Remarks to the 2014 Mutual Funds and Investment Management Conference
Director, Division of Investment Management[*]
March 17, 2014
Thank you, Paul, for that kind introduction. Good morning everyone and before I begin, let me remind you that the views I express are my own and do not necessarily reflect the views of the Commission, any of the Commissioners, or any other colleague on the staff of the Commission.
It is great to be here in Florida, and an honor to give the keynote at the 2014 Mutual Funds and Investment Management Conference, East Coast edition. It is indeed strange to be within 10 miles of Disney World without my four kids. It may be better they’re not here as those of you who were in California last year will remember how sunburned I was after going to Disneyland in Anaheim.
The Division of Investment Management has tremendous personnel located in both Washington, DC and New York, and I am pleased to be joined at this conference by some of the Division’s most knowledgeable and talented staff including: Diane Blizzard, Associate Director of the Division’s Rulemaking office who will be appearing on the Regulatory Developments panel; Doug Scheidt, Associate Director and Chief Counsel will take part in the valuation trends discussion; and Jaime Eichen, Chief Accountant in the Division, will join with others to provide an accounting and auditing update.
It is truly a privilege to be before a group of individuals dedicated to serving the needs of American investors. The importance of mutual funds in the lives of American investors is clear. Mutual funds hold close to $15 trillion of the hard earned savings of over 56 million American households. The majority of Americans access the market- through mutual funds. They invest in funds, and hope their investments will grow, for many important reasons – like making a down payment on a house, saving for college, and most often, providing income for retirement.
The SEC’s mission in this landscape is clear. It is charged with protecting investors, ensuring fair and orderly markets, and promoting capital formation. Every one of us in the Division of Investment Management not only endeavors to fulfill this mandate, but also, through a Division-wide collaboration, we crafted a mission statement containing principles that tailor our regulatory efforts to the unique nature and importance of your industry. Nearly 200 staff, possessing a deep understanding and mastery of the more traditional work of the Division of Investment Management and an increasing expertise in specialized financial services, are committed to protecting investors, promoting informed investment decisions, and facilitating appropriate innovation in investment products and services through regulation of the asset management industry. I am impressed by the talent of the staff of the Division, and humbled by its tireless dedication to fulfill our mission through budgetary restraints and new mandates under the Dodd-Frank and JOBS Acts, and at the same time, conducting a thorough review of the Division’s processes and undertaking a number of changes based on that review.
Today, I will discuss this reorganization, and other developments within the Division, including some recent rulemaking initiatives and our efforts to provide more guidance to the investment management industry. Throughout these topics, I hope to emphasize two central themes: (i) The role of outside stakeholders and the Division in continued innovation that meets the changing needs of American investors; and (ii) The monitoring and management of risk in our industry. In my opinion, the interplay of these two concepts drives both the investment management industry and the Division’s oversight function.
The success of American mutual funds is truly amazing, and can be attributed to many factors. To me, this success is largely due to the ongoing applicability of a regulatory framework enacted nearly 75 years ago. This framework, while unbending in its core investor protection concepts such as mitigating conflicts of interest, has also proven flexible enough to permit the continued innovation required to meet the changing needs and demands of investors.
For example, I view the role of the investment management industry in meeting the shifting challenges of retirement stability for American investors as incredibly important. In the past, many Americans were able to rely on a combination of Social Security and company-sponsored defined benefit pension plans to provide for their retirement needs. Today, however, individuals are increasingly dependent on participant-directed vehicles, such as 401(k) plans, that make them not only responsible for accumulating sufficient assets for their retirement but also for constructing and managing their own retirement portfolios. I encourage certain efforts to assist investors in meeting this daunting challenge, including the innovation of funds designed to make it easier for investors to hold a diversified and rebalanced portfolio, and lower-cost funds with structural designs and fee structures that allow the investor to keep more of their hard earned assets invested and available for retirement.
