Registered Funds Alert

September 2016

Table of Contents
AXA Wins Section 36(b) Trial;
Takeaways Include Potential
Improvements for Your Section
15(c) Process2

A discussion of takeaways from the court’s
decision in the AXA trial, particularly withrespect to multi-manager funds and fundboards. Click here for more
SEC Proposes Rule Requiring
4
Investment Advisers to Prepare a
Business Continuity and Transition
Plan; Issues Guidance Update
Reflecting Similar Expectations for
Registered Funds
A look at the SEC’s recently proposed rule
requiring business continuity and transition
plans and the companion guidance update
discussing the SEC’s expectations for funds.
Click here for more

SEC’s Proposed Rule on Incentive7
Based Compensation Arrangements
Draws Criticism From the Fund Industry
A multi-agency rule proposal to regulate
incentive-based compensation was criticizedby the fund industry, as the rule could
subject advisers affiliated with large banking
institutions to more onerous requirements
than other advisers. Click here for more
SEC Questions Auditor
Independence Under Loan Rule;
Quickly Issues Temporary Relief

8After raising questions regarding theindependence of certain accounting
firms, which could affect audited financial
statements of funds across the industry, theSEC quickly issued conditional no-action
relief. Click here for more
Notable Transactions: Q2 201610
A list of notable transactions occurring inthe second quarter of 2016, including M&A
transactions and closed-end fund initialpublic offerings. Click here for more
Simpson Thacher & Bartlett LLPThis latest edition of Simpson Thacher’s Registered Funds Alert discusses:
AXA’s win in its Section 36(b) trial and lessons for multi-manager funds andfund boards; the SEC’s proposed rule on business continuity and transition
plans; criticism from the fund industry on a multi-agency rule proposal
aimed at regulating incentive-based compensation arrangements; andthe SEC’s recent clarification regarding the “Loan Rule” and its effect on
independence of certain accounting firms.

AXA Wins Section 36(b)Trial; Takeaways Include
Potential Improvements forYour Section 15(c) Process
On August 25, 2016, Judge Sheridan of the U.S.
District Court for the District of New Jersey rendered
his decision in Sivolella v. AXA Equitable Life
Insurance Company, finding that the plaintiffs
failed to meet their burden in demonstrating abreach of fiduciary duty under Section 36(b) of theInvestment Company Act of 1940 (“1940 Act”).
The AXA case was the first Section 36(b) case toadvance to trial since the Supreme Court’s 2010
unanimous decision in Jones v. Harris Associates
L.P. that upheld the Second Circuit’s well-established
Gartenberg precedent.
The Plaintiffs alleged the adviser (“FMG,” anaffiliate of AXA) charged excessive advisory fees andadministrative fees with respect to 12 funds. The
plaintiffs’ case focused on three arguments:• FMG breached its fiduciary duty to the funds bycharging fees that were disproportionate to theadvisory and administrative services provided
by FMG, as FMG delegated most of its duties to
subadvisers and subadministrators that charged
a lower fee;
• The funds’ board breached its fiduciary duty byapproving the disproportionate fees; and• FMG manipulated the materials provided
to the board in connection with the annual
contract renewal process under Section 15(c)of the 1940 Act by providing misleading andunreliable information.

In order to prove a violation of Section 36(b) under
the Gartenberg/Jones precedent, a plaintiff mustshow that the fee charged by the adviser is “sodisproportionately large that it bears no reasonable
relationship to the services rendered and could nothave been the product of arm’s-length bargaining.”
There are six factors that a court generally considersin evaluating a Section 36(b) claim with respect toeach fund:(i)

