Speech of Commissioner Norman Johnson Investment Company Institute December 3, 1996 Washington, D.C. * The views I express herein are my own and do not necessarily express the views of the Commission or any individual Commissioner or of the staff Thank you very much. I am very pleased to be here with you this afternoon as you confer on the many important mutual fund regulatory issues facing the Commission and the industry. Conferences such as this are important in helping us better understand your industry and helping you understand the Commission's concerns and processes. This afternoon I would like to discuss with you what I consider one of the most important accomplishments of any Congress in recent years in the area of securities regulation-- The National Securities Markets Improvement Act of 1996 (the "Improvement Act"). The Improvement Act fundamentally alters the way the securities industry is regulated in the United State by more rationally allocating responsibilities between the states and the Commission. In recognition that the market for the sale of mutual fund shares is a national market, Congress has appropriately preempted state Blue Sky laws in this area. The leadership of Chairman Fields, Representatives Bliley and Markey, and Senators Gramm and D'Amato was key in persuading the Congress to take this bold step, and they deserve a great deal of credit. I also salute Chairman Levitt, who had foresight and courage in calling for preemption of state mutual fund regulation in a 1995 speech to North American Securities Administrators Association ("NASAA") in Vancouver. But today I would like to focus on a more complex and, in some ways, a more interesting part of the Improvement Act that addressed in a most creative fashion a nagging problem -- what to do about the burgeoning investment adviser industry. We at the Commission take great pride in doing a good job at the important tasks given us. It has troubled us that we have been unable to adequately oversee the investment adviser industry, which has grown from 5,400 firms registered with the Commission in 1986 to over 22,000 today. Our resources have not kept up, and we have been able to regularly examine the activities of only the larger advisers and those that pose the greatest risks. It has been a source of concern that many of the advisers registered with the Commission have used registration as a marketing tool suggesting Commission approval when in truth and in fact our limited resources have made difficult if not impossible to maintain a meaningful program of inspection. The creative solution, as you all know, was to make the states the primary regulator of the smaller advisers (those with less than $25 million under management) by prohibiting them from registering with the Commission. The advisers the Improvement Act prohibits from registering with the Commission are mostly small, local businesses offering financial planning services. Their operations generally affect a limited number of clients and do not affect national markets. It is appropriate that state officials have primary responsibility for these businesses. Commission records suggest that, as a result of the enactment of the Improvement Act, over two-thirds of the investment advisers registered today will deregister and be regulated primarily by the states. However, firms remaining registered with the Commission will likely hold over 96% of the assets under management. The smaller number of registrants will permit the Commission to reduce the examination cycle for the larger advisers from about once every seven years to once every four years. This means we are going to be able to do a better job. What about the advisers that will no longer be registered with the Commission? The Commission will not, of course, conduct examinations of these advisers. That responsibility will fall to the state securities regulators. Some people have argued that the states are not up to the task of regulating the smaller advisers, and we all know that some state programs are lacking. But I believe that the states, if made fully responsible for protecting their citizens, will step up to the task. If they do not, and clients of local advisers suffer as a result, state elected officials to whom the state regulators report will be held accountable by their electorate. What makes the Improvement Act so interesting is not merely that Congress finally addressed the reality of the Commission's investment adviser situation, but that it simultaneously addressed other problems by preempting state investment adviser laws as they apply to the larger advisers. Congress recognized that overlapping state and Commission regulation adds little investor protection, is a waste of limited regulatory resources, and imposes considerable burdens on the larger advisers who tend to be subject to the laws of multiple jurisdictions. For years, state administrators and NASAA have worked to enact uniform investment adviser laws among the states. In my view, uniformity of state investment adviser laws may never have been an achievable goal. State legislators will always exercise their prerogative to amend uniform law proposals. Administrators cannot be asked to defer interpreting or applying their laws to particular situations until all other administrators agree to a uniform approach. Therefore, federal preemption was the only real solution. The Improvement Act is an appropriate use of federal powers to foster interstate commerce, and I believe legitimately address the problems created by the dynamic growth we have experienced over the last 20 years within the investment community. At the same time, the Act reflects an important value in our federal system of government--local problems should generally be addressed by local officials, who are likely to be most familiar with them and most responsive to community needs. No matter how splendid in concept a piece of legislation might be, however, it will typically contain a number of ambiguities, and an anxiety creating transition period. The Improvement Act is no exception. We will have to work together to resolve the ambiguities and reduce the anxieties. I want to assure you that the Commission is working very hard to provide as smooth a transition period as possible for the investment adviser industry. In the last month, the Commission staff has met with a number of industry groups to gather information about issues needing resolution. Within the next month, I expect the staff to report back to the Commission outlining these very concerns. In my view, it is very important that the Commission exercise its rulemaking powers to resolve any ambiguities existing in the statute. The Improvement Act amended the Investment Advisers Act of 1940, which is a federal statute, and the resolution of the open questions under it must come from the only federal agency charged with administering that statute. The new law must be administered consistently and uniformly. The power to alter the boundaries of state/federal jurisdiction by exercising rulemaking authority is a new one, and unlike any other the Commission has ever possessed. Congress clearly intended the Commission to have this authority. It gave the Commission the ability to raise the $25 million threshold for SEC registration and thereby subject advisers not meeting the higher threshold to State rather than Federal adviser law. Conversely Congress gives to the Commission the power to permit the registration of firms that are truly national in scope but have less than twenty five million dollars under management and thereby preempts state law as to those advisers. The Commission must, however, exercise this authority with care and due regard for the legitimate views and concerns of state securities commissioners. This is why the staffs of the Commission and NASAA have met several times over the past month. I am pleased to report to you that they are working together in a spirit of cooperation and good faith. I believe that you as well as industry investors will be the beneficiaries of this cooperation. In closing let me make two additional points: No doubt the reallocation of jurisdiction between the States and the Commission will lead to a greater scrutiny on the part of the Commission's Staff of the investment advisers falling within the Commission's jurisdiction putting them in a position to more effectively enforce the Advisers Act. Our examiners will be visiting investment advisers more frequently, looking more closely at practices that may violate the law. For the vast majority this should not be a burden. And I would urge those who may be disappointed that the Advisers Act amendments are not everything you had hoped for - please do not fail to appreciate the very real benefits the legislation will provide. Thank you.