As I encourage the industry to continue to innovate to meet the progressing demands of investors, the Division of Investment Management is working to become smarter, more strategic and more targeted in anticipating, identifying and monitoring the risks of the evolving investment landscape. We want to be a continuous improvement organization that constantly tests and adapts its processes and approaches; and not rely on the old standby that “we have always done it this way.”
In 2013, the Division undertook a process to better understand our key strengths and areas where we could improve. This process was designed to encourage a collaborative working environment, both internally and with outside stakeholders; to increase information and knowledge sharing; and to provide transparency in our work processes.
One of the most important initiatives resulting from this process has been the restructuring of the Division into four groups reflecting our key functions: (1) disclosure; (2) guidance by our Chief Counsel’s office; (3) rulemaking; and (4) business operations, which includes risk monitoring and analysis.
Among other important goals, the reorganization will ensure the continued cooperation of outside stakeholders and the Division that has been so critical to the development of innovative ideas. For example, the exemptive application process is a collaboration of the Commission, the staff and the investment management industry, and is a key process to “facilitate appropriate innovation,” consistent with the protection of investors. We view the exemptive application process as the laboratory where we examine and consider new ideas from market participants. I probably don’t need to remind you that it is through the exemptive application process that money market funds and exchange-traded funds were started. The overall importance of innovation is no better demonstrated than by recognizing the size and growth of these highly imaginative products. The new organizational structure has allowed the Division to devote greater resources to analyzing and reviewing exemptive applications. The new structure also provides the staff with an opportunity to work on a larger breadth of issues, which brings fresh approaches and ideas to all matters while offering the staff a chance to further their professional development. Our tremendous staff can help deploy their efforts better if they have this wider knowledge.
No discussion of this reorganization and our risk monitoring efforts would be complete without highlighting our newly created Risk and Examinations Office, or “REO.” REO is a multi-disciplinary office staffed with analysts with strong quantitative backgrounds, along with examiners, lawyers, and accountants. REO maintains an industry monitoring program that provides ongoing financial analysis of the investment management industry, with a particular focus on strategically important investment advisers and funds. The REO monitoring program’s work includes analysis of the information the industry provides through various regulatory reports, as well as industry information from third party providers, and has already shown results. The recent Enforcement action against Ambassador Capital Management that you may have seen in the press stemmed from REO’s ongoing analysis of money market fund data, in this case a review of the gross yield of funds as a marker of risk. In addition to financial analysis, REO conducts an examination program that gathers information from the investment management industry to inform the Division’s policy making. Although REO may conduct its own exams, where practical, REO will join examiners from the Office of Compliance Inspections and Examinations (“OCIE”) on their examinations of firms. REO’s work will inform the initiatives to which the Division devotes resources and will help inform the rules we recommend.
I am excited at the prospect that REO can help the staff to be proactive and get out in front of new industry risks, rather than reacting when unanticipated issues manifest to the detriment of investors.
I would like to turn now and discuss rulemaking, and explain a four factor approach to analyzing policy initiatives that we instituted last year.
The first factor in the analysis of policy initiatives within the Division involves a thorough review of the risk or risks to be mitigated by the proposed rulemaking. Protecting investors is the fundamental principle upon which the missions of the Commission and Division are built. Second, we consider the urgency associated with a particular initiative. Third, we analyze the potential impact of an initiative on investors, registrants, capital formation, efficient markets, and the Division’s and the Commission’s operational efficiency. And fourth, we review the available resources associated with a policy initiative or freed up by the initiative.
We’ve accomplished a great deal of rulemaking in the last year.
Last July the Commission adopted a new rule to implement a JOBS Act requirement to lift the ban on general solicitation and general advertising for certain offerings, including private fund offerings. On the same day, the Commission also proposed amendments that would require, among other things, issuers to provide the Commission with additional information about securities offerings in order to enhance the agency’s ability to evaluate the development of market practices in Rule 506 offerings. The comment period for these proposals closed on November 4. IM staff and our colleagues in the Division of Corporation Finance are currently reviewing and analyzing the more than 450 comments letters we have received to date which will help inform a recommendation to the Commission.