The nature and quality of the services
provided by the adviser to the fund andits shareholders;(ii) The profitability of a fund to the adviser;(iii) “Fall-out” benefits realized by the adviser due
to its relationship with the fund;(iv) The economies of scale achieved by the fundas it grows in size and whether the adviser
shares such savings with shareholders;(v)Comparison of a fund’s fee structure tosimilar funds; and(vi) The independence and conscientiousness ofthe fund’s board.
Plaintiffs need not prove that all of these factors
weigh in their favor to prevail on a Section 36(b)claim. Additionally, the Supreme Court in Jones
cautioned courts from placing too much weight oncomparisons of a fund’s fees to similar funds, as
there is no guarantee that such fees represent fees
negotiated at arm’s length.
Section 36(b) claims are inherently tied to theboard’s annual contract renewal process pursuant
to Section 15(c) of the 1940 Act. Generally speaking,Section 15(c) requires a fund’s board to consider
the renewal of an advisory agreement on an annual
basis and imposes a duty on the board to request,
and the adviser to provide, all information that
may be reasonably necessary for the board toevaluate the agreement. Under Gartenberg andJones, the decision of a fund’s board, particularly
its independent trustees, is given considerable
weight by a court unless a plaintiff can show that theboard’s process was deficient or the adviser withheld
important information from the board.
In finding for AXA with respect to each of thefactors enumerated above, Judge Sheridan’s decision
heavily discounted the testimony of the plaintiffs’
expert witnesses, citing errors, inconsistencies, lackof relevant experience, poor preparation and even“sarcastic demeanor” as reasons why little weight
was given to their testimony.1 In contrast, Judge
Sheridan appears to have relied heavily on thetestimony of the board’s lead independent trustee
and quoted him at length throughout the opinion.2
This Alert does not provide an in-depth review
of Judge Sheridan’s findings with respect toeach Gartenberg factor, instead focusing on key
takeaways for advisers and boards to consider inassessing the adequacy of their annual Section
15(c) process.
1. Notably, each of the plaintiffs’ experts in the AXA case have been retained
as experts by plaintiffs in a separate Section 36(b) case, pending in the same
court (but before a different judge), against Hartford Investment Financial
Services, LLC. The attorneys for both AXA and the plaintiffs also represent
the parties in the Hartford case.
2. We note that the lead independent trustee, Gary Schpero, is aretired partner of Simpson Thacher who previously led our investment
management practice.
2Services Provided by the Adviser in a MultiManager Structure
A number of recent Section 36(b) claims havetargeted advisers to multi-manager funds thatdelegate responsibilities to subadvisers, as FMG
does, arguing essentially that the adviser is being
paid without providing meaningful services. Thisline of argument relates most closely to the factor
that focuses on the nature and quality of the services
provided by the adviser. Judge Sheridan devoted asignificant portion of his opinion to this topic (over40 pages). In the AXA case, the plaintiffs argued
that the plain text of the advisory and administrative
agreements, when compared to the language of thesubadvisory and subadministrative agreements,
showed that FMG was delegating each and every oneof its responsibilities.
The court found that the administrative contract
language clearly indicated that FMG retained
significant obligations. With respect to the advisory
agreements, however, Judge Sheridan found thatthe contractual language on its face seemed toindicate a complete delegation of FMG’s advisory
responsibilities. In finding for AXA on this point
nonetheless, the court relied on evidence showingthat FMG retained many significant responsibilities
not specified in the various advisory contracts,and found that AXA, an affiliate of FMG, provided
significant services to the funds, the costs of whichwere borne by FMG. The overall services provided to
the funds by FMG and AXA included:• Supervision and management of subadvisers,
including diligence and monitoringof performance;• Construction and restructuring of portfolios;• Setting benchmarks;• Structural changes to funds (such as changing
a fund’s strategy or objective, terminating asubadviser or merging a fund);• Formulating and implementing investment
strategies for each fund (or sleeves of a fund);• Asset allocation and rebalancing;• Fair valuation for hard-to-value securities;• Legal and compliance services;• Preparing and managing board materials
and meetings;• Disaster recovery services; and• Call centers to handle shareholder inquiries.

In light of this discussion in Judge Sheridan’s
opinion, it may be wise for advisers to compare theduties outlined in their advisory and subadvisory
agreements (or other agreements). To the extent that
this comparison shows an apparent delegation of
all duties, an adviser should ensure that its Section
15(c) materials discuss any duties provided by anadviser that are not explicitly discussed in theapplicable agreements. Additionally, advisers should
consider public disclosure, including in shareholder
reports, of the types of services provided to the funds
they advise.

“

In light of this discussion in Judge Sheridan’s
opinion, it may be wise for advisers to compare
the duties outlined in their advisory andsubadvisory agreements (or other agreements). To
the extent that this comparison shows an apparent
delegation of all duties, an adviser should ensurethat its Section 15(c) materials discuss any duties
provided by an adviser that are not explicitly
discussed in the applicable agreements.
The Board”

In the AXA case, the court evaluated whether having
an interested chair of the board undermined theboard’s independence and ability to fulfill its duties.
The funds’ lead independent trustee testified that
he and the other independent trustees were, inreality, responsible for setting the agenda for board
meetings, while the interested chair then carriedout that agenda in running board meetings. Whilethe court questioned whether an interested chair
could realistically look out for the best interests offund shareholders while simultaneously servingas CEO of the adviser, the fact that the board had
a supermajority of independent trustees who
demonstrated that they carry out their duties in a
conscientious manner appears to have mitigatedJudge Sheridan’s concerns. The fact that the board
meeting agenda was decided with input from theindependent trustees also appears to have been an
important factor in the court’s decision. For otherfund complexes, if the board has an interested chair
but no lead independent trustee, it may be time toconsider adopting that practice.3
Notably, Judge Sheridan also made a point of
including a separate section in his opinion discussing
3. Judge Sheridan’s opinion also implies that the appointment of Mr.
Schpero as lead independent trustee was a result of the lawsuit, but thispoint fails to consider that he assumed that mantle from another trustee
upon his retirement from the board.
3

how the filing of the lawsuit seems to have been the
catalyst for several improvements to the board’s
practices and the Section 15(c) materials it receives
in connection with annual contract renewals. For
example, the opinion notes that the lawsuit appears
to have resulted in a more critical review of board
expenses, such as dinners associated with board
meetings, and Judge Sheridan included a footnote
recommending that the board adopt a policy
regarding board expenses to ensure transparency
regarding board-related costs. Additionally, theJudge stated that, since the commencement of thelawsuit, the board had begun receiving informationin connection with the annual Section 15(c) process
regarding the portion of the advisory fee that FMG
retained after paying the subadviser, 4 and that theSection 15(c) materials were supplemented with anindex of materials that tied each document to therelevant Gartenberg factor(s). While adoption ofsimilar policies and practices cannot insulate a board
from a Section 36(b) claim, they could prove to be
helpful in the event a fund complex is sued.
The Plaintiffs in the AXA case have indicated thatthey intend to appeal the decision. We will continue
to monitor this and other pending Section 36(b)cases (of which several are still pending, on similar
and different fact patterns), and will address any
notable developments in future Alerts.

