Several days ago, FINRA released guidance updating its Frequently Asked Questions relating to Rule 2210 on Advertising and Public Communications to address Artificial Intelligence.  This follows after FINRA has consistently been noting that the use of AI and AI tools should be addressed by member firms in their policies and procedures and may implicate their regulatory obligations.  The two new FAQs are accessible from the FINRA page on FAQs About Advertising Regulation.

The first addresses supervising chatbot communications and asks, “If a firm uses AI technology to create chatbot communications that are used with investors, how should the firm supervise that activity?”  FINRA notes in response that these communications may be subject to FINRA communications rules as correspondence, retail communications, or institutional communications.  The communications, like other communications, would be subject to FINRA Rules 2210 and 3110.  Rule 3110(b)(4) requires firms to establish, maintain, and enforce written procedures for the review of incoming and outgoing written (including electronic) correspondence relating to the firm’s investment banking or securities business that must be appropriate for the member’s business, size, structure, and customers.

The second addresses AI-created communications and asks, “Is a firm responsible for the content of communications created using artificial intelligence (AI) technology?”  Of course, as one would expect, firms are responsible for all communications, including AI-generated communications.  FINRA in the response reminds firms that they must ensure that AI-generated communications comply with applicable securities laws and regulations and FINRA rules, including compliance with supervision requirements, recordkeeping requirements and content standards, among others.

The Securities and Exchange Commission announced an upcoming meeting of its Investor Advisory Committee, which will be held on June 6, 2024.  The agenda includes a number of interesting topics.

The Committee will consider and address the impact of “finfluencers.”  The agenda notes that recent studies have found that these social media influencers who focus on financial services seem to have a particular impact on younger investors and on investors of color.  According to studies, investors of color are more apt to rely on social media, trading apps and similar sources of information, rather than investment advisers, for financial information.  Among the materials that will be considered and presented at the meeting is a January 2024 study titled, “The Finfluencer Appeal:  Investing in the Age of Social Media,” which was published by the CFA Research & Policy Center.  The study considered the role of social media in the financial services sector, focusing specifically on finfluencers who provide general investment information, promote investment products, offer investment guidance and sometimes make investment recommendations.  The report analyzes the finfluencer model and the adequacy of regulatory and policy frameworks in several jurisdictions, including the United States, the United Kingdom, Germany, France and the Netherlands.  It notes that generally the content published by these influencers is not tailored or customized by region.  Most of the content discusses individual stocks, index funds, and ETFs.  The study makes a number of suggestions for regulators—among these, the study suggests that regulators should develop a more universal definition of an “investment recommendation;” that national regulators should engage with finfluencers; that national regulators should record and publicly report data on complaints and whistleblower activity relating to finfluencer posts and commentary; regulators should enhance social media controls; and finally that firms using finfluencers should provide compliance training, review their posts, and maintain records of their posts and materials.  FINRA is already focused on the activities of member firms with respect to finfluencers.  We commented on this in an earlier post.  The Committee will consider recommendations in light of the issues raised by the study, as well as those already known to FINRA and observed by others.

The Committee also will consider the development of various AI technologies and address issues related to disclosures, data controls, bias, and education, with the objective of understanding how the SEC might promote the advancement of AI while addressing these concerns. 

Following the financial sector disruptions in 2023, financial institutions turned first to covered bonds for funding and the covered bond market demonstrated its resilience.  Just as the covered bond market remained available through the financial crisis in 2008 through 2010, it remained a safe harbor in recent times.  Now, four continents (in addition to Europe) have a covered bond framework.  The United States remains the only significant market that does not have an efficient legal framework to facilitate issuance.  At the end of 2023, there were more than EUR 2.3 trillion in covered bonds outstanding globally. In 2023, issuance of USD-denominated covered bonds increased by almost 9% year-over-year, reaching over $35 billion in covered bonds issued.  Canadian issuers lead the issuance of USD-denominated covered bonds, with over $78 billion in covered bonds issued since 2018.  In our latest At A Glance infographic, we provide key facts and stats about the covered bonds market.

