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In Wake of Archegos Blowup, Will SEC Overstep?

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What You Need to Know

  • Family offices like Archegos are exempt from the disclosure rules that apply to other types of investment advisors.
  • Expect to see more SEC actions around Form 13F and Schedule 13D, which Archegos didn't have to file.
  • The Dodd-Frank statute that authorizes fund advisor registration puts limits on the SEC.

The most common reactions to the news of Archegos Capital Management’s unraveling last month were variations of “Archegos who?” and “Where are Archegos’ SEC disclosures?”

The absence of any meaningful publicly available information about Archegos or its holdings highlights the fact that not all transactions and advisor roles require public disclosure.

Most commentary on the Archegos situation has called for greater disclosure, which may cause the Securities and Exchange Commission to try to compel that disclosure in ways that exceed its authority.

You will not find an Archegos Form ADV.

Among many other things, Dodd-Frank empowered the SEC to require registration of fund advisors. But Dodd-Frank also instructed the SEC to carve out “family offices” and exempt them from the registration requirement. In 2011, the SEC adopted a rule defining “family office” and excluding them from the requirement to register with the SEC so long as they met certain requirements.

Archegos is reportedly a family office, thus there is no SEC Form ADV that would disclose information other types of investment advisors must disclose.

Similarly, broker-dealers do not normally have to treat family offices as “retail customers” for purposes of Regulation Best Interest or as “retail investors” for Form CRS requirements.

We should expect Archegos to give rise to greater SEC scrutiny of family offices and proposals for tightening the definitions and exceptions that apply to family office disclosure.

However, Congress included the hedge fund advisor registration requirement in Dodd-Frank because the SEC had for years acted without any statutory authorization in requiring such registration and only stopped requiring registration when a federal appellate court famously struck down the policy as a result of a challenge by Phil Goldstein of Bulldog Investors.

It turned out Congress had never authorized the SEC to impose the fund advisor registration rule in the first place.

While Dodd-Frank ultimately provided the SEC with that authorization, the statute’s limitations should give the SEC pause before attempting to shrink the family office registration exemption in reaction to Archegos.

You will not find an Archegos Form 13F.

For decades, the SEC has required certain institutional investment managers to file a Form 13F, disclosing the names, shares, and fair market value of certain securities over which the managers exercise control.

The purpose for requiring this disclosure is to promote competition and decrease market volatility, but because the information can be valuable, the disclosure requirement has been met with resistance over the years in the form of court challenges and requests for exemption.

Even if Archegos qualified for the advisor registration exemption as a family office, that does not necessarily exempt Archegos from disclosing its securities holdings on Form 13F.

For one thing, “institutional investment manager” for purposes of Form 13F disclosure is much broader than the definition of “investment advisor” for purposes of advisor registration. For another, and this seems most relevant to Archegos, only holdings of a very specific list of securities published by the SEC must be disclosed — and only to the extent the manager exercises investment discretion over $100 million of those securities.

Early reports suggested that Archegos owned total return swaps, which are not on the list of securities required to be disclosed on Form 13F.

Later reports suggested that Archegos owned equities in sufficient amounts that, barring the application of some other exemption, should have been disclosed on a Form 13F.

While the SEC investigation may yield information showing Archegos should have filed a Form 13F, plenty of perfectly plausible scenarios under the byzantine 13F disclosure requirements may explain the absence of a filing.

Expect to see more SEC enforcement actions regarding failure to file Form 13F and calls for expanding existing Form 13F disclosure requirements. SEC expansion of 13F disclosure may push the requirement beyond what is legally permissible.

You will not find an Archegos Schedule 13D.

Oversimplifying, a person who acquires beneficial ownership of more than 5% of a company’s securities normally is required to file a Schedule 13D.

If in fact Archegos primarily held total return swaps — even if those swaps related to more than 5% of a company’s securities — a regulatory quagmire may explain the absence of Archegos Schedule 13D filings.

A landmark case over whether swaps are required to be disclosed came to a head in a federal appellate court in 2011 just as Dodd-Frank empowered the SEC to promulgate rules clarifying the issue.

At the time, the SEC recognized that “the use of security-based swaps has not been frequently disclosed in Schedule 13D” filings, but in 2011 the Commission merely readopted existing rules on the subject, maintaining the status quo.

In December 2019, the SEC finalized Dodd-Frank rules for security-based swaps, and the rules will take effect later this year.

Expect to see an increase in SEC actions involving Schedule 13D in the family office context, in the swaps context, or both. As with the other probable SEC reactions to Archegos, expect court challenges to the SEC’s authority to expand or apply the concept of “beneficial ownership” to compel disclosure.

Archegos has not changed the terms of existing debates over the wisdom of or authority for the SEC to compel more disclosure in various corners of the market, but Archegos may accelerate those debates and cause the SEC to push the limits of its authority.