SEC published frequently asked questions(FAQs), providing additional information about the
SCSD Initiative.

Further underscoring the SEC’s focus on this issue,
the SEC announced settlements with three advisers—
PNC Investments LLC, Securities America Advisors,
Inc. and Geneos Wealth Management—for failing todisclose that they invested clients in share classes
with Rule 12b-1 fees when cheaper shares of the same
fund with lower Rule 12b-1 fees or no Rule 12b-1 fees
were also available.6 The SEC ordered each firm to
pay a fine, along with disgorgement and interest.
Background
The SCSD Initiative is intended to be a reporting
mechanism for advisers who have failed to makewhat the SEC views as necessary disclosures
regarding Rule 12b-1 fees. The Advisers Act provides
that advisers have a fiduciary duty to disclose toclients conflicts of interest which may lead anadviser, whether intentionally or not, to renderinvestment advice that is not disinterested. The
SEC asserted that advisers often recommend shareclasses with Rule 12b-1 fees over share classes of thesame fund with lower fees in order to increase theirrevenue. Rule 12b-1 fees are paid by mutual funds
to an adviser on an ongoing basis from the fund’s
assets, thereby reducing a shareholder’s returns. As
such, when a share class with no Rule 12b-1 fee or alower Rule 12b-1 fee is available for the same fund, it
is usually in a shareholder’s best interest to invest in
the lower-cost share class. Advisers are required todisclose conflicts of interest, such as this, and receiptof Rule 12b-1 fees on Form ADV. The SEC believes
this lack of disclosure is prevalent in the mutual fundindustry.

6. The FAQs provide examples of what it means for a lower-fee share class
to be “available”, including when: a client could have purchased a lowercost share class for the same fund because the client’s investment met theapplicable investment minimum; according to a fund’s prospectus, thefund would waive the investment minimum for a lower-cost share classfor the same fund for advisory clients and the adviser had no reasonablebasis to believe the fund would not waive the investment minimum for alower-cost share class for its clients; and the adviser purchased a lowercost share class of the same fund for other similarly-situated clients.
10Consequences of Self-Reporting

True Amnesty?

Advisers had until June 12, 2018 to self-report.
If an adviser elects to self-report under the SCSD
Initiative, the adviser must disclose both the conflictassociated with making investment decisions in lightof the receipt of 12b-1 fees and the conflict associatedwith selecting the more expensive Rule 12b-1 fee
paying share class when a lower-cost share class
was available for the same fund. In exchange forself-reporting, the Enforcement Division has statedthat it will recommend favorable and standardized
settlement terms. The standardized settlement
terms involve:

While the SCSD Initiative seemingly provides a raresafe opportunity for advisers who may have failed
to disclose conflicts of interest regarding Rule 12b-1
fees, the extent of its protection is limited. Anyother potential misconduct discovered throughout
the course of an SCSD Initiative self-reporting
investigation is not subject to the same leniency asa failure to disclose Rule 12b-1 fees, which the SEC
reiterated in the FAQs. Further, the SCSD Initiative
only applies to advisers. If individuals associatedwith the advisers have engaged in any violations of
the securities laws, the SCSD Initiative will not coverthese individuals.

• A cease and desist order under Sections 203(e)and 203(k) of the Advisers Act for violations ofSections 206(2) and 207 of the Advisers Act basedon the adviser’s failure to disclose the conflict ofinterest, along with a censure;• Disgorgement by the adviser of its ill-gotten gain,
as reported on the self-reporting questionnaire
and as discussed with the Staff, and prejudgmentinterest on such gain, which may be offset in the
Staff’s discretion if it determines that the adviser
reduced or offset its advisory fee by the amount of
the Rule 12b-1 fees;• A certification that the disgorgement is accurate
and an order requiring the adviser to make anadviser-administered distribution to affectedclients; and• An acknowledgement that the adviser has taken
certain steps to remedy the violation or an orderof undertakings requiring that within 30 days of
instituting the order, the adviser will take such
steps.

The FAQs also highlighted two interesting features of
the SEC’s approach to this issue. To provide adviserswith certainty regarding the consequences of selfreporting, the SEC emphasized that “the severity andscope” of the conduct will not significantly change
the terms that the SEC would seek to impose inconnection with a settlement. Additionally, unlike
the recent settlements noted above, any settlements
recommended by the Enforcement Division under
the SCSD Initiative will not involve civil penalties.
However, under Section 203(e) of the Advisers Act,cease and desist orders require firms to agree toa “willful” violation of the Advisers Act.7 To date,no settlements have been issued pursuant to the
SCSD Initiative.
7. A finding of a willful violation does not require that an actor knows he or
she is violating a federal security law.