For the latest on covered bonds, visit www.us-covered-bonds.com/.  

Earlier this week, Securities and Exchange Commission Chair Gensler issued a statement regarding the move to a T+1 settlement cycle, which will occur just after the Memorial Day weekend, on Tuesday, May 28, 2024 in the United States.  The transition in Canada will take place on Monday, May 27, 2024.

Chair Gensler reiterated his view that, “[s]hortening the settlement cycle also will help the markets because time is money and time is risk. It will make our market plumbing more resilient, timely, and orderly. Further, it addresses one of the four areas the staff recommended the Commission address in response to the GameStop stock events of 2021.”

His statement included links to the materials published by the Staff, including a risk alert, responses to frequently asked questions, and an Investor Bulletin.

Market participants have been relying on SIFMA and its resources, available here.

On May 15, 2024, the US Securities and Exchange Commission (“SEC”) adopted amendments (the “Amendments”) to Regulation S-P under the Securities Exchange Act of 1934 (the “Exchange Act”), which governs the treatment of nonpublic personal information about consumers by certain financial institutions, to modernize and enhance the protections under the regulation.

The Amendments require broker-dealers, investment companies, SEC-registered investment advisers, funding portals, and transfer agents registered with the SEC or another appropriate regulatory agency as defined in Section 3(a)(34)(B) of the Exchange Act (“transfer agents) to adopt written policies and procedures for incident response programs to address unauthorized access to or use of customer information. Notably, the Amendments create one of the first broad federal consumer notification requirements by mandating timely notification to individuals affected by an information security incident involving sensitive customer information with details about the incident and information designed to help affected individuals respond appropriately.

The Amendments also extend the application of Regulation S-P’s requirements to safeguard customer records and information to transfer agents, broaden the scope of information covered by the requirements for safeguarding customer records and information and for properly disposing of consumer report information, impose requirements to maintain written records documenting compliance with the Amendments, and conform annual privacy notice delivery provisions to the terms of an exception provided by a statutory amendment to the Gramm-Leach-Bliley Act in December 2015.

Continue reading this Legal Update.

In a statement today, the Director of the SEC’s Division of Corporation Finance commented on the relatively new Form 8-K Item 1.05 requirement.  Last summer when the SEC adopted the final rules relating to cybersecurity incidents, the rules included a new requirement under Item 1.05 of Form 8-K relating to the occurrence of an incident that the company had concluded was material.  Division Director Gerding noted in his comments that, “[a]lthough the text of Item 1.05 does not expressly prohibit voluntary filings, Item 1.05 was added to Form 8-K to require the disclosure of a cybersecurity incident ‘that is determined by the registrant to be material,’ and, in fact, the item is titled ‘Material Cybersecurity Incidents.'” 

As a result, he suggested that to the extent a company elects to disclose an incident as to which it has yet to make a materiality incident, it do so under a different item of Form 8-K, such as, for example, Item 8.01.  If, after the passage of time, the incident is determined to be material, the company can make a filing under Item 1.05.

This is a very helpful clarification and one that he notes is not intended to discourage disclosure, but rather to avoid diluting the significance of the Form 8-K Item 1.05 disclosures.

See his full remarks.

On 14 May 2024, the European Securities and Markets Authority (“ESMA“) published its final report on “Guidelines on funds’ names using ESG or sustainability-related terms” (the “Guidelines“). The Guidelines aim to provide fund managers with clear and measurable criteria to assess their ability to use ESG and/or sustainability-related terms in fund names, thereby ensuring that investors are protected against associated greenwashing risk.

Read our Legal Update.

Speaking at the recent conference on Emerging Trends in Asset Management hosted by the SEC’s Division of Investment Management, the Director the Division of Investment Management Natasha Vij Greiner cited a number of statistics from the SEC’s recently published “Registered Fund Statistics.”  She cited the rapid growth of the asset management industry—now comprised of more than 15,000 investment advisers reporting in aggregated approximately $129 trillion in assets under management.  There were several common themes in the Director’s remarks and in those made by Chair Gensler, which are grouped below.  

