Registered Funds Alert
This inaugural edition of the Simpson Thacher Registered Funds Alert discusses recent
developments in the registered funds industry, including the latest SEC guidance relating toalternative funds and non-transparent actively managed exchange-traded funds. In addition, it
discusses pending SEC enforcement actions that could have an impact on the industry. Finally,
we report on notable transactions that occurred in the fourth quarter of 2014, including M&A
transactions and closed-end fund initial public offerings.
February 2015

Regulators Indicate Intention to Propose Risk-Based Regulatory Framework Based on
Growth of Alternative Funds
Recent statements by regulators, including the SEC and its Staff, indicate a focus on the growth of alternative
funds and a potential shift to a more risk-based oversight approach to mutual fund regulation (as opposedto the traditional rules-based model). The SEC’s regulatory agenda for 2015 includes its intention to propose
rules related to fund liquidity management and use of derivatives. Fund advisers and boards should be
prepared for the impact that new SEC rules and potential examination activity by OCIE and FINRA may haveon their fund complexes. (click here for full article)

SEC Focusing on Alternative Funds
OCIE is in the process of conducting a national sweep of alternative funds focusing on compliance withregulatory requirements relating to valuation, liquidity and leverage. Recent actions and remarks by the SEC
and its Staff also have focused on disclosure and board oversight issues related to alternative funds, among
other issues. (click here for full article)“Distribution in Guise”—Financial Intermediaries’ Practices Under Review
The SEC has been conducting examinations regarding payments by mutual funds to financial intermediaries
to determine whether such payments constitute “distributions in guise” and would be prohibited underthe 1940 Act. Unrelated to those examinations, but with respect to the same underlying activities, the SEC
initiated administrative proceedings against the Robare Group alleging violations of Sections 206(1) and206(2) of the 1940 Act with respect to disclosure of intermediary payments. (click here for full article)

Novel Complaint in Excessive Fee Litigation—“Double-Charging” of Advisory Fees
Plaintiffs in Curd v. SEI Investment Management Corporation recently filed an amended complaint that
includes a novel allegation that SEI violated its fiduciary duties by not waiving advisory fees charged forinvesting fund assets in affiliated money market funds resulting in the alleged “double-charging.”(click here for full article)

SEC Guidance and Sweep Examination for Bond Funds
On the heels of a Staff “IM Guidance Update” on fixed-income funds in January 2014, in September 2014,
OCIE announced plans to sweep a sampling of fund complexes to review (1) how well prepared bond funds
Simpson Thacher & Bartlett LLP

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are for a changing interest rate market and (2) the adequacy of disclosures relating to risks associated withchanges in interest rates. (click here for full article)

SEC Weighs in on Non-Transparent Actively Managed ETF Proposals
The ability to offer non-transparent actively managed exchange-traded funds historically has been prohibitedby the requirement that such funds disclose their portfolio holdings on a daily basis. However, the SEC
recently has considered requests for exemptive relief that would reduce the transparency required for certain
actively-managed ETFs. Several applicants have submitted different proposals. The SEC has granted relief toone applicant, but has thus far declined to grant relief to the other applicants. (click here for full article)

4th Quarter 2014 Notable Transactions
List of notable transactions occurring in the fourth quarter of 2014, including M&A transactions and closedend fund initial public offerings. (click here for full article)(OCIE) activity suggest that not only is the SEC
Regulators Indicate
squarely focused on the growth of alternative funds,
but that it is planning on using that growth as a basis
a more risk-based (as opposed to rules-based)
Intention to Propose forapproach to mutual fund regulation.
Risk-Based Regulatory In a recent pair of high profile speeches, Norm
Champ, the outgoing Director of the Division
Framework Basedof Investment Management, acknowledged theattractiveness of the traditional registered fundon Growth ofwrapper for alternative strategies—both for sponsors
and investors—and highlighted certain key risks,
Alternative Funds
most notably liquidity management and derivatives
Although many in the U.S. registered fund industry
might quibble over the definition of what constitutes
an “alternative” fund, there is universal agreementthat the alternative asset class, however defined, hasbeen a source of significant growth in the industry
over the past several years.1 And not surprisingly,
the Securities and Exchange Commission (SEC) has
noticed. Recent comments by the SEC Chair andDivision of Investment Management senior staff and
Office of Compliance, Inspections and Examinations

use. Later in this Alert, we discuss in greater detail
Mr. Champ’s comments regarding alternative funds.

Following Mr. Champ’s speeches, the SEC announced
its regulatory agenda for 2015, which included its
intention to propose rules related to fund liquidity
management and use of derivatives. In December,
SEC Chair Mary Jo White gave a speech in which shehighlighted liquidity management and derivatives
use as areas of concern, and framed each issue in thecontext of systemic risks to the financial system as awhole.

1 For example, under the Wall Street Journal’s definition, assets under management in alternative funds have grown 347% since 2008.
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Mr. Champ’s remarks are notable because he was
the first senior official at the SEC to hint broadly that
the SEC may be considering risk-based oversightapproaches to regulation of registered funds,
including with respect to liquidity management andderivatives use. There had been some indication of ageneral concern regarding liquidity at the Staff levelin an IM Guidance Update relating to fixed-income
markets published in January 2014, in which theStaff suggested that fund managers may wish to“assess and stress test liquidity” in light of changing
fixed income market conditions. In addition to the
update and Mr. Champ’s remarks, OCIE announced
a national sweep of alternative funds in early January
2014. This sweep examination is under way, and has
focused heavily on liquidity management, in addition
to other issues (also identified in Mr. Champ’s
speeches). With respect to derivatives, in August
2011, the SEC issued a “concept release” relating
to the use of derivatives by registered investmentcompanies. There have been strong indications thatderivatives guidance has remained a priority of theStaff since that time, with the delay stemming froma requirement to focus attention on Dodd-Frankrelated rulemaking, rather than any implicationthat the concept release and subsequent industry
comment obviated the need for further guidance.
Chair White’s speech is notable in this context
primarily because of the connection she drew
between liquidity management and derivatives use,on the one hand, and systemic risk on the other.
The Staff has indicated for some time that a new
mutual fund data-gathering rule has been a priorityof its rule-making group. Chair White reiterated
that initiative as well, placing it in the context ofalternative funds by saying that current reporting has
not “adequately kept pace with emerging products
and strategies.” Together, the three rule-making
initiatives she discussed are reflective of the politicalrealities facing the SEC’s continued regulation of

