Welcome to our February and March 2025 Regulatory Roundup, where we provide practical advice on the latest regulatory headlines. We start this issue with some clarifications about performance advertising under the SEC’s Marketing Rule and a new rule that requires Commission approval before the Division of Enforcement can use its full investigative powers.  Next, we review the SEC’s changes in its attitude toward crypto assets, indicating a more measured regulatory approach. Similarly, the Division of Corporate Finance relaxes the “general solicitation” Rule 506(c) under Regulation D, allowing issuers more leeway in determining whether investors are truly accredited.  Then we see the new U.S. President flexing his executive muscle by requiring a White House review of all new regulations. The Treasury Department backs off the beneficial ownership reporting requirements under the Corporate Transparency Act. We will also discuss how the SEC also took pity on institutional investment managers by granting a one-year exemption from reporting short sale data (Form SHO) – until February 17, 2026. Finally, we discuss a few of the latest SEC settlement orders. Enjoy!

SEC Eases up on Extracted Performance and Portfolio Characteristics in New Marketing Rule FAQs

Private fund managers received some welcome guidance as SEC staff issued two new FAQs on the Marketing Rule (Advisers Act Rule 206(4)-1) dealing with extracted performance and investment portfolio statistics.  Two new FAQs were issued on March 19, 2025, clarifying that firms do not have to use both gross and net performance in two instances: when showing extracted performance and when using portfolio and investment characteristics.

In one of the new FAQs, the staff discussed the use of “extracted performance” in advertisements, i.e., showing the performance of one or a group of investments from a fund or portfolio.  The plain language of the rule requires that if an adviser shows the gross performance of an extract, it must also show the net performance. The FAQ response allows extracted performance to be shown gross of fees, as long as it is accompanied by a presentation of the total portfolio’s gross and net performance, with at least equal prominence, consistent with the requirements of the Marketing Rule.

The second FAQ addresses the presentation of certain portfolio characteristics, and whether they should be considered “performance” under the rule, requiring both gross and net presentations.  Many firms objected to this broad interpretation of performance, noting that even if it would be possible to calculate these characteristics both gross and net of fees, the results would be misleading. For example, certain characteristics such as yield, coupon rate, contribution to return, volatility, sector returns, geographic returns, attribution analysis, and Sharpe and Sortino ratios are commonly used by private fund managers as part of a fund’s overall performance. Instead of clarifying which characteristics are considered performance, the staff provided a safe harbor.  Advisers that display the gross and net performance of the total portfolio calculated as required by the Marketing Rule, along with appropriate disclosure about characteristics presented and how they are calculated, will comply with the rule. If those conditions are met, the staff felt that “there is little risk that prospective clients and prospective investors will be misled about the impact of fees and expenses on their returns when viewing such a characteristic.”   

The staff noted, however, that the “positions stated herein do not apply to total return, time-weighted return, return on investment (RoI), internal rate of return (IRR), multiple on invested capital (MOIC), or Total Value to Paid in Capital (TVPI), regardless of how such metrics are labelled in the advertisement.  Whether a presentation of a characteristic in an advertisement is subject to Rule 206(4)-1(d) depends on whether such characteristic is performance.”

One other note of caution: These clarifications do not change the general prohibitions of the Marketing Rule, so advisers must still ensure that their performance advertisements are presented in a fair and balanced manner and are not materially misleading. 

SEC Limits Enforcement’s Investigation Power 

The Commission issued a final rule that eliminates the Director of the Division of Enforcement’s authority to issue formal orders of investigation. A formal order of investigation must be issued before Enforcement staff can subpoena testimony or documents. This final rule rescinds a 2009 rule that allowed the SEC’s Director of Enforcement and other senior officers of that Division to issue formal orders of investigation. This change will now require the Commission to approve a formal order of investigation before Enforcement staff use its full investigative powers.

By way of background, before 2009, Enforcement staff conducted informal investigations on a voluntary basis before a formal investigation against a firm would be launched.  The information was then shared with the Commission at an early stage, and the Commission would have the final say about which cases merited a formal investigation.     

SEC Warms Up to Digital Assets

SEC Ends Investigations Against Crypto Firms to Focus on Regulation

As Acting SEC Chairman Mark T. Uyeda recently stated, “It’s time for the Commission to rectify its approach and develop crypto policy in a more transparent manner.” One of the first steps was the creation of a Crypto Task Force headed by Commissioner Hester Peirce, to provide “workable solutions to difficult crypto regulatory problems.” Following on the heels of that announcement, the SEC reported that it would dismiss the ongoing civil enforcement action against Coinbase Inc and Coinbase Global Inc. without any penalties.  Other news outlets have reported that the SEC has ended its investigation against Kraken, Consensys, the Tron Foundation, Gemini, OpenSea, and Uniswap.