  • Continued growth and importance of private funds and private markets:  the Director noted that many advisers are advisers to private funds, which have tripled in number in the past decade from 30,000 to 90,000.  The focus on private funds and on the private markets was a notable theme throughout the conference.  For example, in her remarks, the Director pointed out that alternative investments have grown, including private market securities and loans.  She cited the SEC’s DERA statistics that, in 2022, exempt offerings raised $3.7 trillion of new capital, compared to the $1.0 trillion raised in registered offerings.  Consequently, investors are allocating assets to private funds by investing directly through products offered to accredited investors or qualified purchasers, or indirectly through pension fund investments.  In his comments, Chair Gensler focused on the growth of the private credit market and the reliance on leverage, with its accompanying risks
  • SMAs and CITs:  Both the Director and Chair addressed the growth in institutional and retail separately managed accounts (SMAs) and collective investment trusts (CITs).  In his remarks, Chair Gensler noted that today, there are more than 54 million separately managed accounts and that in the last 15 years, the number doubled.  He attributed much of the growth to the rise of robo-advisers.  He pointed out that SMAs now represent more than $49 trillion in assets, up nearly 50 percent in the last five years.  Both the Director and the Chair referenced the growth in CITs.  The Chair noted that the SEC staff has been discussing CITs with bank regulators since these are exempt from SEC oversight.  He estimated that CIT funds are approximately $7 trillion, $5 trillion at the federal level and $2 trillion at the state bank level.  He cautioned that there may be risks associated with this rapid growth and with “regulatory gaps.”
  • Index or “passive” products:  The Director observed that this year marks the 100th anniversary of the formation of the first mutual fund.  While at the end of 1940, mutual funds had aggregate assets of $448 million and commercial banks had $70.7 billion, today, registered funds (including mutual funds), hold more than $32 trillion, and commercial bank total assets are $23 trillion.  Investors can choose from over 12,000 registered funds, of which approximately 9,000 are mutual funds and 3,000 are exchange traded funds.
  • RFC on Index Providers, Pricing Services, etc.:  Chair Gensler commented at length on the growth of passive investment strategies—noting that these stand at $12 trillion, versus actively managed funds at $14 trillion.  The three large ETFs, he pointed out, manage nearly 75 percent of the more than $7 trillion in net assets.  Unfortunately, this led to an update:  Chair Gensler noted that the SEC Staff is considering comments on the SEC’s request for comment on whether index providers, model portfolio providers and pricing services may be acting as investment advisers.  So, it would appear that there will be more to come.
  • Technology:  Of course, much of the attention was focused on technology and the use of artificial intelligence and machine learning, and the possibility of a re-proposal of the controversial predictive data analytics rule proposal.

Access the Director’s remarks and the Chair’s remarks. The full report is available here.

On May 17, 2024, the Director of the Division of Corporation Finance of the Securities and Exchange Commission, Erik Gerding, and the Chief Accountant, Paul Munter, issued a statement regarding International Financial Reporting Standard (IFRS) 19, Subsidiaries without Public Accountability:  Disclosures, or IFRS 19. 

What is IFRS 19?  IFRS 19 allows certain subsidiaries of reporting companies to provide reduced disclosures in certain instances.  In announcing the adoption of the standard, the International Accounting Standards Board (IASB) noted that “Applying IFRS 19 will reduce the costs of preparing subsidiaries’ financial statements while maintaining the usefulness of the information for users of their financial statements.”  The IASB went on to explain that when a parent company prepares consolidated financial statements that comply with IFRS Accounting Standards, its subsidiaries are required to report to the parent using IFRS Accounting Standards. However, for their own financial statements, subsidiaries are permitted to use IFRS Accounting Standards, the IFRS for SMEs Accounting Standard or national accounting standards and this may mean that subsidiaries keep more than one set of accounting records and “provide disclosures that may be disproportionate to the information needs of their users.”  A subsidiary is eligible to apply IFRS 19 if it does not have equities or debt listed on a securities exchange or hold assets in a fiduciary capacity for third parties, and its parent company applies IFRS Accounting Standards in their consolidated financial statements.