the asset management industry. As evidenced by
the protracted battle regarding regulation of money
market funds, there is significant pressure on the
SEC from the Financial Stability Oversight Council(FSOC) to demonstrate that the SEC should remain
the primary regulator of the asset management
industry and that its historical rules-based approachis adequate to oversee the perceived risks mutual
funds may pose to the financial system. Viewed
in that light, the SEC’s initiatives may be seen as
focusing on the types of systemic risk issues that are
the primary focus of FSOC and moving towards a
prudential regulatory framework more familiar to theother members of FSOC.
The form that these new rules will take is unclear.
For example, we would not expect that the SEC willpropose the creation of a “chief risk officer” in thesame manner in which it required a chief complianceofficer in adopting Rule 38a-1. This belief is based on
the fact that no uniform definition exists for what arisk officer would do, and partially on the lack of clear
statutory authority for the SEC to create such a role,even under the Dodd-Frank Act.
We also do not know the extent to which the newrules will require mutual fund boards to be involved
in risk management oversight. Currently, disclosurerules require disclosure of the extent of the board’srole in the risk oversight of a fund. Several comments
by the Staff and Chair White suggest that a heavier
emphasis on the board’s substantive role may beforthcoming, although there are many reasons whythat would not seem to be an appropriate expectation
for fund boards, which are, by design, oversightboards and substantially independent of the day-today management of the funds they oversee.
Finally, it would seem to be difficult to propose rulesthat provide for prudential oversight, as opposed
to disclosure or rules-based oversight. Liquidity3rules would be based on the statutory requirementfor open-end funds to pay redemption proceeds inseven days found in Section 22(e) of the Investment
Company Act of 1940 (1940 Act). Derivatives rules
would be based on the prohibitions against issuanceof senior securities found in Section 18 of the 1940
Act. Such statutory provisions provide the SEC withthe ability to proscribe behaviors, but only to theextent the underlying principles of the 1940 Act are atissue. The SEC has broad power to require disclosure
on topics, but that is different from requiring actions
beyond the requirements of the 1940 Act. It also isworth mentioning that the SEC would not appear
to have the requisite amount of examination staff
that would be required to implement a prudential
regulatory scheme similar to that used by the Federal
Reserve with respect to national banks, for example.
If and when the SEC proposes rules on these topics,
we would expect substantial industry comment.
Regardless of the form these rules take, fund advisers
and boards should continue to think carefully
about these issues in the context of their own fundcomplexes. They should also be prepared for multipronged regulatory activity on this front in themeantime, including from FINRA and OCIE.
FINRA’s recent release of its Examination Priorities
Letter for 2015 also highlighted alternative mutual
funds. The release discusses the importance of
accurate disclosures regarding how alternative
mutual funds work, as well as the importance of
maintaining consistency between their prospectuses
and communications regarding such funds. FINRA
indicated in the release that its review of current
practices suggested that investors in such funds
might not be able to fully appreciate alternative fundstrategies or how such funds will respond in various
market situations.
Finally, OCIE recently released its Examination
Priorities for 2015. Specifically, the examination
priorities release includes “Alternative” investmentcompanies as one of its priorities under its goalof protecting retail investors and those investorssaving for retirement. The release indicated afocus on leverage, liquidity and valuation policies
and practices and the adequacy of the funds’internal controls, including staffing, funding andempowerment of boards, compliance personnel andback-offices. Similar to FINRA’s recent Examination
Priorities Letter, OCIE also indicated a focus on theadequacy of current disclosure practices during themarketing period.

SEC Focusing on
Alternative Funds
Earlier in this Alert, we discuss recent remarks andactions from the SEC and its Staff that suggest thatthe growth of alternative funds has been seized
upon as a basis for greater risk-based regulation in
the registered fund industry. This piece focuses on
the compliance and regulatory issues identified by
the Staff as relating primarily to “alternative” funds(however defined).
As noted above, in a recent pair of high profile
speeches (click here and here for links to the
speeches), Norm Champ, the outgoing Director of
the SEC’s Division of Investment Management, both
acknowledged the attractiveness of the traditional
registered fund wrapper for alternative strategies—
both for sponsors and investors—and highlighted
certain key risks.2 With respect to the attractivenessof the products, Mr. Champ cited investment
liquidity, portfolio transparency, lower advisory fees,
lower investor minimum requirements and lack ofminimum eligibility requirements as key factors thathave fueled investor demand compared to similar
privately offered funds (to which we would also
add simplified tax reporting). But he also cited key
compliance risks in managing such products, mostnotably with respect to the regulatory requirements
relating to valuation, liquidity and leverage. He also
highlighted certain disclosure and board oversight
responsibilities as areas that deserve focus.
Mr. Champ’s remarks are notable in several respects,
beyond the implications for rule-making discussed
earlier in this Alert. First, and most obviously, hehighlights areas for heightened attention by sponsorsof new and existing alternative funds. Second, hefocused his remarks, particularly in his second
speech, not just to sponsors of alternative funds
but to sub-advisers of alternative funds who may
have limited experience in dealing with the rules
and regulations applicable to registered investmentcompanies, indicating a potential Staff focus on thosefirms’ involvement in the management of alternative
funds.
In addition to Mr. Champ’s remarks, OCIE
announced a national sweep of alternative funds inearly January 2014. This sweep examination is underway, and, unsurprisingly, has focused on many of thesame issues identified by Mr. Champ in his speeches.