An adviser who self-reports will inevitably face an
SEC enforcement action, which may be disruptive tothe adviser’s business and harmful to its reputation.
The primary upside to self-reporting is that the
Enforcement Division would not recommend a
civil monetary penalty in connection with suchan enforcement action. Fearing the peripheral
consequences of an enforcement action and publicsanctions, many advisers may, on balance, be
deterred from self-reporting despite the standardized
settlement terms.
Suggested Enhancements to a Self-Reporting
Mechanism
The SEC could promote much greater levels of
self-reporting if it lessened the potential collateraleffects that an enforcement action may have on anadviser and its business. To encourage self-reporting,whether related to Rule 12b-1 fee disclosure orother issues, the SEC should consider taking analternative approach with less severe consequences.
In the past, the SEC has from time to time decided
to take no enforcement action at all if a registrant
self-reported. In a 2001 report investigation, the SEC
emphasized that one of the factors it considered in
not recommending an enforcement action was thatthe company self-reported its misconduct. Currently,
the odds of an adviser avoiding an enforcement
action are better if the adviser does not self-report.
If the threat of an enforcement action was a lesscertain result of self-reporting, advisers may be more
willing to initiate a dialogue with the SEC regarding
potential violations.
Another potentially viable alternative to thecurrent self-reporting regime may include solutions
comparable to non-prosecution agreements
or deferred prosecution agreements. Nonprosecution agreements are entered into in limited
circumstances in which the SEC agrees not topursue an enforcement action against an individual
or company if they agree to cooperate fully and11truthfully and comply with express undertakings,
while deferred prosecution agreements also requirethat an individual or company comply with express
prohibitions and undertakings during a specified
period of time. While these agreements typically are
entered into with respect to criminal conduct, theSEC should consider similar leniency under its selfreporting programs to better incentivize advisers toparticipate.
Conclusion
The SEC should be applauded for its creativity inlaunching the SCSD Initiative. It presents a rareopportunity for advisers to self-report violations of
the securities laws with reasonable certainty as tothe consequences that the SEC will impose. On theother hand, the consequences of self-reporting, andall of the attendant intangible harms to an adviser’s
business and reputation, may outweigh the benefitsof such certainty to advisers considering whether toself-report. The SEC should consider alternatives tosanctions in order for the SCSD Initiative, as wellas similar future initiatives, to better encourage
participation and remove the incentive for advisers
to sweep minor violations under the rug.

New York Attorney General’s
Investigation Into Actively
Managed Mutual Funds
Leads to Enhanced Disclosure
to Retail Investors
In April 2018, the Investor Protection Bureau of the
Office of the New York Attorney General (“NYAG”)
released its findings and recommendations
following an investigation into mutual fund fees. The
investigation resulted in pressure on mutual fundfirms to disclose to retail investors more information
about just how “active” their management is withrespect to actively managed funds. Specifically, the
NYAG reached an agreement with several large
mutual fund firms in which the firms agreed to
publicly publish a metric known as “Active Share.”This metric purports to measure the difference
between a mutual fund’s holdings and the holdingsof its benchmark index based on the number ofissuers and the weight of each holding in the fund’s
portfolio compared to the weight of each holding in
the benchmark’s portfolio.
The NYAG’s initiative reflects two significant
trends in the asset management industry: (i) state
governments stepping in to regulate the industry,