 What does it all “meme”?

In related news, the SEC’s Division of Corporate Finance released its views of “meme coins”,  stating that they are not considered securities under federal securities laws and do not require SEC registration.  As defined in the release, “a ‘meme coin’ is a type of crypto asset inspired by internet memes, characters, current events, or trends for which the promoter seeks to attract an enthusiastic online community to purchase the meme coin and engage in its trading.”  That may be good news for sellers, but meme coin buyers will not be protected by federal securities laws. 

The Division based its analysis on the traditional “investment contract” test from SEC v W.J. Howey Co. (328 U.S. 293 (1946)), more commonly known as the “Howey Test”.  The Howey test concludes that an investment contract, and therefore a security, exists when there is an investment in an enterprise with a “reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.” The Division noted that meme coin purchasers are not investing in an enterprise, since their funds are not pooled together to be deployed by the promoters of others.  Second, profits from meme coins are based not on the efforts of others, but from speculative trading and the “collective sentiment of the market.”  

Of course, simply calling something a meme coin is not enough to avoid registration, since the staff of the Division of Corporate Finance will continue to focus on the “economic realities of a particular transaction. 

Creation of Cyber and Emerging Technologies Unit (CETU)

The SEC announced the creation of a new Cyber and Emerging Technologies Unit,(CETU) to “focus on combatting cyber-related misconduct and to protect retail investors from bad actors in the emerging technologies space.” The new unit replaced the Cyber Unit formed in 2017. This new unit’s priorities include combating fraud committed using emerging technologies, such as artificial intelligence and machine learning, use of social media to perpetrate fraud, hacking to obtain material nonpublic information, takeovers of retail brokerage accounts, use of blockchain technology and crypto assets to commit fraud, compliance with cybersecurity rules and regulations, and fraudulent disclosures relating to cybersecurity.  These focus areas are not all that different from those of the original Cyber Unit (see SEC press release), established during President Trump’s first term.  In 2022, then SEC Chair Gary Gensler expanded the Cyber Unit from 30 to 50 positions and renamed it the “Crypto Assets and Cyber Unit”.  CETU, however, has only 30 positions.

Although only time will tell, this rebranding may be the SEC’s way of looking beyond crypto and instead focus on overseeing emerging technologies and their effect on the securities market. It may also indicate a greater focus on ferreting out fraudulent activity that affects retail investors, as opposed to the “regulation by enforcement” approach by the prior administration.

SEC Makes Private Placements Easier under Rule 506(c)

Back in 2013, Rule 506(c) under Regulation D was issued, which allows private placement issuers to use “general solicitation” to raise money from qualified investors. To take advantage of this rule, however, all fund investors must be accredited and the issuer must “take reasonable steps” to verify the investor’s accredited status. Rule 506(c)(2)(ii) provides a nonexclusive list of four methods for reasonable verification, including reviewing tax returns, bank statements and consumer reports, or receiving confirmation from an attorney, certified public accountant or investment adviser that has used such methods to confirm the investor’s status. Understandably, investors have been reluctant to participate in this verification process, since they do not like to share such sensitive personal information with the issuer. Moreover, issuers do not necessarily want to take on the liability for reviewing the documentation and making the accredited investor determination. Ultimately, the Rule 506(c) exemption has not been very popular with issuers.  

Now this may change.  The SEC’s Division of Corporate Finance issued a no-action letter on March 12, 2025, that opens the door for more issuers to take advantage of Rule 506(c).  The SEC said that the “reasonable steps” for verification can now include:

• A high minimum investment (at least $200,000 for natural persons and at least $1 million for legal entities)
• Written representations from the investor confirming that it is an accredited investor and has not financed the investment through a third party
• No actual knowledge by the issuer that the investor (i) is not an accredited investor, or (ii) has financed the investment

Executive Order Requires White House Oversight of New Regulations

On Feb. 18, Trump issued an executive order (Ensuring Accountability for All Agencies Executive Order, or “the Order”)) applicable to independent agencies like the SEC, which says that draft regulations must be submitted to the White House for review before publication and that the agencies must consult with the Trump administration on their priorities and strategic plans.  The Order requires the independent agencies to submit major regulations to the White House for review and approval and further grants the President and the Attorney General the final say in interpreting the laws.  The Order also authorizes the Director of the Office of Management and Budget to review the independent regulatory agencies’ obligations for “consistency with the President’s policies and priorities.”   The OMB is also granted the power to control spending by the independent regulatory agencies, if such spending is inconsistent with the President’s policies. 