2 Mr. Champ explicitly excluded closed-end funds and business development companies from his discussion.
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Valuation
In fulfilling statutory responsibilities for valuationof securities for which market quotations are not“readily available,” Mr. Champ highlighted several
key issues for boards of directors and the entities towhich they may have delegated day-to-day valuation
determinations. In addition to reiterating the needfor robust policies and procedures, he suggested thatpolicies should include:• requirements for monitoring circumstances that
may necessitate the use of fair value prices;• methodologies for determining fair value;• processes for price overrides;• assurances that controls are in place to review,monitor and approve all overrides in a timely
manner; and• prompt notification to, and review and approvalby, persons not directly involved in portfolio
management to mitigate conflicts of interest.
In a sense, these considerations are no different
than ones that many fund complexes have alreadydrawn from the recent Morgan Keegan enforcement
action against the directors of those funds. The focus
on these matters in the alternative fund context,
however, is not surprising as many alternative funds
use instruments that do not have deep markets or
may be bespoke, and in many instances, the portfolio
managers will be in the best position to understandthe instrument and its proper valuation. Questions
posed by OCIE in the sweep examination have
similarly focused on many of the issues that arose
in Morgan Keegan (for example, by specificallyreferring to valuation practices for mortgage-backed
securities and by asking about the use of indicative
broker quotes in valuation). In addition, the OCIE
sweep examination has focused on “back-testing”
of valuations, indicating a growing expectation thatfund complexes will review fair valuation decisions
in the context of subsequent market valuations if
and when they become readily available, or when the
instrument is sold.

Liquidity
Mr. Champ also noted that there was a “close
relationship between the liquidity of a portfolio
security or asset and the ease with which the security
or assets may be valued.” In effect, Mr. Champ statedthat the Staff would expect that alternative funds that
hold a large number of hard-to-value instruments
would face issues with respect to regulatory
requirements related to liquidity. For open-end

funds, the Staff has typically required that such funds
hold no more than 15% of their assets in illiquid
securities or assets, defined as an asset that cannot besold or disposed of in the ordinary course of businesswithin seven days at approximately the value ascribedto it by the fund.
Mr. Champ’s comments suggest an increasing
expectation on the part of the Staff that complianceprograms for registered investment companies andinvestment advisers will include written policies
and procedures with respect to oversight of fundliquidity.3 Mr. Champ noted several factors to beconsidered when assessing liquidity, including:• frequency of trades and quotes for a security;• number of dealers willing to purchase/sell the
security and the number of potential purchasers;• dealer undertakings to make a market in the
security; and• the nature of the security and the nature of themarketplace in which the security trades.
Questions posed by OCIE in the sweep examination
also have focused on the existence of written policies
and procedures and whether investment advisers
have stress-tested liquidity expectations under
different market scenarios. OCIE’s questions havealso focused on board oversight of such policies andstress-tests, as applicable, including by requesting
minutes of board meetings where such topics werediscussed.

Leverage
In August 2011, the SEC issued a “concept release”
relating to the use of derivatives by registeredinvestment companies. While the SEC and its Staff
have not taken any action with respect to the concept
3 Indeed, as discussed above, the SEC, in announcing its 2015 agenda, statedthat the adoption of a liquidity management rule would be a priority.
5release to date, the release catalogued long-standing
guidance by the Staff relating to maintaining “asset
coverage” of derivative positions to maintain an
adequate limit on leverage and to avoid treatmentof the instruments as senior securities underthe 1940 Act. Mr. Champ’s recent remarks withrespect to alternative funds’ use of derivatives
suggest that the SEC may be looking for boards orinvestment advisers to take on a more extensive risk
management oversight function in connection withthe use of derivatives than previously suggested by
the SEC or its Staff. OCIE’s examination questions inthe sweep examination have focused on compliancewith the existing guidance, but also have asked
for descriptions of limits on “economic leverage,”presumably in contrast to “regulatory” leverage.
Nonetheless, there appears to be an expectation thatalternative funds will be subject to a level of risk
oversight not otherwise mandated by prior guidance.
While such oversight might be employed by mostfirms in practice, it remains to be seen whether
OCIE will expect some form of formalization of suchpractices and procedures upon inspection.
During a speech in December 2014, Chair White
discussed a set of initiatives, which included a plan
to enhance risk monitoring specifically related to theuse of derivatives.4 While the imposition of additional
caps on derivative use is unlikely, a rule or guidancemight suggest that firms develop policies to assess
and manage risk specific to the use of derivatives.
Specifically, Chair White indicated that such policies
may require a decrease in derivative use during
periods of high redemptions. Further, Chair White
indicated a need to significantly increase disclosure
regarding to fund investments in derivatives.