claiming that the SEC is abdicating its role; and(ii) the battle between active and passive funds forretail investments. In support of this Active Sharecampaign, now-former Attorney General Eric
Schneiderman stated that public disclosure of thisnew metric will allow retail investors to make more
informed decisions prior to investing in a mutualfund by helping them determine if a fund’s high fee isappropriate based on its level of active management.
Although the NYAG insists that the Active Sharemetric is a necessary tool, it is unclear how retailinvestors will actually benefit from this disclosure.
Indeed, there is a risk that investors may end up
putting too much emphasis on the Active Sharemetric at the expense of other relevant factors that
influence a fund’s fee rate.
The NYAG was prompted to conduct this industrywide investigation due to the popularity of actively
managed mutual funds despite the fact that theycharge higher fees than passively managed mutual
funds. As part of its investigation, the NYAG
surveyed several mutual fund firms that manage
more than 2,000 actively managed mutual funds.
The survey sought to determine whether and how
these firms use the Active Share metric, and whether
the Active Share metric is publicly disclosed toinvestors. The NYAG found that every surveyed firmused the Active Share metric in some capacity—
including measuring risks for an individual fund,setting informal targets for portfolio managers,
selecting and assessing performance of portfolio
managers and sub-advisers—and that every firm
disclosed Active Share information to institutional
investors in presentations or pitch books (or at least
upon request). In contrast, the NYAG found that only
four of the 14 surveyed firms provided any Active
Share information to their retail investors, either
on the firm’s website or in supplemental data sheets
posted online.8
Following the NYAG’s investigation, all of thesurveyed firms that were not already publishing
Active Share data have agreed to publish theinformation on their websites for their actively
managed mutual funds. Although the NYAG’s
recommendation did not include a compliance date
for mutual fund firms, this disclosure should soon,
if not already, be available to U.S. investors.9 The
NYAG urged all mutual fund firms to follow suit andrecommended that retail investors take advantageof this new information when deciding whether anactively managed mutual fund’s fee is acceptable
8. The report noted that some firms provided the Active Share information
to retail investors through brokers and other intermediaries, but only
upon request.
9. Eight of the firms have already published their Active Share data either
on their website, through a fund fact sheet or in a quarterly statistic
report for each relevant fund.
12

based on the level of the fund’s overlap withits benchmark.
The investigation is part of a long history of state
governments getting involved in regulating themutual fund industry
In its politically charged report, the NYAG explainedthat it was prompted to conduct its investigationin part because of the increasing complexity
surrounding mutual fund market and the NYAG’sview that the federal government has rolled backprotections designed to heighten the duty of careowed to investors and address investment advisers’
conflicts of interest. Specifically, the NYAG’s report
noted the uncertainty concerning the future of the
Department of Labor’s Fiduciary Rule, including theinconsistent decisions from federal appellate courts
regarding the validity of the rule and the Trumpadministration’s decision to delay the enforcementof the rule until July 2019. The report also noted the
SEC’s inaction with respect to implementation of a
uniform best interest standard.10 The NYAG believes
that pervasive, unaddressed conflicts of interest,
especially in the retirement advisory business,
could cost investors between $95 billion and $189
billion over the next 10 years. In light of these issues,
the NYAG believes that disclosing Active Shareinformation will give retail investors the tools theyneed to be more vigilant in evaluating investment
choices and recommendations from their investment
advisers. Assuming for the sake of argument that theclaim of harm is true, it is difficult to understand how
Active Share disclosure would cure it.
State governments’ involvement in regulating theasset management industry is not novel. Beginningin 2003, Eliot Spitzer, New York’s Attorney Generalat the time, investigated several mutual fund andhedge fund firms in an attempt to crack downon alleged widespread illicit trading practices,
specifically late trading and market timing. The
probe ultimately resulted in settlements witha number of firms. Mr. Spitzer’s findings fromthese cases also convinced both the SEC and theCommonwealth of Massachusetts to launch theirown investigations into hedge fund and mutualfund practices, and the SEC agreed to work with
Spitzer on his probe. Also at that time, William
F. Galvin, the Massachusetts Secretary of theCommonwealth, launched a joint inquiry with Mr.
Spitzer into a firm’s sale of proprietary mutual
funds to investors who were not aware that brokers
received additional compensation for selling suchfunds, which ultimately led to a settlement. The
10. The NYAG report predated the SEC’s recent proposals regarding thestandards of care for broker-dealers and investment advisers, which
are discussed elsewhere in this Alert.

inquiry not only focused on the firm’s practice, butalso sought to determine if other firms had similar
practices. Commentators at the time asserted that
the SEC was lagging Mr. Spitzer’s aggressivenesswith investigating conflicts of interest in the asset
management industry, although the SEC insisted
that it had not been made aware of these allegations
until Mr. Spitzer filed his complaints.
Given assertions by certain state regulators that
the Trump administration is seeking to roll backand/or halt the federal regulatory process, state
governments likely will seek to increase efforts toextend their authority over the asset management
industry and could cause significant headaches andburdens for the industry if responding to inquiries
from a patchwork of state regulators.