SEC Proposes Rule Requiring
Investment Advisers to
Prepare a Business Continuity
and Transition Plan; Issues
Guidance Update Reflecting
Similar Expectations for
Registered Funds
As discussed in prior Alerts, the Securities andExchange Commission is in the process of proposing
a series of reforms designed to minimize certain
perceived risks in the asset management industry.
The most recent reform effort targets an alleged lackof adequate planning by some investment advisers
to account for business disruptions. To address thisconcern, the SEC proposed Rule 206(4)-4 (“Proposed
Rule”) and an amendment to Rule 204-2 underthe Investment Advisers Act of 1940, as amended(“Advisers Act”). If adopted, the rule changes would
require SEC-registered investment advisers to:
4. We note, however, that the record seems to reflect that this information
was considered by the board prior to the commencement of the lawsuit.

(i) adopt and implement a business continuity andtransition plan; (ii) review the plan at least annually;and (iii) maintain a record of the current plan
and any prior iteration of the plan in effect during
the preceding five years, as well as other records
related the adviser’s annual review. The Proposed
Rule appears to be aimed at smaller investment
advisers, as larger and more sophisticated advisers
likely already have business continuity measures inplace. Comments on the Proposed Rule were due on
September 6, 2016.
Key Components of a Business Continuity
and Transition Plan
Under the Proposed Rule, a business continuity andtransition plan must be reasonably designed to deal
with operational risks such as cyber-attacks, system
failures, natural disasters or acts of terrorism. Other
operational risks may include those stemming from
unexpected losses of service providers, facilities or
key personnel. A business continuity and transition
plan must address the following “key components” inthe event of a significant disruption:(i)

maintaining critical operations andsafeguarding data;(ii) pre-arranging an alternate office location;(iii) communicating with clients, employees,
service providers and regulators;(iv) assessing critical third-party services; and(v)

preparing a transition plan to sell, transfer or
liquidate the managed assets.

Although the Proposed Rule requires all plans toaddress these key components, it recognizes that thedegree to which a particular adviser’s plan addresses
each component will vary depending on the size andcomplexity of that adviser’s business.
Maintaining Critical Operations andData Protection
The Proposed Rule explains that a business
continuity and transition plan should identify,
prioritize and consider alternatives to criticaloperations in order to maintain continuity during asignificant business disruption. Critical operations
include those that are utilized for quickly processing
transactions, delivering securities and maintaining
client accounts. A plan should provide a contingency
strategy for handling the temporary or permanent
loss of key personnel. Additionally, data backup andrecovery measures also should be incorporated into
the plan, with an eye towards potential cyber-attacks

4and preserving key documents (e.g., organizational
documents, contracts and policies and procedures).
A notable aspect of the Proposed Rule is the extent
to which it uses continuity planning as a platform
to discuss cybersecurity issues. The Proposed Rule
posits that the impact of cybersecurity incidents canbe reduced by robust business continuity planning,and states that “[a]n adviser generally should
consider and address as relevant the operational andother risks related to cyber-attacks.” Language like
this, interspersed throughout the Proposed Rule,appears to provide a basis for a new, independentcause of action that can be used by the SEC against
advisers who fail to take sufficient steps to prevent,mitigate and respond to cyber-attacks. In any case,as we have noted in prior Alerts, advisers would be
prudent to shore up their cybersecurity protocols inlight of other recent SEC actions5 and statements.6
Pre-Arranged Alternate Location
According to the Proposed Rule, a plan must
“pre-arrange alternate physical location(s) of its
office(s) and/or employees.” Advisers should take
into account the geographic diversity of different
locations to preempt localized disruptions. Advisers
should also consider how to maintain each location’s
remote access to technology and resources inorder to continue with critical operations. Thisrequirement generally applies to “extended”
disruptions—consistent with past SEC guidance on
this topic, enabling employees to work remotely is
an appropriate plan for shorter disruptions. In theevent of an “extended” issue, without providing any
guidance on what period of time would constitute an“extended” period, the proposing release states that
smaller advisers may be able to rely on remote accesswhile larger advisers may need to plan to have analternate location.7
5. E.g., R.T. Jones Capital Equities Mgmt., Inc., Order, No. 3-16827 (Sept.
22, 2015) (imposing a $75,000 civil money penalty on an investment adviser
for failing to failing to adopt sufficient procedures to safeguard customer
information during a data breach); Morgan Stanley Smith Barney LLC,
Order, No. 3-17280 (June 8, 2016) (imposing a $1 million dollar penalty on
an investment adviser for failing to safeguard customer information duringa cyber-attack).
6. Cybersecurity Guidance, IM Guidance Update, No. 2015-02 (Apr. 2015)(noting that “advisers should identify their . . . compliance obligations
under federal securities laws and take into account these obligations whenassessing their ability to prevent, detect and respond to cyberattacks”).
See also, e.g., Mary Jo White, Chair, SEC, Opening Statement at SEC
Roundtable on Cybersecurity (Mar. 26, 2015); Kenneth Corbin, SEC
Warns More Cyber Enforcement Actions Coming, Financial Planning,
Apr. 20, 2016, (Andrew Ceresney, head of the SEC’s Enforcement Division,
explained, “[c]yber is obviously a focus of ours . . . we’ve brought a numberof cases relating to Reg S-P and failure to have policies and procedures
relating to safeguarding information . . . [t]here’ll be others coming down
the pike.”).
7. As noted below, in the Guidance Update issued in tandem with the
Proposed Rule, the SEC’s Division of Investment Management apparently
does not consider three days to be an extended period of time.