Disclosure
Mr. Champ also noted several key considerations
regarding disclosures for funds which invest inalternative investment strategies. First, he notedthat all funds should assess whether current
disclosures are in conformity with the plain English
standards of the federal securities laws. Secondly,
Mr. Champ underscored the Staff’s expectation thatall disclosures regarding alternative investment
strategies be specifically tailored to the particularfund’s expected investment strategies andmanagement of those strategies, and noted that
the Staff was actively engaged in looking at data
regarding fund investments and tying that databack to disclosure. Third, Mr. Champ noted that all
such disclosures should reflect the specific fund’s
4 See also Andrew Ackerman, SEC Details Plan to Target Risks at Asset Managers, The Wall Street Journal, Dec. 11, 2014, available at http://www.wsj.
com/articles/sec-chief-calls-for-stress-testing-of-mutual-funds-other-asset-managers-1418312083.

“complete risk profile … taken as a whole,” insteadof a list of various investment strategies. Specifically,
Mr. Champ indicated that alternative funds should
include disclosure relating to risks associated withvolatility, leverage, liquidity and counterparty
creditworthiness. Finally, Mr. Champ suggested that
registrants should assess disclosure on an “ongoingbasis” to evaluate the completeness and accuracyof disclosures “in light of its actual operations,” asuggestion which he reiterated in a speech in October
2014. Our attorneys have publicly taken issue withthis statement, advocating that shareholder reportdisclosure is a more effective tool to educate investors
about changes in operations and the associated risks.5

Board Oversight
Mutual fund boards traditionally oversee theinvestment companies’ key service providers andthose service providers’ compliance programs andpolicies as they relate to the operation of thoseinvestment companies. Boards have a statutory
obligation to oversee the fair valuation of securities
for which there are no readily available market
quotations, and in several other aspects are called
upon, by statute or rule, to protect fund shareholders
in situations where service providers might overreachin navigating conflicts of interests. Mr. Champ, in
his speeches, has specifically highlighted board
obligations to oversee policies and procedures
relating to each of the key risk areas identified by
Mr. Champ and discussed above. To the extent
that Mr. Champ has indicated the intention of theStaff to expand registrants’ obligations with respect
to practices discussed above, in the context ofalternative funds, one would expect a concomitant
increase in the responsibilities of board members tooversee those practices.
Additionally, Mr. Champ also highlighted theimportance of board oversight regarding conflictsof interest, particularly with respect to allocation
decisions, when the portfolio manager of a strategy
also manages a similar strategy in a private fundwrapper. In this regard, Mr. Champ’s remarks
focused on sub-advisers who were advising registeredfunds for the first time. In a speech in September
2014, Mr. Champ also warned advisers that were
becoming first-time sub-advisers to registered funds“to proceed thoughtfully and cautiously before
becoming advisers in registered funds.” These
remarks, coupled with OCIE requests for findingsof material non-compliance by sub-advisers toalternative funds, indicate a particular attention tocomplexes using third-party sub-advisers as they
expand into the alternative fund space.
5 See Peter Ortiz, SEC, Finra: Liquid Alts Not Always Used as Directed,
IGNITES, Nov. 3, 2014 (quoting Rajib Chanda)
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“Distribution in
Guise”—Financial
Intermediaries’
Practices
Under Review
As has been widely reported, the Staff has been
conducting examinations regarding payments
by mutual funds to financial intermediaries. In
announcing its review, the Staff referred to the
purpose of the examinations as reviewing whether
such payments constitute “distribution in guise.” Ifsuch payments were for distribution, and made out offund assets and outside of a Rule 12b-1 distribution
plan, then the payments would be impermissible
under the 1940 Act. These examinations, withrespect to mutual fund complexes, have sometimes
resulted in follow-up document requests (at times
multiple follow-ups) and interviews, but to datehave not resulted in any announced referrals to theenforcement division.
The SEC examinations regarding compensation
arrangements also have seemed to focus on theintermediaries who receive such payments, andone such intermediary was the subject of a recent
enforcement action. While mutual funds haveobligations governed by Section 12(b) of the1940 Act and Rule 12b-1 thereunder, financial
intermediaries that are investment advisers havevarious fiduciary duties with respect to their clients
under the Investment Advisers Act of 1940 (Advisers
Act), including the duty to act in their clients’ bestinterests. A conflict of interest arises when fee
arrangements between investment advisers andmutual fund firms are not adequately disclosed toclients, because the advisers have added incentive torecommend certain mutual funds (from which they
will receive compensation) over other funds.
The SEC initiated administrative proceedings against
the Robare Group, a Houston-based investment
advisory firm (Robare), on September 2, 2014,
alleging that Robare violated Sections 206(1) and206(2) of the Advisers Act, which make it unlawful
for any investment adviser to defraud or engage in apractice that would operate as a fraud or deceit upon
any client or prospective client. In particular, the SEC
has alleged that Robare recommended that clients
invest in certain mutual funds while failing to disclose
to them a hidden fee arrangement with a broker thatcompensated Robare for investing client assets incertain mutual funds through the broker’s platform.
The order alleged that Robare entered into acompensation agreement with a broker that it did
not disclose to its clients. Under the terms of theagreement, the broker would pay Robare between
2 and 12 basis points on the client’s investments inno-transaction-fee mutual funds. The SEC allegedthat from 2005 through 2013, the advisory firm
received approximately $441,000 from the broker
pursuant to the compensation agreement.
Robare denied the allegations brought against it andargued in its answer filed September 25, 2014 thatit provided adequate disclosure surrounding the fee
arrangement with the broker.
If found to have been in violation of federal securities
laws, Robare and certain principals face possible
disgorgement of profits and civil penalties. The parties
were to have filed motions and briefs with the SEC inlate January and early February 2015 and hearings willcommence in Houston, Texas on February 9, 2015.