Money market mutual fund reform has been an important focus of the Division for some time, and it remains a key initiative for 2014. Last June, the Commission proposed additional money market mutual fund reforms, which were designed to address money market mutual funds’ susceptibility to heavy redemptions, improve their ability to manage and mitigate potential contagion from such redemptions, and increase the transparency of their risks while preserving, as much as possible, the benefits of money market funds.1
The Commission’s proposal included two alternatives that could be adopted alone or in combination. Under the first alternative, prime institutional money market funds would be required to transact at a floating net asset value, not at a $1.00 stable share price. Government and retail money market funds would be permitted to maintain a $1.00 stable share price. Under the second alternative, money market funds would continue to transact at a stable share price, but would be able to use liquidity fees and redemption gates in times of stress.
The staff is currently reviewing and analyzing the more than 1,400 letters that were submitted, with the intention of making a recommendation to the Commission. As Chair White has indicated, the rule is a critical priority for the Commission in the relatively near term of 2014.
Moving beyond money market funds, essential to the way we develop policy to mitigate risks is the ability for the Division and the Commission to identify and monitor risks. To this end, the staff is considering ways to improve the information we receive about other mutual funds, closed-end funds and ETFs. As a result, staff is undertaking an initiative to develop a recommendation that would modernize and streamline the information that funds are reporting to the Commission to give us more timely and useful information about fund operations and portfolio holdings. In pursuing this initiative, our goal is to not only improve the quality of the data we receive and to inform our efforts to monitor risk, but also to reduce unnecessary burdens by making the reporting regime workable with, or at least minimally disruptive to, a fund’s systems, eliminating duplicative filings, and addressing concerns about front-running.
As part of this project, we are considering recommending that the Commission propose substantial improvements to Form N-SAR. As part of this overhaul, we are aiming to preserve the most useful items in Form N-SAR, adding some others that we think would be particularly valuable, and eliminating those in the form that we’ve found to be less useful. Among issues under consideration is how frequently reports should be filed, and whether reports could be filed in a structured format, replacing the DOS filing that is currently required. As we pursue this rulemaking, we would like to partner with industry participants to get their perspective on the various filings currently required. We look forward to our collective work on this important initiative, which would be a big step forward for us as well as investors, the industry, and the public generally.
Reforming variable annuity disclosure is also a current policy initiative of the Division. Our efforts here are critical to improving communications about how these products are sold to seniors and others who are seeking ways to fund their retirement. The mutual fund summary prospectus offers a useful model for providing variable annuity disclosure. It is admittedly a challenge – and a very worthwhile one - to boil down long and complex disclosures about variable annuities into the key elements that investors need to know about the complexities and costs, as well as the benefits, of their investment.
Target date retirement funds are also on the rulemaking list for the Division. Target date funds are a prime example of an industry innovation developed to meet the incredibly important and shifting challenge of retirement stability to American investors. In addition to continued consideration of a proposed rule related to target date fund marketing materials and investor understanding of these products, we are preparing for the Commission’s consideration a request soliciting additional comment on standardized risk-based glide path illustrations for target date funds, as recommended by the Investor Advisory Committee.
Last December, the Commission, together with the banking regulators and the CFTC, adopted final rules2 implementing the provisions of the Dodd-Frank Act known as the Volcker Rule. 3 While working to prevent risks that can stem from proprietary trading and investments in private funds by banks, the Volcker Rule is also designed to maintain the strength and flexibility of the domestic capital markets.
The final rule reflects the collaborative efforts of the many financial regulators involved and of multiple divisions and offices within the Commission. As a further indication of this collaborative effort, and in light of the many market participants and regulators that Volcker touches, the Commission staff, along with staff from the banking regulators and the CFTC, continue to participate in interagency working group meetings so that staff from each of the agencies can communicate on a regular basis on questions from market participants, on technical issues, and on supervision and examination approaches.
