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Shutdown puts regulatory action in fog of uncertainty for industry

Gail Bernstein believes SEC reforms could lose momentum because of the shutdown.

With the partial government shutdown now in its fifth week, "uncertainty" is the key word for many investors and retirement industry stakeholders seeking information from affected federal agencies.

Industry sources are uncertain whether the Securities and Exchange Commission will have to alter its rule-making timeline, including its much discussed standards of conduct package.

Hopeful firms don't know when employees at the SEC will sign off on their applications to become registered investment advisers, as only a limited number of the agency's employees are working.

Foreign investors looking to invest in U.S. businesses that could be seen to present a national security concern are facing a similar state of limbo. Those investments are now subject to review by the Committee on Foreign Investment in the United States, which is part of the Department of Treasury and not fully staffed.

And for the roughly 800,000 federal workers who don't know when their next paycheck will arrive, there's a whole different level of uncertainty.


For furloughed federal employees who already missed one paycheck and may soon miss another, the financial situation is precarious. According to Federal Retirement Thrift Investment Board data, the number of hardship withdrawals federal workers have made from their retirement accounts has increased since the shutdown began.

There were 7,055 hardship withdrawals from Dec. 26, 2018, to Jan. 14, 2019, data shows. That's up from 5,249 such withdrawals over the same period a year earlier.

Kim Weaver, spokeswoman for the $553.8 billion Thrift Savings Plan, said in an email that it's too early to know for sure if a rise in hardship withdrawals is due to the shutdown, and noted that the number of plan participants has risen to about 5.5 million as of Dec. 31, 2018, up more than 330,000 since the end of 2017. Also, Ms. Weaver said the IRS is still allowing hardship withdrawals for several natural disasters "so we can't isolate those."

Economic impact

The longer the shutdown lasts, the greater its negative impact will have on the U.S. economy, according to a report from Moody's Investors Service published on Jan. 9. If it lasts until the end of January, Moody's estimates U.S. economic output could be reduced by $8.7 billion, or 0.2% of 2019 first-quarter annualized growth. The effect will be more pronounced if it stretches into February and "exacerbates recent softness in business and consumer confidence or triggers an adverse reaction by financial markets," Moody's wrote.

Moreover, if the shutdown continues, "liquidity strains are likely to emerge for some entities reliant on federal monies for revenue or debt servicing, such as certain municipal bond issuers and defense services contractors," Moody's added.

On Jan. 16, Rep. Richard Neal, D-Mass., chairman of the House Ways and Means Committee, invited Treasury Secretary Steven Mnuchin to appear before the committee on Jan. 24 to provide testimony regarding the shutdown's impact.

SEC questions

Most SEC employees are furloughed. In the agency's shutdown plan posted on its website, it said "all non-emergency rule-making, non-emergency interpretive advice, staff no-action letters, and processing new or pending applications for exemptive relief" will be halted during the shutdown.

That could lead to a delay in the SEC's rule-making agenda, Gail Bernstein, general counsel for the Investment Adviser Association, said in an email. "The agency will need to play catch-up once it gets back to work and, at the very least, rule-making initiatives will probably have lost some momentum," she said.

The SEC has a host of proposed rules currently under consideration, including the standards of conduct package, also known as Regulation Best Interest, that's slated to be finalized by September. The proposal has three legs: the best-interest standard, which compels brokers to put clients' financial interests ahead of their own and requires them to mitigate financial conflicts; the client relationship summary, or Form CRS, which necessitates that firms disclose to retail investors the nature and scope of their services, the types of fees incurred, conflicts of interest faced by the firm and the firm's disciplinary history; and a proposed standard of conduct for investment advisers that requires them to act and provide advice that is in the best interest of the client.

Ms. Bernstein said whether the package gets delayed depends on "how close it was to going out the door at the time of the shutdown. If it was close to ready, the shutdown likely won't derail it."

David G. Tittsworth, a Washington-based lawyer at Ropes & Gray LLP, said the SEC's rule-making operation is losing at least a month and likely will cause timelines to slide, although there are no exact deadlines that must be met.

"It is disruptive," Mr. Tittsworth said of the shutdown. "It isn't like at these agencies, once the shutdown is over, that you walk in the door and nothing has changed. It takes a little time for them to get back up and running."

Clients who have filed applications with the SEC to become registered investment advisers, like private equity firms and hedge fund managers, also don't know where they stand, Mr. Tittsworth said. Since the SEC isn't currently reviewing applications, those applicants would be taking a risk in launching their operations before the shutdown is over. "It just puts people in a really difficult situation."

There's also uncertainty for some businesses planning to go public through an initial public offering. For those that have largely completed the SEC review process, the process should be straightforward once the SEC staff to return to work, according to Andrew L. Fabens, New York-based co-chair of Gibson, Dunn & Crutcher LLP's capital markets practice. But those that are in the beginning stages of an IPO filing are subject to the staff working through a growing backlog, he added. Private equity general partners seeking to use an IPO to exit investments will also face a delay.

Foreign investments

CFIUS is in the early stages of an 18-month pilot program of broader jurisdiction to review foreign investment in U.S. businesses that could present national security risks. But as of now, the committee isn't reviewing any deals, said Richard L. Matheny III, a partner and head of global trade at Goodwin Procter LLP in Washington.

There's now a degree of uncertainty surrounding transactions that need CFIUS approval and parties should expect delays even when the committee is fully operational, Mr. Matheny said. "Once it does (reopen) we can expect an even longer review period just given the substantial backlog that's accumulating," he added.

Following the passage of the Foreign Investment Risk Review Modernization Act of 2018 last summer, a pilot program launched on Nov. 10 that grants CFIUS the ability to review certain non-control foreign investments in U.S. businesses that both engage with certain "critical technologies" and operate in or develop products for one or more of 27 specifically identified U.S. industries.

Mr. Matheny expects some transactions, including private equity-led deals, that require CFIUS approval could fall apart because of the shutdown. The delay could become "intolerable" for some parties and could cause a deal "to crater," he added.

While on the phone with Pensions & Investments on Jan. 16, Mr. Matheny received an automated message saying CFIUS wouldn't be able to review a declaration submitted on behalf of a client earlier that day because of a lapse in appropriations. For prospective deals that fall within the pilot program's jurisdiction, there's a 45-day pre-investment declaration requirement, which presents further uncertainty.

"Parties are going to be in the position of saying we met the affirmative requirement, but if you close the transaction you still have the possibility that CFIUS, once it does come around to reviewing the declaration, could ask for the filing of a notice and you could still have your transaction impacted once it's ultimately reviewed," he explained.

But some companies may not be able to wait. "They may be in a position where they're trying to avoid bankruptcy and need investment in order to stay open," he said. "It becomes an existential question for some companies."