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Novel Complaint
in Excessive Fee
Litigation—“DoubleCharging” ofAdvisory Fees
The mutual fund industry has seen a recent spate ofclaims that investment advisers charged excessive
fees by virtue of delegating substantially all of theirduties to sub-advisers while retaining much of theadvisory fees. Plaintiffs in Curd v. SEI Investments
Management Corporation recently filed an amended
complaint which, in addition to the sub-adviser
delegation claim, also includes a novel allegation in
the context of excessive fee litigation. The amended
complaint alleges that SEI violated the fiduciary
duties inherent in Rule 12d1-16 of the 1940 Act byinvesting fund assets in affiliated money market
funds and not waiving or reimbursing the fees
charged by the money market funds, resulting in“double-charging” of fees.
Accordingly, the complaint alleges that the board
violated Section 36(b) of the 1940 Act by failing toconduct a conscientious review of the double-charged
fees. Fund managers investing fund assets in money
market funds (particularly affiliated money market
funds) without waiving or reimbursing the fees
charged by such money market funds should consider
the potential risk of a similar shareholder derivative
claim. In particular, boards should consider whether
the fees charged at the investing fund level arefor services that are in addition to, rather thanduplicative of, services provided to the underlying
funds. In addition, boards may wish to consider
including disclosure regarding such review inpublicly filed documents (such as shareholder reports
describing the board considerations in connection
with the annual contract renewal process), so thatthe consideration is available as an argument in asummary judgment motion rather than only available
in proceedings that occur after discovery hascommenced (which would be the case if, for example,
the board’s considerations were only described in theminutes of a board meeting).
6 While Rule 12d1-1 does not explicitly require such fees to be reimbursed
or waived, plaintiffs rely on language in the Rule’s proposing release thatstates: “to the extent advisory services are being performed by anotherperson, such as the adviser to an acquired money market fund, [the Section
36(b)] fiduciary duty would require an acquiring fund’s adviser to reduce its
fee by the amount that represents compensation for the services performedby the other person.” However, the Rule’s adopting release also states: “Afund could pay duplicative fees if an adviser invests a fund’s cash in a money
market fund (which itself pays an advisory fee) without reducing its advisory
fee by an amount it was compensated to manage the cash. Fund directors
have fiduciary duties, which obligate them to protect funds from being overcharged for services provided to the fund, regardless of any special findings
we might require.”

SEC Guidance andSweep Examinationfor Bond Funds
Beginning in January 2014, the SEC has indicated afocus on the effect that changing interest rates haveon bond funds. In the OCIE’s 2014 Examination
Priorities, OCIE indicated that it would bemonitoring the risks that a changing interest rateenvironment would pose to bond funds as well
the appropriate disclosures to investors relating
to such changes. Soon thereafter, the Division of
Investment Management released a new guidance
update regarding risk management in changing bondmarket conditions, which outlined several measures
for fund advisers to consider, including: conducting
fund liquidity stress tests; reviewing the adequacy ofcommunications with fund boards, which allows theboards to oversee responses to manage effectively
changing interest rate environments; and reviewing
the adequacy of shareholder disclosures in light ofthese additional interest rate risks.
In September 2014, Staff announced plans to conduct
a sweep examining between twenty-five and thirty
fund complexes to review how well prepared bondfunds are for a changing interest rate market andthe adequacy of disclosures, among other subjects.
The sweep information requests that have been sentby the SEC thus far include, among other things,
requests related to: liquidity (including policies
and procedures, responsible overseers, compliancerisks, breakdown of liquid and illiquid assets, adescription of the redemption lines of credit andprocedures for and results of stress tests); generalcompliance reports and other documents; minutesof meetings; membership of the board and its
committees and a board self-assessment; and othergeneral fund and portfolio information. Accordingly,
bond fund managers that have not already received
such a request from the SEC should examine their
preparedness for responding to such a request and,more generally, their preparedness for changes ininterest rate environments.

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SEC Weighs in on
Non-Transparent
Actively Managed
ETF Proposals
In the past few months, there has been a flurry of
SEC activity in the non-transparent actively managed
exchange-traded fund (ETF) space. As the ETF
industry continues to grow at a blistering pace, with
global assets under management recently eclipsing
the $2.5 trillion mark, actively managed ETFs
present a new opportunity for asset managers togrow market share. Traditionally, the advantage ofoffering ETFs as opposed to mutual funds has been
in tax efficiencies and externalization of trading costs
to the fund. Even where those advantages are blunted(for example, because creation units are purchased
and redeemed in cash instead of in-kind), ETFs are
attractive to certain investors who wish to use their
existing brokerage accounts or who prefer intraday
pricing. The ETF channel is, therefore, an attractive
distribution channel for many fund sponsors at aminimum.
However, actively managed ETFs currently represent
less than one percent of total ETF assets undermanagement in the U.S., partially as a result of
the SEC requirement of daily portfolio disclosure.
While the benefits of actively managed ETFs seem
clear, thus far fund transparency requirements
have stunted the growth of this market. In the pastquarter, there have been significant developments
relating to these transparency requirements.