The Volcker Rule was not the only recent example of regulatory coordination that required thoughtful joint action. We also worked with our fellow regulators at the CFTC on the “Identity Theft Red Flags Rules”, rules that require funds, broker-dealers, advisers and other regulated entities to adopt programs and guard against ID theft.4 These rules help to achieve important investor protection goals, particularly as the risk of identity theft has grown exponentially.
Lastly, we will continue to work on longstanding regulatory initiatives, including ETFs, and focus on the few remaining IM-specific Dodd-Frank mandated rulemakings, which involve removing references to credit ratings in our rules and the “say-on-pay” rulemaking addressing reporting of certain proxy votes by institutional investment managers. As you know, fulfilling Dodd-Frank legislative mandates is an important priority to the Chair.
One focus of the Division’s efforts in 2014 is to carry forward our recent practice of issuing staff Guidance Updates on a regular basis. Guidance Updates, which are available on the revamped IM Webpage, are a vehicle for enhancing our communications with the public and addressing a range of disclosure, regulatory, and compliance matters, by setting out the staff’s views on a particular matter in a timely and transparent way. The Division issued 14 Guidance Updates during 2013 and three so far in 2014.
As you may have seen, the Division’s Guidance Updates cover a broad variety of topics. We expect to continue issuing Guidance Updates when appropriate topics are identified and in continuation of our mission, and I encourage you to follow our web site for new postings. I would also encourage you to contact the staff if you have ideas about any investment management areas that would benefit from greater clarification, and if you would like to provide any further feedback regarding issued Guidance Updates. We hope that the Guidance Updates encourage a dialogue with the staff and we welcome input from all of our stakeholders, including investors, industry participants, and others.
We see Guidance Updates as helpful communications representing staff thinking on discrete issues, not as substitutes for the established rulemaking, exemptive application and No-Action processes. In a former life, I served as a General Counsel and Chief Compliance Officer and advised on investment management regulatory matters in both the in-house and outside counsel roles. In those roles, I found that guidance from the SEC and its staff was extremely beneficial in making the right calls and promoting a culture of compliance. I appreciate that interpretive ambiguity is costly; both in terms of time and money spent consulting with regulatory professionals, and can also have a dampening effect on progressing innovative ideas. We see the Guidance Update process as another avenue to remove uncertainty and enhance the public’s understanding of the staff’s view on critical issues to investors and the industry.
In addition to Guidance Updates, the staff issued over 30 no-action and interpretive letters in 2013 and responded to thousands of e-mail and phone questions from practitioners, the industry and the public.
In addition to enhancing the way the Division communicates with you, we are also seeking ways to inform the Division about industry developments and investors’ experiences. As part of this process, we have met with senior management at funds and advisory firms and fund boards. In these discussions, we have learned a great deal about the identification and management of risk – risks specific to certain firms, funds or products, as well as critical risks to the industry as a whole. These meetings allow us to obtain a first-hand view of the systems, controls, personnel, and even sense of culture of an individual firm. We will be better regulators to the extent that we better understand the workings of the industry we regulate.
One issue we have identified from a number of sources, including the discussions noted above with senior management at advisers, is the migration of individual investors from brokerage accounts to advisory accounts. We will continue to monitor this trend, with a keen interest in evaluating the impact of this migration on investors. Indeed, our colleagues in OCIE’s National Exam Program have indicated that as part of their examination priorities for 2014 that they will examine the significant risks to investors presented by dual registrants’ conflicts, including risks from migration of accounts for the purpose of generating fees with little benefit to clients. I think dual registrants should consider whether the recommendation to move from a brokerage account to an advisory account is consistent with fiduciary obligations and whether the move is in the client’s best interests.