Communications
Another key component of a business continuity
and transition plan is that it must addresscommunications with clients, employees, service
providers and regulators. The plan should consider
different communication methods, and whenand how to inform clients of significant businessdisruptions. Moreover, the plan should consider theprocess of communicating with service providers
about disruptions that might affect the systems ofboth the investment adviser and the service provider.
Critical Service Providers
A business continuity and transition plan also must
identify and assess third-party services in supportof critical operations. An adviser could deem
certain providers to be “critical” based on a variety
factors including whether the service provider
has backup systems, whether the service provider
has direct contact with investors and whether theservice provider has access to investors’ personallyidentifiable information. The Proposed Rule explainsthat critical service providers would generally
include those who offer services “related to portfolio
management, the custody of client assets, trade
execution and related processing, pricing, client
servicing and/or recordkeeping and financial andregulatory reporting.” The adviser should review
and assess how critical service providers plan tomaintain business continuity during a significant
business disruption.
The distinction between critical and non-critical
third-party service providers potentially puts
advisers between a rock and a hard place. While
the proposing release emphasizes that a business
continuity and transition plan should entail robust
diligence regarding critical providers, it does notelaborate on the specific protocols required for
non-critical third-party service providers. The only
clear guidance is that advisers should give more
scrutiny to critical providers than non-critical ones.
An adviser that applies a consistent, high-scrutiny
approach to all providers, regardless of importance,
may be left wondering whether it needs todifferentiate its approach for critical providers, even
if just in form, to avoid the appearance of not giving
critical providers sufficient scrutiny.
Transition Plan
The final key component is a transition plan thatconsiders how to transfer client relationships when
an investment adviser exits the market or undergoesa change in ownership. Whether a transition
occurs due to a merger, sale or an inability of theadviser to continue providing advisory services,5a transition plan should be designed to facilitate
a prompt, smooth transition in both normal andstressed market conditions. A transition plan should
contain procedures for safeguarding client assets
and handling client-specific information; it should
also include an assessment of the applicable law andcontractual obligations governing the adviser andits clients.

“

Whether a transition occurs due to a merger,
sale or an inability of the adviser to continue
providing advisory services, a transition planshould be designed to facilitate a prompt, smoothtransition in both normal and stressed market
conditions.

”

The Proposed Rule acknowledges that manyadvisers already have transition plans as a standard
business practice and in compliance with parallel
regulations. The concept of transition plans is ofcourse well known to firms that are part of banking
conglomerates, who have had to grapple with theconcept of “living wills” in the post-financial crisis
regulatory framework. However, the same concept,
as applied to investment advisers, is inapt at best.
Investment advisers invest assets for their clients,and follow stringent rules regarding the custody andsafekeeping of those assets. A bankruptcy, suddentransition or other “black swan” event with respect
to the adviser will not have any effect on the valueof the assets held in client accounts. The investment
management industry is robust, with several players.
If an adviser were to fail, there are many others who
would be ready to step in. Living wills and transition
plans are particularly important to avoid government
bailouts; it is difficult to imagine how a transitionof an adviser could require a government bailout(indeed, after Lehman Brothers collapsed and went
into bankruptcy at the onset of the financial crisis,
its advisory arm was able to smoothly transition
clients to Neuberger Berman without harm toinvestors). The Proposed Rule may serve a greater
regulatory purpose for smaller advisers, which
essentially would add to the category of business
continuity disruptions the departure or incapacityof the adviser’s owner or a key member of a smallorganization. For larger advisers, who employ
investment teams and likely have a multitude of
personnel who are capable of stepping in to ensure
uninterrupted advisory services, and are unlikely toundergo any sort of meaningful transition without
careful planning, even in extreme circumstances,
the requirement for a written transition planseems to us to be driven more by the regulatory