Non-Transparent Active ETF Proposals
Under current exemptions granted to sponsors of
ETFs, actively managed ETFs are required each
day to publish their entire portfolio holdings to
the public. Traditional mutual funds, on the other
hand, are only required to disclose their portfolio
holdings on a quarterly basis, and even then on adelayed basis. From a sponsor’s point of view, amajor drawback of portfolio transparency is that itallows potential front-runners to anticipate an ETF’s
positions by buying or shorting the securities that
the ETF is looking to purchase or sell. Moreover, thedaily disclosure requirements make it difficult forfund managers to disguise their investment tactics
and strategies more generally.
In a bid to limit SEC disclosure requirements,
several sponsors have submitted proposals to the
SEC requesting exemptions that would permit
less transparency. The BlackRock and Precidian
proposals utilize a blind-trust mechanism placed
between the ETF and the authorized participant,which acts as a screen preventing the public, andthe authorized participant, from viewing the fund’s
underlying assets. T. Rowe Price’s proposal advocatesfor replacing full-portfolio disclosure with partial
disclosure of a daily hedge portfolio in which eachfund invests at least 80% of its total assets, acting asa type of proxy basket. In addition, investors would
be provided data points detailing the differences
between the actual portfolio and the hedge portfolio
to narrow the differential between the proxy andactual baskets.
Lastly, Eaton Vance’s proposal advances a novel
mutual fund-ETF hybrid called an exchange tradedmutual fund (ETMF). ETMFs possess characteristics
of both ETFs and mutual funds. Like ETFs, ETMFs
would issue and redeem large chunks of shares
known as “creation baskets” to and from authorizedparticipants primarily via in-kind transfers composedof the fund portfolio’s underlying securities. The
authorized participants would then trade the shareson a national security exchange where retail investors
can purchase the shares in smaller quantities.
Perhaps most important to Eaton Vance, portfolio
disclosure would only be required on a quarterly
basis. In order to protect the confidentiality of thefund’s holdings, ETMF advisers would decide which
underlying securities to include in the creationbaskets issued to authorized participants with thebalance paid in cash. This allows ETMFs to disguisethe implementation of their investment strategy
and make predatory front running a more difficult
endeavor.

9

The pricing mechanism for ETMFs is novel. Shareswould trade throughout the day on exchanges atprices quoted relative to NAV (plus or minus apremium or discount decided by market makers);
however, the final transaction price would not belocked in until the end of the day when the NAV is
calculated. The result is that investors would know
the premium or discount at the time of each trade,but like intraday orders to buy or sell shares ofmutual funds, an ETMF investor would not know
the NAV (and thereby the final price per share)at the time the order is placed. The amount of thepremium/discount would depend on a myriad ofmarket factors, including the balance of supply anddemand for shares among investors, the transaction
fees and other costs associated with creating andredeeming creation units, competition amongmarket makers, share inventory positions, inventory
strategies of market makers and the volume ofshare trading.
Eaton Vance’s proposal allows ETMFs to benefit
from the tax efficiencies and cost savings of an ETF,
accomplished through in-kind transfers that passon a portion of the costs to authorized participants,
plus the more limited quarterly transparency
requirements of a traditional mutual fund.

The SEC Responds
Almost two weeks after the SEC published notices(click here and here for links to the notices) stating
its intent to deny exemptive relief requests sought byBlackRock and Precidian, the SEC published a noticeof intention on November 6, 2014 giving preliminary
approval to Eaton Vance’s ETMF request. The SEC
has not yet commented on T. Rowe Price’s proposal,
the last amendment to which was submitted in
March 2014.

SEC is Critical of BlackRock andPrecidian Proposals
ETFs are permitted to function pursuant to SEC
exemptive relief from various provisions of the 1940
Act. A hallmark of these exemptions is the SEC’s
expectation that ETF shares trade at a price thatis as close as possible to the NAV per share of the
ETF. Historically, the SEC has viewed daily portfoliotransparency as one key mechanism that ensures thatmarket prices of ETF shares are close to the NAV.
The theory is that transparency provides authorizedparticipants sufficient information to implement aneffective arbitrage strategy.
In their applications, BlackRock and Precidian
propose several novel mechanisms that would enable
them to operate on a less transparent basis while atthe same time purportedly preserving market makers’
ability to capitalize on arbitrage opportunities in themarket:• The funds would be required to disclose portfolio
holdings on a quarterly basis instead of on a daily
basis similar to traditional mutual funds.
• Authorized participants would have access to an
intraday indicative value (IIV) disseminated byexchanges every 15 seconds during the trading
day, based on the last available market quotationor sale price of the ETF’s portfolio holdings.
However, the applicants concede that the IIV
is not a real-time NAV for the ETF and would
not include extraordinary expenses or liabilities
booked during the day.
• Blind trusts would be established whereby
authorized participants could purchase or redeem
creation baskets by paying cash to the trusts
which would then transact with the ETFs via
in-kind transfers of the fund’s securities without
revealing the identity of the ETF’s underlying
portfolio contents to authorized participants or
the general public.
• Retail investors would be able to redeem
individual shares directly from the ETFs in theevent of a persistent and significant deviationof closing market price from the NAV, subject
to a redemption fee of up to 2% and additional
brokerage commissions.
The SEC disagreed with the assertion by Blackrock
and Precidian that the proposed mechanisms would
keep the market share price close to the NAV.
Specifically, the SEC stated: “the specific features
proposed by the Applicants that would cause theproposed ETFs to operate without transparency
fall far short of providing a suitable alternative tothe arbitrage activity in ETF shares that is crucial
to helping keep the market price of current ETF
shares at or close to the NAV per share of the ETF.”
The SEC release also casts doubt on the use of IIV
or blind trusts as alternative mechanisms to ensure
appropriate arbitrage opportunities, a key factor inprevious SEC exemptions.
The SEC stated that the use of IIV in place of realtime data could result in inaccurate calculations ofshare price, particularly in times of market stress orvolatility. The SEC was unconvinced that IIV would
serve as a good substitute for the transparency of afund’s underlying holdings—a necessary component
to provide information to enable effective arbitrage
by market makers. The SEC noted that in the case oftransparent ETFs, market makers calculate their own
NAV using proprietary algorithms based on the ETFs’
10

actual holdings and they only use IIV as a secondaryor tertiary indicator of ETF share value. If market
makers can no longer calculate their own NAV
based on the value of an ETF’s underlying assets,then arbitrage opportunities will be limited, causing
market makers to hesitate to trade under suchconditions. The SEC also voiced concern that because
there are no uniform methodology requirements
in calculating the IIV, it could result in potentiallyarbitrary and inconsistent valuations.
Additionally, the release highlighted the SEC’sconcern that quarterly disclosure of portfolio
holdings would be insufficient and quickly lose
relevance as ETF’s holdings could change daily(although it is not clear why that is more true for
ETFs than other products that disclose holdings
quarterly). Finally, the SEC was not convinced thatthe proposed back-up mechanism would be utilized
by retail investors or provide an effective backstop to
authorized participant arbitrage.