The investigation reflects the ongoing battle between
passively managed and actively managed mutual
funds
Another major factor that the NYAG claimed
prompted its investigation into the mutual fundindustry was a desire to better understand whether
actively managed funds’ significantly higher
advisory fees correlate with higher levels of active
management. The NYAG found that actively
managed funds cost 4.5 times more than passively
managed funds. The NYAG compared each fund’s
Active Share metric to its advisory fee and discoveredthat funds charged a wide range of fees for the samelevel of active management. The NYAG concluded
that investors could not assume that the higher fees
reflected the funds’ opportunity to outperform theirbenchmarks through more active management. The
NYAG’s comparison, however, contains a flawed
assumption (discussed further below) that the only
way to outperform a benchmark is to have little
overlap with it.
The NYAG’s report highlights the ongoing battle
between passively managed and actively managed
funds for investors’ dollars. The NYAG’s report
noted that by 2016, nearly half of all U.S. households
13

invested in mutual funds, either directly or indirectly
through an employer’s 401(k) plan. Although mostinvestors choose to invest in passively managed
funds, actively managed funds still remain a popular
option for investors looking for an opportunity tooutperform a benchmark, despite the higher fees
charged for such funds. Some critics, however,believe that some actively managed mutual funds
are merely index funds in disguise. At this point, it isunclear how much weight investors put on the Active
Share metric and whether this new disclosure will
impact actively managed fund flows.
The Active Share metric is unlikely to be as
informative for retail investors as the NYAG expects
Although the NYAG concluded that disclosureof Active Share information is critical to close
the information gap that hinders retail investors’ability to make informed investment decisions, thedisclosure of Active Share information in practicelikely is not as informative as the NYAG believes. In
the NYAG’s view, investors cannot look at a mutual
fund’s advisory fee alone to determine its level ofactive management and, in turn, its potential togenerate better returns compared to its benchmark
or avoid losses. The NYAG’s report recommends thatretail investors use the Active Share metric whenevaluating investment options, but fails to explain
how investors should use this information and does
not recommend that investors view the Active Sharemetric as only one of a number of factors relevant toevaluating a mutual fund.
Despite the level of importance the NYAG attachedto the Active Share metric, its agreements with themutual fund firms only require this metric to be
updated quarterly, as opposed to daily. As such,
the Active Share metric is only providing retailinvestors with a snapshot of the mutual fund’s active
management at one point in time, which is unlikely

to paint an accurate picture of the actual extent
of active management for a fund. Certain mutualfund firms may decide to publish more frequent
Active Share information or historical Active Shareinformation, either in the spirit of transparency
or in order to highlight their active management
to retail investors. In addition, the NYAG’s report
only acknowledges that the Active Share metric
may be less relevant when comparing different
types of mutual funds, such as those with different
market-caps. It does not recognize that the Active
Share metric may be far less useful for funds withflat benchmark indexes, such as the Russell 2000,
or when comparing funds that utilize different
strategies in their active management (e.g., sector,
geographic or momentum strategies). It remains tobe seen if retail investors will actually appreciatethese limitations of the Active Share measure.
Finally, too much emphasis on the tenuous link
between the Active Share metric and investment
advisory fees may encourage plaintiffs to pursue
frivolous excessive fee lawsuits. While the NYAG’s
report appears to suggest that a high advisory fee
for an actively managed fund is not justified if thefund has a low Active Share metric, a fund’s advisory
fee involves many other considerations beyond theamount of active management, such as the level ofcomplexity involved with a particular strategy. If
investors do not appreciate the intricacies involved
in setting a fund’s advisory fee, they may jump to theconclusion that a high advisory fee is not warranted
based solely on the Active Share metric.
In light of Mr. Schneiderman’s recent resignation,
the future of the NYAG’s Active Share campaign is
uncertain. However, there regrettably has been no
indication that his replacement will take a morecautious, thoughtful approach into inserting the
NYAG into the regulation of actively managed
mutual funds.