By inserting another layer of government review, this Order will undoubtedly slow down the rule-making process. Expect to see the Order challenged in court.

Let’s Try this Again – Treasury Department Backs Off Beneficial Ownership Reporting Requirements

The Treasury Department announced an “interim final rule” on the beneficial ownership information reporting requirements (“BOI Rule”) of the Corporate Transparency Act (the “CTA”). By way of background, the BOI Rule requires reporting companies to report information about their beneficial ownership to a national corporate registry. After some whiplash-inducing legal maneuvers, FinCEN removed BOI reporting requirements for U.S. companies and U.S. persons. As discussed in FinCEN’s press release, “[f]oreign entities that meet the new definition of a “reporting company” and do not qualify for an exemption from the reporting requirements must report their BOI to FinCEN under new deadlines…” Foreign entities, however, are not required to report any U.S. persons as beneficial owners and U.S. persons are not required to report their beneficial ownership of foreign entities.

According to FinCEN, existing foreign companies that must report their beneficial ownership information have at least an additional 30 days from the date of publication of the interim final rule.  FinCEN will accept comments on the March 21 Rule for 60 days and intends to issue a final rule this year.

One-Year Reprieve from Rule 13f-2 Filings Obligations

On February 7, 2025, the SEC issued a temporary exemption from compliance with Rule 13f-2 under the Securities Exchange Act of 1934 (the “Exchange Act”) and the requirement to file Form SHO from February 14, 2025 to February 17, 2026 for the January 2026 reporting period. Rule 13f-2 and related Form SHO impose new short sale reporting obligations for institutional investment managers. Industry participants asked the commission for extra time to comply, citing challenges “in completing implementation of system builds and testing for Form SHO reporting pending finalization and publication of the Form SHO XML technical specifications, which the Commission published on December 16, 2024.”  Apparently, the SEC was sympathetic and agreed to the one-year extension.

The rule applies to institutional investment managers, defined as “any person, other than a natural person, investing in or buying and selling securities for its own account, and any person exercising discretion with respect to the account of any other person.” This extremely broad definition can include broker-dealers, investment advisers (both registered and unregistered), banks, insurance companies, pension funds and corporations. The SEC is using the same definition of “institutional investment manager” as used for Schedule 13F filers.

What must be reported and when?

Institutional investment managers are required to file Form SHO via EDGAR within 14 calendar days after the end of each month that they meet any of the following thresholds (for all accounts over which they have investment discretion):

Threshold A (Short Position in a Reporting Issuer):

• An institutional investment manager holds a monthly average gross short position of at least $10 million in the security at the close of regular trading hours
• An institutional investment manager holds a monthly average gross short position equal to 2.5 percent or more of the issuer’s total outstanding equity securities

Threshold B (Short Position in a Non-Reporting Issuer):

• An institutional investment manager holds a gross short position of $500,000 or more in equity securities at the close of regular trading hours on any settlement date during the calendar month

The filings made on Form SHO are confidential.

According to the SEC’s fact sheet, institutional investment managers will be required to report the following on Form SHO:

• Their end-of-month gross short position in the equity security at the close of regular trading hours on the last settlement date of the calendar month
• Detailed information about the institutional investment manager’s “net” activity in the reported equity security, including activity in derivatives such as options.

Form SHO also requires disclosure of the settlement date, issuer name, issuer Legal Entity Identifier (LEI), title of class, CUSIP number, and Financial Instrument Global Identifier (FIGI) (if assigned).

What securities are covered?

Rule 13f-2’s definition of equity securities is broader than those required to report on Schedule 13F. “Equity securities” under this rule include common and preferred stock and securities that are convertible, exercisable, or exchangeable for equity securities. Rule 13f-2 also covers equity securities of privately-held companies and equity securities of companies that are only traded outside of the United States. Institutional investment managers can exclude short positions established through derivatives and securities held by an ETF for short positions in that ETF from their calculations.

The definition of “equity securities” under the rule is defined as “each equity security that is of a class of securities that is registered pursuant to section 12 of the Exchange Act or for which the issuer of that class of securities is required to file reports pursuant to section 15(d) of the Exchange Act.” Fixed income securities are not subject to the reporting requirements.