pressures on the SEC from the other members of the
Financial Stability Oversight Council, which noted
its recommendation for a transition planning rule
for investment advisers in its April 2016 update on
its review of the asset management industry, thanby the existence of an actual problem that requiresa solution.
Accordingly, it seems unnecessary to require large
advisers to have a detailed transition plan and the
Proposed Rule is unclear with respect to what would
qualify as a transition event that requires a written
plan for larger advisers. For example, while a founder
selling his or her controlling stake in an adviser isa manifest example of a transition event, what if
an adviser’s chief investment officer leaves? Whatabout a junior portfolio manager? If the SEC insists
on applying the transition plan requirement to large
advisers, some guidance would be useful to assist
advisers in this line-drawing exercise.
Annual Review
The Proposed Rule requires each adviser to perform
a review of its business continuity and transition
plan at least annually. The purpose of the review
is to ensure the efficacy of the current plan and to
consider whether the plan should be modified inlight of changes to the adviser’s products, operations,critical third-party service providers, structure,business activities, clients, or location.
Recordkeeping
Under the proposed amendment to Rule 204-2,
advisers must maintain records of their current
business continuity and transition plans and any
prior iterations of their plans in effect during thepreceding five years. An adviser must also maintainrecords related to the annual review. The records
may be stored electronically, but advisers must keepcopies to ensure easy access to necessary information
during periods of stress and to facilitate review by
SEC staff to check for compliance.
Companion Guidance Update forRegistered Funds
On the same date as it issued the Proposed Rule,the SEC’s Division of Investment Management
published a separate Guidance Update pertaining
to the business continuity plans of funds registeredunder the 1940 Act. Several recent system failuresexperienced by fund complexes served as an impetus
for the SEC to issue this Guidance Update. For
example, in August of 2015, a system failure of athird-party service provider resulted in clients ofmultiple fund complexes receiving stale pricing
information over a three-day period. Although6the Guidance Update did not appear to consider
three days to be an “extended outage,” it noted thatan extended outage could have had a far greater
negative impact. In the wake of these incidents,
the SEC requested information from various funds
and service providers, which revealed that somefund complexes appear to be unprepared to deal
with extended outages of critical service providers.
Accordingly, the SEC released the Guidance
Update to discuss its general continuity planning
expectations for fund complexes under Rule 38a-1 ofthe 1940 Act.
The continuity measures espoused in the Guidance
Update for registered funds are similar to thosein the Proposed Rule. For instance, the Guidance
Update also emphasizes the importance of
safeguarding business operations against potential
system failures and cyber-attacks. Additionally,
the Guidance Update defines critical service
providers to registered funds to include at least“each named service provider under Rule 38a-1 (i.e.,each investment adviser, principal underwriter,administrator and transfer agent), as well as eachcustodian and pricing agent.” Overall, the Guidance
Update suggests that the SEC will hold funds andtheir control persons to similar standards as thoseexpressed in the Proposed Rule.

SEC’s Proposed Ruleon Incentive-Based
Compensation Arrangements
Draws Criticism From theFund Industry
In June 2016, the SEC and several other regulatory
agencies published a revised rule proposal (the“Proposed Rule”) on incentive-based compensation
for covered financial institutions, which are thoseinstitutions with total consolidated assets (i.e.,balance sheet assets) of at least $1 billion andincludes asset managers. The Proposed Rule,
which is mandated by Section 956 of the DoddFrank Act, calls for prohibitions on incentive-based
compensation arrangements, or any feature of any
such arrangements, that encourage inappropriate
risks that could jeopardize the stability of thefinancial institution.
Under the Proposed Rule, an incentive-based
compensation arrangement would be considered
to encourage inappropriate risks that could leadto material financial loss to the covered financial
institution unless the arrangement: (i) appropriatelybalances risk and reward; (ii) is compatible
with effective risk management and controls;and (iii) is supported by effective governance. A
compensation arrangement would not be considered
to appropriately balance risk and reward unless: (i)it includes financial and nonfinancial measures of
the covered person’s performance; (ii) is designed
in such a manner that it would allow, whereappropriate, nonfinancial measures of performanceto override financial measures of performance; and(iii) amounts awarded are subject to adjustment
to reflect actual losses, inappropriate risks taken,
compliance deficiencies, or other measures or aspectsof financial and nonfinancial performance. For
example, under the Proposed Rule a bonus structurethat rewards covered employees for significant gains
but offers no disincentives for significant losses
would be potentially problematic because it does not
appropriately balance risk and reward.

The Proposed Rule divides covered
institutions by average total
consolidated assets:

Level 1

≥ $250 billion

Level 2

≥ $50 billion and< $250 billion

Level 3

≥ $1 billion and< $50 billion

The sprawling 706-page proposal contains significant
revisions from the initial 2011 proposal for
regulation of incentive-based compensation, someof which have been well received. But several fundindustry representatives submitted comment lettersthat argue the Proposed Rule is still too broad andcaptures certain investment advisers unnecessarily.
With respect to revisions that were embraced by
the asset management industry, the Investment
Company Institute (“ICI”), among others,commended the SEC for clarifying that investment
advisers should include only proprietary assets inthe calculation of consolidated assets and exclude
non-proprietary assets, such as client assets undermanagement, regardless of whether they appear
on an investment adviser’s balance sheet. This7