14

M&A Transactions
Acquiror(s)Acquired or
Target Company

Type of Transactionand Status

BlackRock, Inc., a global investment
manager with approximately $6.28
trillion in AUM

Tennenbaum Capital Partners, LLC, aprivate credit manager with approximately $9billion of committed client capital

Acquisition(terms not disclosed)

Blackstone Strategic Capital
Holdings, a Blackstone permanent
capital vehicle which specializes
in acquiring long term interests inleading alternative asset managers

Rockpoint Group, L.L.C., a real estate
private equity firm and registered investment
adviser

Acquisition of a passive, minority
equity stake (terms not disclosed)

Franklin Templeton, a Californiabased global investment management
organization with approximately $753
billion AUM

Edinburgh Partners Limited, an
independent fund management company thatspecializes in global and emerging markets
equities with approximately $10 billion AUM

Acquisition(terms not disclosed)

Lovell Minnick Partners LLC,a private equity firm with expertisein investing in the financial andrelated business services sectors
with approximately $1.7 billion incommitted capitalCenterSquare Investment Management,a global investment manager focused on
actively managed real estate and infrastructure
strategies with approximately $8.9 billion
AUM of real estate and infrastructure
securities

Acquisition(terms not disclosed)

Macquarie Infrastructure andReal Assets, a division of Macquarie
Asset Management of Macquarie
Group with approximately €94 billion
AUM

GLL Real Estate Partners, a realestate investment management group that
focuses on commercial property portfolios
in the international real estate sector withapproximately $8.66 billion in AUM

Acquisition(terms not disclosed)

Mercer, a wholly-owned subsidiary ofMarsh & McLennan Companies, Inc.

BFC Asset Management Co., Ltd., aJapanese independently owned multi-manager

Acquisition(terms not disclosed)

Oaktree Capital Management, L.P.,
an investment manager specializing
in alternative investments withapproximately $100 billion AUM

Kudu Investment Management, LLC,
a capital provider to asset management andwealth management firms

Acquisition of minority stake for$250 million

Scotiabank, a Canadianinternational bank

Jarislowsky, Fraser Limited, an
independent investment management firmwith approximately $40 billion AUM

Acquisition with a purchaseprice payable at closing ofapproximately $950 million will besatisfied primarily by the issuanceof Scotiabank common shares

StepStone Group Real Estate LP,a real estate investment firm that ispart of StepStone Group LP, a private
firm that oversees approximately $130
billion in private capital allocations
with approximately $34 billion AUM

Courtland Partners, Ltd., an institutional
investment adviser that provides advisory
services in the real estate, infrastructure,energy, timber and agriculture sectors withapproximately $95 billion AUM

Acquisition(terms not disclosed)

andWhite Mountains InsuranceGroup, Ltd., a Bermuda-domiciled
financial services holding company
with approximately $6.5 billion AUM

15

M&A Transactions (continued)
Acquiror

Acquired or
Target Company

Type of Transactionand Status

Virtus Investment Partners, Inc.
a distinctive partnership of boutiqueinvestment managers

Sustainable Growth Advisers, a growthequity manager focused on providing highconviction U.S., global and international
portfolios primarily for institutional clientswith approximately $11.6 billion AUM

Acquisition of a majority interest(terms not disclosed)

W.E. Donoghue & Co., LLC,
a boutique investment firm withapproximately $2.6 billion AUM

JAForlines Global, a New York-based
investment management company withapproximately $700 million AUM

Acquisition(terms not disclosed)

White Oak Equity Partners, aprivate equity firm that purchases
non-controlling GP interests inalternative asset managers

FCO Advisors LP, a private municipal credit
focused investment fundAcquisition of a minority interest(terms not disclosed)

1st Quarter 2018
Closed-End Fund Public Offerings
Tortoise Tax-Advantaged Social Infrastructure Fund
Structure:

Interval fund with quarterly repurchase offers of 5% of its outstanding common stock

Investment Objectives/
Policies:

The Fund’s investment objective is to seek to generate attractive total return with an emphasison tax-advantaged income. “Tax-advantaged” income is income that by statute or structuringof a security is in part, or in whole, tax-reduced, tax-deferred or tax-free with respect to federal,state or municipal taxes. The Fund seeks to achieve its investment objective by investing atleast 80% of its total assets in the social infrastructure sector. The “social infrastructure sector”
includes assets and services that accommodate essential services related to education, healthcare,housing, human service providers and social services. Such assets and services may include, but
not be limited to, primary, secondary and post-secondary education facilities; hospitals and other
healthcare facilities; seniors, student, affordable, military and other housing facilities; industrial/
infrastructure and utility projects; and nonprofit and civic facilities. The Fund is not required toinvest in all such types of social infrastructure securities at all times. Issuers of social infrastructure
securities and obligations may include governmental entities or other qualifying issuers of states,
municipalities, territories and possessions of the United States and the District of Columbia andtheir political subdivisions, agencies and instrumentalities, private non-profits, 501(c)(3)s, public
nonprofits and other entities authorized to issue private activity and tax-exempt municipal bonds.