SEC Approves ETMF Structure
On the other hand, on December 2, 2014 the SEC
issued an order approving the proposal advancedby Eaton Vance, after initially granting approvalon November 7 for NASDAQ to list ETMF shares.
Eaton Vance has created a structure that enjoys
the benefits of ETFs’ lower operating costs andenhanced tax efficiencies, without the burden of daily
disclosure requirements. Eaton Vance’s proposal
persuaded the SEC that unlike the BlackRock andPrecidian pricing mechanisms, the ETMF structure
would keep the market share price sufficiently close
to NAV because shares would trade at a premiumor discount based directly off of the NAV. The SEC
evidently was satisfied that this will adequately
protect retail investors without the benefit of
portfolio transparency.
Eaton Vance has obtained patents with respect tocertain aspects of ETMF’s NAV-based trading pricing

mechanism. Eaton Vance expects that investment
advisers that desire to manage ETMFs will obtain alicense from Eaton Vance and apply for a separate
exemptive order from the SEC that incorporates
by reference all the terms and conditions of Eaton
Vance’s order.7

Precidian Refiles
In the wake of the SEC’s notice of its intent to denyPrecidian’s application, Precidian decided to pull
its original application and refile with the hope ofaddressing the SEC’s main concern, namely keeping
the market price of ETF shares close to NAV. The
first innovation of Precidian’s application is that eachauthorized participant would establish a blind trust
to transact on its behalf with the ETF. The ETF’s
portfolio holdings would be fully transparent to theblind trusts, which would allow them to calculate
and convey a close approximation of the actual NAV
to authorized participants. This mechanism would
allow ETFs to maintain confidentiality from thepublic at large while maintaining a mechanism thatwould presumably keep the market share price close
to NAV.
The second innovation advanced by Precidian’s
application is the verified intraday indicativevalue (VIIV). VIIV differs from IIV in that it will
be calculated based on the currently quoted bid/
ask midpoint price of the underlying securities (asopposed to the last sale of the underlying securities)
and will include all accrued income and expensesof the fund in share quotes. Precidian asserts in its
application that this will increase price reliability andaccuracy. The funds will disclose to the blind trusts
the identity of the securities and other price inputs sothey can independently calculate and verify the fund’s
share price.

Looking Forward
Now that Eaton Vance has successfully run the
SEC’s regulatory gauntlet, the next question iswhether investors will want to invest in actively
managed ETMFs. In recent years, there has been ashift of investor capital away from actively managed
mutual funds and ETFs towards index-based funds(including ETFs). Moreover, there will be a learning
curve as investors try to comprehend the novel andsomewhat complex pricing structure of ETMFs.
Regardless, for many sponsors a “holy grail” hasbeen accessing the ETF channel for actively managed
strategies without full portfolio disclosure. Eaton
Vance may have found it, and Precidian and others
may not be far behind.
7 We are not expressing a view on the strength or validity of such patents.
11