distinction was not clear in the 2011 proposal.
Since the aim of the Proposed Rule is to curtailsystemic risk that may be threatened if the financial
institution becomes unsound, it is only the advisers’
assets that are relevant, and not those of their clients.
Other portions of the Proposed Rule were met
with more criticism. Possibly the most criticizedcomponent of the rule is its tiered system forclassifying covered institutions based on size.
The Proposed Rule imposes increasingly detailed
disclosure and record-keeping requirements forLevel 1 and Level 2 entities and would require thatincentive-based compensation arrangements forcertain covered persons at such entities include
additional features, such as clawback provisions,
to appropriately balance risk and reward. These
more stringent requirements affect two categories
of individuals: “senior executives” and “significant
risk-takers.” At Level 2 institutions, “significant
risk-takers” are those employees who derive atleast one-third of their annual compensation fromincentive-based metrics and fall among the top 2%of earners. At Level 1 institutions, however, suchconditions apply to the top 5%. If an investment
adviser were to be deemed to be a Level 1 or Level 2
institution, these requirements would likely impact
key personnel, such as portfolio managers.

“

Several comment letters critical of the
proposal argue that this inflexible leveling system
unfairly puts advisers who are affiliated withlarger parent banks at a significant recruiting
disadvantage relative to their standalone peers,and does so without regard to how they might
actually operate.

”

Notably, an investment adviser that is a subsidiaryof a banking institution could have its level dictatedby the level that applies to the top-tier holding
company. Several comment letters critical of the
proposal argue that this inflexible leveling system
unfairly puts advisers who are affiliated with larger
parent banks at a significant recruiting disadvantage
relative to their standalone peers, and does so
without regard to how they might actually operate.
If viewed on the basis of their own assets, most fundadvisers subject to the rules would be Level 3; butthose that happened to be under the umbrella of alarger bank would face stricter requirements solely
because of that affiliation. Wells Fargo submitted
a comment letter arguing that the result of the
Proposed Rule would be that its asset manager
subsidiaries will be forced to abide by tight Level 1

restrictions, while many of its subsidiaries’ peers will
only have to comply with Level 3 restrictions despite
being “much larger and hav[ing] higher risk profiles.”The ICI’s letter also argues that the rigid application
based on size tiers does not properly account for thereality that many asset managers operate completely
independent of their parent financial institutions.
A potential fix put forth by the ICI would be to
add an escape valve by which the SEC would havethe discretion to treat a Level 1 or 2 institution
as a Level 3 if it determines that the adviser’s
activities, complexity of operations, risk profile andcompensation practices are consistent with those ofa Level 3 adviser. This would allow for independent
determinations in cases where the applicants believe
circumstances warrant a different classification.
Comments on the proposal were due on July 22,
2016. Because of the multiagency basis on whichthese rules were proposed and will assumedly
be adopted, it is unclear when these rules will be
adopted, if at all, and the extent to which the SEC will
have flexibility to apply the rules to asset managers
in a manner appropriate to the asset management
industry, as compared to the financial institutions
that are the primary target of the rules.

SEC Questions Auditor
Independence Under
Loan Rule; Quickly Issues
Temporary Relief
Under the 1940 Act, registered funds (includingETFs) are required to provide financial statements,
which must be audited by an independent accounting
firm, to their shareholders on an annual basis andfile them with the SEC. The SEC has set forth strict
requirements identifying what conditions must
be met for an accounting firm to be considered“independent.” The requirements are intended
to ensure that accounting firms are qualified andindependent of their audit clients both in fact andin appearance. Specifically, under Rule 2-01(c)(1)(ii)(A) of Regulation S-X, an accountant is notindependent when:“[t]he accounting firm, any covered person in
the firm, or any of his or her immediate family
members has . . . [a]ny loan (including any marginloan) to or from an audit client, or an audit client’s
officers, directors, or record or beneficial owners ofmore than ten percent of the audit client’s equity
securities.

”

8Second, the SEC only granted relief for potential
independence issues arising out of certain
lending relationships:(i)This is commonly referred to as the “Loan Rule.”
For over a decade, the four major accounting firms,
among others, have generally interpreted the Loan
Rule as not being applicable in the registered fundcontext. Accordingly, an accounting firm would
be independent with respect to a registered fund,even when a large shareholder of the fund, suchas a financial institution, has lent money to theaccounting firm. However, in May 2016, it was
revealed that the SEC’s Office of Chief Accountant
and the Chief Accountant of the SEC Divisionof Investment Management indicated to certain
accounting firms that they may be misinterpretingthe Loan Rule. A change in the interpretation of
the rule could have far reaching consequences
for the fund industry. For example, the financial
statements of many funds (who have been operating
under the long standing interpretation of the Loan
Rule) could be deemed deficient, given that theaccounting firms would no longer be considered
independent, and funds would be required toobtain a new (independent) audit and refile theirfinancial statements.
In June 2016, however, the SEC granted temporary
no-action relief addressing this issue. The relief
allows fund complexes to continue to use financial
statements audited by accounting firms that may
not comply with the Loan Rule so long as certain
conditions are satisfied.
First, the accounting firm must have complied withPCAOB Rule 3526(b)(1) and (2) (“Rule 3526(b)”),which requires the firm to describe to a client’s
audit committee on at least an annual basis all
relationships between the accounting firm (or anyof its affiliates) and the audit client or persons infinancial reporting oversight roles at the audit
client that may impact the accounting firm’s
independence and to discuss the potential effectsof those relationships. The accounting firm mustalso confirm in writing that it meets applicable
independence requirements. To the extent that
Rule 3526(b) does not apply to an audited fund,the accounting firm must provide substantiallyequivalent communications.

