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(Article from Registered Funds Regulatory Update, January 2022)

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The Staff of the SEC released a statement reminding investment advisers and mutual funds of their obligations, including their fiduciary duties, when recommending securities linked to LIBOR or investment strategy recommendations involving other LIBOR-linked securities, including interest rate swaps, municipal securities or securitizations. In light of these obligations and the impending LIBOR transition, the Statement highlights the following issues for advisers and funds to consider.

• Client Recommendations: Advisers should consider whether any investment advice and risks related to LIBOR-linked securities are consistent with a client’s goals. Moreover, an adviser should consider whether any recommendation for any LIBOR-linked securities or any such securities being held by a client remains in the client’s best interests.
• Fallback Language: Advisers should consider whether LIBOR-linked investments or related contracts have “robust fallback language” providing for an alternative rate for when LIBOR ceases to be published. Furthermore, if such fallback language is referenced, the adviser should consider that the economic consequences that the alternative rate could cause the investment to depart from a client’s strategy or risk tolerance.
• Disclosure Obligations: Funds and business development companies should be mindful of their disclosure obligations with respect to LIBOR. Importantly, this disclosure should include the principal risks associated with such securities and the anticipated impact, as well as the anticipated timing of such impact, of the LIBOR transition, including with respect to volatility, valuation and liquidity.
• Valuation: Given that many funds use valuation measurements that use LIBOR inputs, advisers, funds and fund boards should be aware of any valuation risk and impacts to valuation inputs related to the LIBOR transition.
• Conflicts of Interest: Conflicts of interest associated with the LIBOR transition should be managed and monitored by the adviser. For example, the adviser should carefully consider its disclosure and other legal obligations relating to any performance fees that use a hurdle rate tied to LIBOR. In such circumstances, advisers should clearly disclose the impact of the transition and the fact that the transition to a new benchmark rate may make it easier for the adviser to earn a performance fee.
• Operational Challenges: The transition away from LIBOR could introduce operational complexities that may require significant changes to processes and systems. Advisers, funds and their services providers should prepare for the transition accordingly.

SEC Staff Statement on LIBOR Transition, Key Considerations for Market Participants (Dec. 7, 2021), available at https://www.sec.gov/news/statement/staff-statement-libor-transition-20211207.