Manager:

Tortoise Credit Strategies, LLC

Distributor:

Quasar Distributors, LLC

16

Simpson Thacher’s dynamic, long-standing Registered Funds Practice encompasses all
aspects of the investment management business. Our practice focuses on alternative asset
managers seeking to access retail investor channels, asset management mergers andacquisitions, and advising on cutting-edge regulatory policy and strategy matters.
David W. Blass • 1-202-636-5863 • david.blass@stblaw.com
David Blass is a Partner in Simpson Thacher & Bartlett LLP’s Investment Funds Practice. David is a leading
regulatory lawyer in the funds industry and has advised on matters involving innovative registered funds
products, Investment Advisers Act compliance, SEC examination and enforcement matters, and broker-dealer
regulatory compliance. Prior to joining Simpson Thacher, David served as General Counsel of the Investment
Company Institute (ICI), where he was responsible for the full range of legal and regulatory matters affecting
the asset management industry, including investment company, capital markets, pension and tax issues. He alsopreviously was Chief Counsel of the SEC’s Division of Trading and Markets.

Rajib Chanda • +1-202-636-5543 • rajib.chanda@stblaw.com
Rajib Chanda is a Partner in the Washington, D.C. and New York offices of Simpson Thacher & Bartlett LLP,
and is the Head of the Firm’s Registered Funds Practice. Rajib’s practice focuses on all aspects of issues facing
registered investment advisers and sponsors of registered funds. Rajib has particular experience working withalternative asset managers seeking to access retail investor channels through mutual funds, business development
companies, closed-end funds, exchange-traded funds and permanent capital vehicles. He also works extensively
with more traditional registered fund sponsors and works closely with the firm’s asset management M&Agroup on transactions involving registered advisers and funds. In addition, Rajib provides counsel to boardsof registered funds, and has substantial experience advising companies on issues relating to social media andcybersecurity.

Sarah E. Cogan • +1-212-455-3575 • scogan@stblaw.com
Sarah Cogan is a Partner in the New York office of Simpson Thacher & Bartlett LLP. Sarah’s practiceencompasses all aspects of the registered funds industry and she represents closed-end investment companies,
open-end mutual funds, investment advisers and independent directors of investment companies. She has aparticular expertise in advising underwriters and sponsors in offerings by closed-end funds and businessdevelopment companies. In addition, Sarah advises fund clients on corporate and securities law, including
investment management, regulatory, compliance and M&A matters.

The contents of this publication are for informational purposes only. Neither this publication nor the
lawyers who authored it are rendering legal or other professional advice or opinions on specific facts
or matters, nor does the distribution of this publication to any person constitute the establishment of
an attorney-client relationship. Simpson Thacher & Bartlett LLP assumes no liability in connection
with the use of this publication. Please contact your relationship partner if we can be of assistanceregarding these important developments. The names and office locations of all of our partners, as wellas our recent memoranda, can be obtained from our website, www.simpsonthacher.com.

17SimpsonThacherWorldwide

UNITED STATESEUROPE

SOUTH AMERICANew York
425 Lexington Avenue
New York, NY 10017+1-212-455-2000

LondonCityPoint
One Ropemaker Street
London EC2Y 9HUEngland+44-(0)20-7275-6500

São Paulo
Av. Presidente Juscelino
Kubitschek, 1455
São Paulo, SP 04543-011
Brazil+55-11-3546-1000

Houston
600 Travis Street, Suite 5400
Houston, TX 77002+1-713-821-5650
Los Angeles
1999 Avenue of the Stars
Los Angeles, CA 90067+1-310-407-7500
Palo Alto
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Palo Alto, CA 94304+1-650-251-5000
Washington, D.C.
900 G Street, NW
Washington, D.C. 20001+1-202-636-5500

ASIA

Beijing
3901 China World Tower
1 Jian Guo Men Wai Avenue
Beijing 100004
China+86-10-5965-2999
Hong Kong
ICBC Tower
3 Garden Road, Central
Hong Kong+852-2514-7600
Seoul
25th Floor, West Tower
Mirae Asset Center 1
26 Eulji-ro 5-gil, Jung-gu
Seoul 100-210
Korea+82-2-6030-3800
Tokyo
Ark Hills Sengokuyama Mori Tower
9-10, Roppongi 1-Chome
Minato-Ku, Tokyo 106-0032
Japan+81-3-5562-6200
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