the financial institution that has lent money
to the accounting firm holds more than ten
percent of the shares of an audited fund (or anentity within the same fund complex);(ii) an insurance company that has lent money
to the accounting firm holds more than ten
percent of the shares of an audited fund (oran entity within the same fund complex) in
separate accounts that it maintains on behalfof its insurance contract holders; or(iii) an institution that has lent money to theaccounting firm and acts as an authorizedparticipant or market maker to an audited
fund (or an entity within the same fundcomplex) and holds of record or beneficiallymore than ten percent of the shares of theaudited fund.
Finally, notwithstanding such non-compliance, theaccounting firm must conclude that it is objective andimpartial with respect to the issues encompassed
within its engagement.
In relying on the relief, a fund is required to makereasonable inquiry regarding a lending relationshipand its potential impact on an accounting firm’s
independence prior to submitting certain proxy
proposals to fund shareholders, including(i) the election of trustees, (ii) the appointmentof an independent accounting firm or (iii) any
other proposal that similarly could impact theindependence and impartiality of the independentaccounting firm. The no-action letter includes
an expectation that funds will adopt policies andprocedures to provide for such an inquiry, which
may require contacting institutions that owns
a significant stake in a fund and has a lending
relationship with the accounting firm. In this regard,
the no-action letter notes that the initial request
for relief included a representation that if a funddiscovers that a lending institution owning morethan 10% of a fund’s outstanding shares actually
exercises discretionary voting authority with respect
to those shares, the fund would not be able to rely on
the relief.
Notably, the SEC’s no-action letter is explicit thatthe relief is temporary and expires in December
2017. The temporary nature of the relief suggests
the Commission may consider modifying the Loan
Rule prior to the relief’s expiration. We will continue
to monitor this issue and provide any significant
updates in future Alerts.
9

M&A Transactions
Acquiror

Acquired or
Target Company

Type of Transactionand Status

State Street Corporation, aprovider of financial services toinstitutional investors with $2 trillion
AUM

GE Asset Management, manager of General
Electric Company’s U.S. pension and benefit plans

Acquisition for $485 million(pending)

Union Bank & Trust, a subsidiaryof Richmond, Virginia-based Union
Bankshares Corporation

Old Dominion Capital Management, Inc.,a registered investmentadviser with nearly $300
million AUM

Acquisition (pending)(terms not disclosed)

Mesirow Financial, a financial
services firm based in Chicago

Fiduciary Management Associates, LLC, asmall- and mid-cap value equity money manager
with $1.7 billion AUM

Acquisition(terms not disclosed)

Huatai Securities, a China-based
securities group that provides wealthmanagement, investment banking andasset management services, with amarket capitalization of approx. $18.5
billionAssetMark Inc., a provider of investment andconsulting solutions to financial advisors, with over
$29.3 billion in assets

Acquisition for $780 million

D.A. Davidson & Co., a full service
investment firm offering equity and
fixed income capital markets services
and advice

SMITH HAYES Companies, a financial services
holding company with approx. $4 billion AUM
and AUA that provides asset management services
to institutions, wealth management services
to individuals, and retirement planning andinvestment banking services to both municipal andcorporate clients

MergerPacific Asset Advisors LLC,
an investment management firmthat offers life-insurance products,
annuities, mutual funds and a variety
of investment products and services

Cadence Capital Management, a boutiqueinvestment firm that manages approx. $4 billion on
behalf of institutions, mutual funds and high net
worth individuals

Acquisition(terms not disclosed)

Tortoise Credit Strategies LLC, aregistered investment advisor, and key
Bradford & Marzec LLC employees
and management

Bradford & Marzec LLC, an investment advisor
that manages long-only domestic and global fixedincome portfolios for institutional and high net
worth individuals

Partial management buyout
by key Bradford & Marzec
employees and managementfor 37%, while Tortoise will
own the remainder(terms not disclosed)

BlackRock, provider of investment
management, risk management andadvisory services to institutional andretail clients, with $4.737 trillion AUM

Bank of America’s asset management business,
BofA Global Capital Management

Assignment of investment
management responsibilities
of approx. $80 billion AUM

Nuveen Investments Inc., an
investment management firm
specializing in helping financial
advisors with affluent and high-networth investors

Incapital LLC’s Unit Investment Trust
platform

Acquisition(terms not disclosed)

10

M&A Transactions (continued)
Acquiror

Acquired or
Target Company

Type of Transactionand Status

Foresters Financial, a Toronto-based
international financial services provider
that provides life insurance, savings,
retirement and investment solutions tomore than three million clients and has
assets of approx. CAD $14 billion

