SEC Exam Staff Issues LIBOR Transition Risk Alert for Investment Advisers and Investment Companies

On May 11, the Securities and Exchange Commission’s (SEC) Division of Examinations published a Risk Alert on the results of a series of examinations that the division conducted to assess investment advisers’ and investment companies’ (“firms”) preparedness for LIBOR cessation (scheduled to be discontinued after June 30, 2023). The Risk Alert is intended to remind firms about the transition and discusses certain practices firms have implemented to address the transition. Firms could use the Risk Alert as a tool to compare their current LIBOR transition practices with those noted by division staff in the Risk Alert.

Two LIBOR transition practices that the staff noted relate to other areas of regulatory focus for the SEC and its staff, namely oversight of service providers (see SEC 2022 rule proposal under the Investment Advisers Act of 1940) and conflicts of interest (see, e.g., SEC Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Conflicts of Interest):

1. Outsourcing/Oversight – The staff noted that firms have actively engaged with service providers, sub-advisers, and third-party managers and have planned their level of engagement with service providers, sub-advisers, and third-party managers according to the importance of that entity to the firm’s business or the level of exposure at that entity. The staff pointed out that many firms extensively worked with fund administrators and pricing or data providers to understand their transition readiness and commonly used due diligence questionnaires to gauge transition readiness at sub-advisers and third-party managers. Regarding fiduciary duty, the staff noted that advisers with indirect client exposure typically appeared to manage exposure through due diligence on third-party fund managers concerning their transition readiness.
2. Conflicts of Interest – Although the staff has mentioned conflicts of interest relative to the LIBOR transition in the past, in this Risk Alert, the staff provided more specific examples, namely cross and principal trades (i.e., trades made in the course of transition management), allocation of transition costs, and clients with conflicting priorities in connection with the transition.