4th Quarter 2014 Notable Transactions
M&A Transactions• American Beacon Advisors, Inc., a provider of investment advisory services to institutional and retailmarkets, announced that its parent company, Lighthouse Holdings, Inc., reached a definitive agreement tobe acquired by investment funds affiliated with Kelso & Company and Estancia Capital Management,
two leading private equity firms. Lighthouse Holdings, Inc. is majority owned by investment funds affiliatedwith TPG Capital and Pharos Capital Group, LLC. As of September 30, 2014, American Beacon
Advisors had $57.2 billion in assets under management.
• Wunderlich Securities, a full-service investment firm headquartered in Memphis, announced anagreement to acquire the wealth management assets of Dominick & Dominick LLC, a privately held
investment firm based in New York, New York. Following the acquisition, the purchased business will
operate as Dominick & Dominick, a division of Wunderlich Wealth Management, Wunderlich’s private clientgroup.
• American Realty Capital Properties, Inc. announced that it signed an agreement for the sale of Cole
Capital, ARCP’s private capital management business, to RCS Capital Corp. for at least $700 million.
As part of the transaction, ARCP will act as sub-advisor to Cole Capital’s non-traded real estate investment
trusts (the “Managed Funds”) and acquire and property manage net lease real estate assets for the Managed
Funds. ARCP also agreed to source, underwrite and acquire U.S. net lease properties for American Realty
Capital Global Trust II, Inc.
• BNY Mellon announced that it reached an agreement to acquire Cutwater Asset Management. Uponcompletion of the deal, Cutwater will operate as part of BNY Mellon Investment Management and will work
closely with, and be administered by, Insight Investment, one of BNY Mellon’s investment management
boutiques. Cutwater is a U.S.-based fixed income and solutions specialist with approximately $23 billion in
assets under management.
• Janus Capital Group Inc. reported that it agreed to acquire VS Holdings Inc., the parent company of
VelocityShares, LLC, a provider of exchange-traded products, including exchange-traded funds. As of
September 2014, VelocityShares had raised approximately $2 billion in assets across 21 investment products.
• Old Mutual Wealth reached an agreement to acquire Quilter Cheviot for a consideration of up to £585
million. Following approval from regulators, Quilter Cheviot will become the discretionary investment
management business within Old Mutual Wealth.
• Austrian lender BAWAG P.S.K. and France-based Amundi Group SA announced BAWAG P.S.K.’s saleof its asset management arm, BAWAG P.S.K. Invest, to Amundi. Amundi, which has more than €800
billion under management, intends to continue operating Invest out of Austria. As of June 2014, Invest had€4.6 billion under management.
• Ares Management, L.P. (NYSE: ARES) announced that its subsidiary reached an agreement to acquire
Energy Investors Funds for an undisclosed sum, to be financed primarily in cash, including a portion of
the proceeds raised from a prior offering of senior notes by an indirect subsidiary of Ares, and with equity
interests in Ares. The transaction was expected to close by the end of 2014 and is subject to regulatory
approval. Energy Investors Funds, founded in 1987, is an asset manager in the energy infrastructure industry
and has approximately $4 billion of assets under management.
• Affiliated Managers Group, Inc., a global asset management company, announced the completion of its
investment in Veritas Asset Management LLP. As part of the transaction, Veritas’ senior professionals
agreed to long-term commitments with the firm.
• BlackRock Kelso Capital Advisors LLC entered into an agreement to sell certain of its assets toBlackRock Advisors, LLC, a wholly-owned subsidiary of BlackRock, Inc. Contingent upon BKCA
stockholder approval and subject to other closing conditions, BlackRock Advisors will serve as BKCA’s
investment manager following the completion of the transaction.
• Securian Financial Group announced that it agreed to acquire a majority interest in Asset Allocation& Management Company, a Chicago-based insurance asset manager, from a private equity fund managed
by Stone Point Capital and related investors. AAM will operate independently within Securian following theacquisition and be governed by its own board of directors. Securian is one of the largest financial service
providers in the nation, holding close to $46 billion in assets under management and more than $1 trillion of
insurance in force. AAM manages $16.4 billion in insurance company assets.
12• Mercer, a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), announced that it
agreed to acquire SCM Strategic Capital Management AG, an independent Swiss-based investment
advisor and solutions provider for institutional investors. SCM is based in Zurich and has offices in
Luxembourg and Hong Kong. The firm is a leading investor for private market fund investments and advises
on or manages portfolios with a net asset value of $4 billion.
• New York Life Investment Management subsidiary of New York Life Insurance Co. agreed to acquire
Rye Brook, New York-based asset manager IndexIQ. The ETF and liquid alternatives manager, which has
12 funds including its IQ Hedge Multi-Strategy Tracker ETF, will join New York Life’s MainStay Investments
platform. The acquisition will add $1.5 billion to MainStay’s $101 billion in assets under management.
• Affiliated Managers Group, announced that it agreed to meaningfully increase its minority ownershipinterest in AQR Capital Management, LLC. AQR’s principals will maintain majority ownership in AQR,
as well as operational independence. Founding Principals Clifford S. Asness, David G. Kabiller and John M.
Liew, as well as the firm’s other 18 Principals, entered into long-term commitments with the firm.

Closed-End Fund Initial Public Offerings
BlackRock Science and Technology Trust (NYSE: BST)
• Amount Raised: $420.0 million• Investment Objectives/Policies: The company’s investment objectives are providing income and total
return through a combination of current income, current gains and long-term capital appreciation. Under
normal market conditions, the fund will invest at least 80% of its total assets in equity securities issued by
U.S. and non-U.S. science and technology companies in any market capitalization range, selected for theirrapid and sustainable growth potential from the development, advancement and use of science and/or
technology (high growth science and technology stocks), and/or potential to generate current income fromadvantageous dividend yields (cyclical science and technology stocks).
• Investment Adviser: BlackRock Advisors, LLC• Book-runners: Morgan Stanley & Co. LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, UBS
Securities LLC and Wells Fargo Securities, LLC
Eagle Point Credit Company Inc. (NYSE: ECC)
• Amount Raised: $103.1 million• Investment Objective/Policies: The fund’s investment objective is to generate high current income andcapital appreciation primarily through investment in equity and junior debt tranches of collateralized
loan obligations.
• Investment Adviser: Eagle Point Credit Management LLC• Book-runners: Deutsche Bank Securities Inc. and Keefe, Bruyette & Woods, Inc.
Miller/Howard High Income Equity Fund (NYSE: HIE)
• Amount Raised: $245.0 million• Investment Objectives/Policies: The fund’s primary investment objective is to seek a high level of current
income. As a secondary objective, the fund seeks capital appreciation. The Fund will attempt to achieve
its investment objectives by investing, under normal market conditions, at least 80% of its total assets individend or distribution paying equity securities of U.S. companies and non-U.S. companies traded on U.S.
exchanges. The Fund will terminate on November 24, 2024, absent shareholder approval to extend the term.
If the Fund’s Board of Trustees believes that under then current market conditions it is in the best interestsof the Fund to do so, the Fund may extend the termination date for one year, to November 24, 2025, withouta shareholder vote, upon the affirmative vote of three-quarters of the Trustees then in office.
• Investment Adviser: Miller/Howard Investments, Inc.
• Book-runners: Wells Fargo Securities, LLC, Raymond James & Associates, Inc. and Ameriprise Financial
Services, Inc.

13

Simpson Thacher’s dynamic, long-standing Registered Funds Practice encompasses all
aspects of the investment management business. Our practice is multidisciplinary—it brings
together such other areas as securities, mergers and acquisitions, banking, tax and ERISA.

Rajib Chanda+1-202-636-5543
rajib.chanda@stblaw.com

Sarah E. Cogan+1-212-455-3575
scogan@stblaw.com

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.

14

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