Interaction with SEC rules:  The joint statement points out that there may be situations when financial statements that apply IFRS 19 are included in SEC filings.  In these instances, the Division Director and Chief Accountant noted that they believe that the requirements of IFRS 19 are likely to necessitate additional disclosures in financial statements filed with the SEC because such financial statements are intended for use by investors in the capital markets for making investment and voting decisions.

The joint statement acknowledges the IASB’s efforts to promote efficiency but highlights the need to maintain “decision-useful information for users of financial statements in certain contexts.”  The Division Director and Chief Accountant point to the requirement in IFRS 19 for entities to consider whether additional disclosures are necessary to provide an understanding of particular events or circumstances and observe that “disclosures that are fit for other purposes for entities without public accountability may not be sufficient to satisfy the needs of investors in the U.S. public securities markets.” 

See the full text of the statement.

Introduced under Title III of the JOBS Act, Regulation Crowdfunding (“Regulation CF”) was promulgated to allow startups and emerging companies to raise capital from a wider pool of investors through equity crowdfunding platforms.  Regulation Crowdfunding allows non-accredited investors to invest through these platforms.  Currently, a company may raise up to $5 million in a 12-month period. 

A study produced for the SEC’s Small Business Capital Formation Advisory Committee by Melody Chang, PhD, USC Marshall School of Business, reviewed crowdfunding data between May 2016 and December 2022.  The report, “Women and Minority-Owned Businesses in Regulation Crowdfunding,” noted that $1.4 billion in capital was raised in 5,969 offerings by 5,211 individual businesses.  Notably, during the COVID-19 pandemic, Regulation CF offerings increased to 1,133 deals in 2020 (a 62% increase year-over-year).

Number of Regulation CF Offerings & Amount Raised by Year

Source: SEC

Regulation CF Data

The median amount raised by Regulation CF deals was $115,250 in 2022.  However, Seed VC funding amounts overshadowed crowdfunding and all other funding alternatives, with a median $3 million raised per round.  Pre-seed VC funding raised a median $600,000 per round.  Angel investments were comparable to Regulation CF offerings raising a median $121,000 and $85,000 in seed and pre-seed rounds, respectively.

The report reviewed the offering structure of Regulation CF offerings.  Of the 5,969 deals, 77.9% were equity or equity-linked offerings, 15.6% were debt offerings, and 6.5% involved other securities.  Equity and equity-linked securities included common stock (27.4% of deals), limited/non-voting common stock (5.6%), preferred units (9.1%), simple agreements for future equity or “SAFEs” (27.8%), and convertible notes (8%).

Platforms

The study also looked at 101 active Regulation CF platforms during the study period, and of these, 39 had at least 10 crowdfunding offerings and 20 platforms had at least 20 crowdfunding offerings.   The study showed that the top two crowdfunding platforms accounted for 60% of all crowdfunding offerings, with 2,860 deals completed raising  approximately $857 million.

Participation by Women & Minority-Owned Businesses

The study noted that overall, women and underrepresented minority entrepreneurs have a higher chance of obtaining funding by participating in crowdfunding offerings compared to traditional funding sources.  The gender composition of the management teams of companies has shifted.  The share of companies with “all-female” management teams increased to 14.2% in 2022 from 9.6% in 2016.  In addition, “all-non-white” management teams increased from 11.4% in 2016 to 22.5% in 2022.  Of course, there are still significant disparities the study found.  For example, companies with “all-female” management receive 1.5-2 times lower funding than that of “all-male” management teams.  In addition, “all-non-white” management teams receive disproportionally less funding compared to “all-white” management teams.

Dr. Chang’s presentation and report provided policy recommendations that encourage the SEC to incentivize outreach to underrepresented entrepreneurs, reduce barriers to participation, address funding biases, and facilitate networking and mentorship.  The report emphasized the overlooked opportunities of women and underrepresented minority entrepreneurs, who are shown to often outperform yet face market undervaluation.

Read the report and Dr. Chang’s presentation for additional data and conclusions.