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IM Director Reflects on Recent Events

Last week, the director of the SEC’s Division of Investment Management, David Grim, outlined the recent rulemakings that would affect funds.  In the same speech, he reflected on some recent events that impacted the fund industry – the suspension of redemptions by the Third Avenue Focused Credit Fund and the computer outage last August that disrupted the ability of hundreds of funds to calculate their daily net asset values.

With respect to the Focused Credit Fund, Grim stated that the staff was reviewing the events to “distill the lessons that can be learned.”  While the staff’s efforts are still ongoing, he shared his initial thoughts on the event.  He encouraged any fund that is considering suspending redemptions to approach the Division as soon as possible because, in his view, “investors fare best when a fund facing acute liquidity pressures brings the Division into the conversation at the earliest possible juncture.”  In addition, Grim stated that, assuming certain assets are too illiquid to be held in large amounts by open-end funds, “certain investment strategies—such as those focused heavily on distressed debt—may be more suitable as closed-end or private funds, rather than as funds that are subject to daily redeemability.”  He encouraged fund management and boards to consider the issue carefully – and recommended that funds “implement robust policies and procedures to ensure that their investment strategies are appropriate for an open-end structure, both at a fund’s inception and throughout the life of a fund.”   Grim also highlighted aspects of the Commission’s liquidity risk management proposal that he felt could enhance the ability of funds to manage liquidity risks, including the uniform factors that funds would use to assess liquidity risk, the required written program to assess and manage the risks, a fund board’s “added layer of objective oversight to management’s determinations,” and more access by the Commission staff and investors to information about a fund’s liquidity profile.    

Grim also discussed issues that may arise as a result of funds’ increasing reliance on third party service providers for daily operations.  He used the outage at a service provider last August that prevented it from calculating net asset values of hundreds of funds “to illustrate the importance of mitigating operational risk, particularly through proper business continuity planning.”  He identified several lessons that could be drawn from the event, including:

  • The importance of robust initial and ongoing due diligence of third party service providers, particularly those responsible for critical functions.  He stated that the due diligence should consider “the robustness of such vendors’ business continuity plans, including how they intend to maintain operations during a significant business disruption.”
  • How the fund complex will monitor when a service provider experiences a significant disruption, how that service interruption might impact the fund’s operations and its investors, and “the communication protocols and steps that may be necessary to successfully navigate such events.”
  • That a fund should consider developing a “detailed playbook” outlining how it will respond to a disruption, because “once a crisis strikes, it is already too late to being formulating a response.”