Aegon Capital Management Inc., an
investment manager, and Aegon FundManagement Inc., a mutual fund manager

Acquisition(terms not disclosed)

Angel Oak Capital Advisors, LLC, an
investment management firm focusing
on opportunities in fixed income, with
$5.5 billion AUM

Rainier High Yield Fund, a U.S.-based
investment manager offering equity and fixedincome strategies

Acquisition (pending)(terms not disclosed)

Hennessy Advisors, Inc., a publicly
traded investment manager that offersa range of domestic equity, specialty,balanced and fixed income products

The Westport Funds, which currently manage
approx. $640 million of assets

Acquisition of assets related
to the management of The
Westport Funds (pending)(terms not disclosed)

Columbia Threadneedle
Investments, an asset management
group with $464 billion AUM

Emerging Global Advisors, a registeredinvestment advisor based in New York with $892
million AUM

Acquisition (pending)(terms not disclosed)

Aegon, an international providerof life insurance, pensions and asset
management

BlackRock UK’s defined contribution
pension business, which has approx. £12billion of assets and 350,000 customers

Acquisition (pending)(terms not disclosed)

John Hancock Financial Network,
Inc., a distribution channel of financial
services company John Hancock

Transamerica Financial Advisors, Inc.,a Baltimore-based provider of life insurance,savings and retirement and investment solutions

Acquisition of certain assets ofTransamerica(terms were not disclosed)

Hartford Funds, a provider of mutual
funds and college savings plans

Lattice Strategies, an investment management
firm based in San Francisco specializing instrategic beta exchange-traded funds with $215
million AUM

Acquisition (pending)(terms not disclosed)

C-III Capital Partners LLC, acommercial real estate services company
that focuses on primary and special
loan servicing, loan origination, fundmanagement, CDO management,
principal investment, investment sales
and multifamily property management

Resource America, an asset managementcompany specializing in real estate and credit
investments, with $22.4 billion AUM

Acquisition for approx.
$207 million

WisdomTree Investments, Inc., a
New York-based exchange-traded fundand exchange-traded product sponsor
and asset manager, with $43.0 billion
AUM globally

Boost, a UK-based ETF provider

Buyout for $6 million

11Closed-End Fund
Initial Public Offerings
Nuveen High Income December 2019 Target Term Fund(NYSE: JHD)
Amount Raised(Inception Date):$245 million(May 10, 2016)

Investment
Objective/Policies:

The Fund’s investment objectives are to provide a high level of current income exempt from
regular federal income tax and to return $9.85 per share to Common Shareholders on or about
March 1, 2021. The Fund’s subadviser seeks to identify relative value in the market and selectmunicipal securities across diverse sectors that are underrated or undervalued. In seeking toreturn the target amount on or about the Termination Date, the Fund intends to utilize various
portfolio and cash flow management techniques, including setting aside a portion of its net
investment income, possibly retaining gains and limiting the longest maturity of any holding
to no later than September 1, 2021. As a result, the average maturity of the Fund’s holdings is
generally expected to shorten as the Fund approaches its Termination Date, which may reduce
interest rate risk over time.

Managers:

Nuveen Fund Advisors and Nuveen Asset Management

Book-runners:

Morgan Stanley, Bank of America Merrill Lynch, Wells Fargo Securities and Nuveen Securities

Eaton Vance High Income 2021 Target Term Trust(NYSE: EHT)
Amount Raised(Inception Date):$190 million(May 31, 2016)

Investment
Objective/Policies:

The Trust’s investment objectives are high current income and to return $9.85 per share percommon share of beneficial interest, before deducting offering costs of $0.02 per Common
Share, to holders of Common Shares on or about July 1, 2021. The Trust seeks to achieve its
investment objectives by investing, under normal circumstances, at least 80% of its Managed
Assets in corporate debt obligations and separately at least 80% of its Managed Assets incorporate debt obligations that, at the time of investment, are rated below investment grade(BB+ or lower) or are unrated but deemed equivalent by the Adviser. The Trust intends toutilize a limited duration strategy, which declines over time and is less sensitive to high yieldinterest rate risk than longer duration funds. The average maturity of the Trust’s holdings
is generally expected to shorten as the Trust approaches its Termination Date, which may
reduce interest rate risk over time but which may also reduce amounts otherwise available for
distribution to Common Shareholders.

Managers:

Eaton Vance Management

Book-runners:

Wells Fargo Securities, RBC Capital Markets and UBS Investment Bank

12

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
Rajib Chanda is a Partner in the Washington, D.C. and New York offices of Simpson Thacher & Bartlett LLP.
Rajib’s practice focuses on all aspects of issues facing registered investment advisers and sponsors of registeredfunds. Rajib has particular experience working with alternative 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 andworks closely with the firm’s asset management M&A group on transactions involving registered advisers andfunds. In addition, Rajib provides counsel to boards of registered funds, and has substantial experience advising
companies on issues relating to social media and cybersecurity.

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 and Head of the Firm’s
Registered Funds Practice. Sarah’s practice encompasses 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 a particular expertise in advising underwriters and sponsors inofferings by closed-end funds and business development 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.

13

SimpsonThacherWorldwide

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14