Another issue we have identified through this engagement with senior management is the challenges that funds and investment advisers face concerning cyber security risk. I understand there is a panel discussion on this important topic here at this Conference, and the SEC is holding a cyber security roundtable later this month in which personnel from the Division will actively participate. The Division believes that funds and investment advisers should identify their respective obligations under the federal securities laws and assess the impact of a potential cyber attack on these obligations. For example, IM staff would expect that the compliance policies and procedures of investment advisers and funds would focus on Commission rules, such as Regulations S-P and S-ID, which address data protection and identity theft, including service provider oversight in these areas. Appropriate planning to address cyber security and a rapid response capability may assist funds and investment advisers in mitigating the impact of any such attacks and any related effects on fund investors and advisory clients, as well as complying with the federal securities laws.
Before finishing up today I would like to provide a few closing thoughts on the ideas of innovation and risk. First, my door is always open to discuss new and innovative ideas, but you must come ready to demonstrate the potential for the idea to provide clear benefits to investors. Ingenuity and creative solutions are the tools used to tackle the ever-changing needs and demands of investors, but they can also be self-serving, and provide benefits to the industry at the expense of investors. We must continue to be deserving of the trust that investors are clearly ascribing to the investment management industry.
As mentioned, one of our goals in the Division is to do more to monitor and manage risk and inform our policy initiatives with real-world, contemporary data and information. To this end, we are engaging the industry on a number of fronts. As Chair White mentioned in her speech at the recent SEC Speaks event, the Division is working on an “action plan” to expand our asset manager risk management oversight program. The initiative to modernize and streamline the information that funds are reporting to the Commission that I mentioned earlier is part of that action plan and REO also plays an important role.
Another important part of our risk monitoring efforts is a continued focus by our staff to stay on top of market events and to spot trends. For example, our staff works with registrants to determine potential impacts of market events, like the European debt crisis, on funds and investors. As another example, we recently issued a guidance update on the use of fund names suggesting safety or protection from loss after staff noticed an increase in the use of the term “protected” in fund names without any qualifications.
In addition to the REO examination program and the senior level engagement initiative discussed above, my staff has joined up with OCIE examiners in an ongoing nationwide initiative to review distribution fees and practices. This direct engagement allows the staff to see how the current regulatory landscape operates on the ground and get a sense of trends. Open communication and education are essential to crafting targeted policy responses, and in determining whether a regulatory response is warranted at all.
As my predecessor Buddy Donohue once said, while speaking at this conference in this very role, “we all have been handed a legacy.” We have indeed inherited a regulatory framework and a legacy of collaboration that is the foundation of an industry envied around the world. The responsibilities of anyone entrusted with the leadership of the Division of Investment Management include the preservation of this legacy, and to make the organization better than when they found it; an accomplishment that each of my predecessors have achieved. All of our efforts in the Division are to meet the goal of making the Division better, and I hope I have been able to convey a sense of the dynamism currently at work in the Division, and the serious commitment the staff of the Division has to the important work we do in the service of the investing public.
I encourage you to keep up our dialogue. Please continue to approach me and the staff with your thoughts for areas where our guidance may be helpful, and continue to develop the innovative ideas that will meet the new challenges faced by investors in the twenty first century.
Thank you very much.
[*] The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author’s views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.
 Money Market Fund Reform; Amendments to Form PF, Investment Company Act Release No. 30551 (June 5, 2013), 78 FR 36834-01, available at http://www.sec.gov/rules/proposed/2013/33-9408.pdf.
 Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds, Bank Holding Company Act Release No. 1 (December 10, 2013), available at http://www.sec.gov/rules/final/2013/bhca-1.pdf.
 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §619, 124 Stat. 1376, 1620 (2010) (codified at 12 U.S.C. §1851).
 Identity Theft Red Flags Rules, Investment Company Act Release No. 30456 (Apr. 10, 2013), 78 FR 23637 (Apr. 19, 2013), available at http://www.sec.gov/rules/final/2013/34-69359.pdf.