SEC Charges RIA with Breaching Fiduciary Duties to Clients for Account Conversions

The first investment adviser enforcement action under the Acting Commission Mark Uyeda seemed like a blast from the past with charges of fraud and harm to retail investors. The case involved a registered investment adviser (the “Adviser”) and one of its investment adviser representatives (the “IAR”).  The IAR convinced his elderly, long-term customers from his prior firm, a broker-dealer, to convert their brokerage accounts to advisory accounts and his new employer, the Adviser.  Unfortunately for the IAR’s clients, the change from brokerage to advisory accounts resulted in significantly higher fees for them and increased compensation for the IAR. Moreover, the IAR failed to (i) provide these clients with appropriate disclosures, such as the Adviser’s brochure (Form ADV Part 2A), (ii) conduct meaningful reviews of client accounts, or (iii) consider whether the conversion to an advisory account was in the best interests of each client.  The Adviser also failed to meet certain of its compliance obligations, such as providing a firm brochure (Form ADV Part 2A), and getting signed advisory agreements from the new clients.

With hindsight, it is easy to see how this could have happened.  The IAR had been a registered representative of a broker-dealer for many years and, despite having taken a Series 65 exam, he did not fully comprehend the effect that switching his clients from brokerage accounts to advisory accounts would have. Investment advisers have fiduciary obligations to act in the best interest of their clients, while broker-dealers are only required to provide suitable recommendations and engage in fair dealing. Therefore, when the IAR started working for the Adviser, he couldn’t just move his clients’ assets over and manage them in the same way. He had a fiduciary duty to disclose his conflict of interest to his clients– specifically, that they would be paying higher fees for essentially the same services and that he would be receiving more compensation. Moreover, he also had a duty to advise clients about which type of account would be best for them. While these accounts were being managed at the brokerage firm, they had relatively low trading activity and low fees. By converting these accounts to advisory accounts, the IAR’s clients were paying more but were not receiving any additional services to justify this increase.

Ultimately the Adviser had to pay a $150,000 fine, retain an independent compliance consultant to help improve its compliance policies and procedures, and make the clients whose accounts were converted whole. The IAR was suspended for nine months and required to pay a $75,000 fine.  

Only time will tell whether this case signals that the SEC’s enforcement program will pursue more traditional cases, focusing on fraud, harm to retail investors, and holding individuals accountable for wrongdoing.  

Private Fund Adviser Fails to Identify Conflicts and Misappropriation

There are a lot of SEC settlement orders dealing with advisers that steal from their clients, and generally, we do not discuss them because there is little to be learned aside from “do not commit fraud or steal from your clients.” Instead, we focus on cases where we can learn from the mistakes of others.  A recent settlement order involves a little of both, where an adviser’s principal used client assets to fund personal expenses that might have been prevented by better risk and conflicts identification.

In this case, the Chief Operating Officer of the Adviser (“COO”) and another firm principal (a managing partner, (the “Partner”) created a private fund (the “Fund”) to purchase and develop franchise businesses, using the Adviser’s clients’ assets. The COO was involved in managing the portfolio companies in the Fund and used cash from those companies to pay her personal expenses. Additionally, the COO and the Partner also owned an entity that sold its interests in two portfolio companies to the Fund. The purchase price included paying off those companies’ debts, resulting in an unearned benefit to that entity since it should have paid a portion of that debt. The Adviser also violated the Custody Rule by failing to have independent public accountants perform financial audits of the financial statements annually and send those statements to investors in the Fund.

So, what can other firms learn from this case? First, as part of establishing a compliance program to meet the requirements of Rule 206(4)-7 of the Advisers Act, advisers should inventory the risks specific to their operations and implement policies and procedures to address those risks. In this case, the SEC pointed out that there was no review or oversight of expenses charged to the portfolio companies. This allowed the COO to use portfolio fund money to pay her personal expenses.  The SEC also charged the COO personally for her misappropriation of assets from the portfolio companies.  

Second, the SEC also went after the Partner for “failure to supervise” since he was responsible for overseeing the COO. The Commission pointed out several red flags that the Partner, as the COO’s supervisor, should have investigated. Even after the COO told the Partner that she had mistakenly used portfolio company funds to pay her personal expenses, he did not implement any additional controls or oversight, which allowed the COO to continue stealing funds. The Partner’s failure to respond to the red flags appears to have been the nail in his coffin.  Even if your firm does not initially identify a risk, failure to investigate anomalies, especially those that negatively impact investors, can lead to SEC sanctions.  In this case, the Partner was personally fined $80,000 and banned from acting in a supervisory capacity in the securities industry for a year. The COO was permanently barred and fined $200,000.

Finally, both the COO and the Partner had ownership interests in portfolio companies that were sold to the Fund.  In fact, the Partner helped negotiate the sale of two portfolio companies to the Fund. Despite this clear conflict of interest, the settlement cases do not indicate that the Adviser took any steps to mitigate this conflict of interest. 

The broader view from this case is that the SEC continues its focus on private fund expenses. Additionally, like the case cited above, the SEC wants to make individuals accountable for actions that harm investors.     

Photo by Charles Gao on Unsplash

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