National Association of Insurance and Financial Advisors
2901Telestar Court · Falls Church, VA 22042-1205 · (703) 770-8188 · www.naifa.org
April 17, 2003
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
RE: Compliance Programs of Investment Companies and Investment Advisers, File No. S7-03-03
Dear Mr. Katz:
This letter will provide the comments of the National Association of Insurance and Financial Advisors ("NAIFA") on the Securities and Exchange Commission's ("SEC's") proposed rule on Compliance Programs of Investment Companies and Investment Advisers. NAIFA (formerly the National Association of Life Underwriters) is a federation of approximately 800 state and local associations representing over 70,000 life and health insurance agents and investment advisors. Originally founded in 1890, NAIFA is the nation's oldest and largest trade association of insurance agents and financial services professionals. NAIFA's mission is to improve the business environment, enhance the professional skills and promote the ethical conduct of agents and others engaged in insurance and related financial services who assist the public in achieving financial security and independence.
NAIFA supports the adoption of reasonable, sound compliance programs by investment advisers. The SEC's efforts on this issue complement NAIFA's mission of promoting the ethical conduct of agents and others engaged in insurance and related financial services. There are, however, three issues that we would like to raise regarding the SEC's proposed rule and request for comments on possible future actions. NAIFA recommends that the SEC: 1) Change the proposed rule's recordkeeping requirements so that advisers only need to maintain the final reports of compliance reviews (rather than any records documenting said reviews) and that they be able to maintain those reports in an electronic format; 2) Create an exemption or make other allowances for small advisers; 3) Not require third parties or accountants to review the compliance policies and procedures of investment advisers; and 4) Not require advisers to have fidelity bonds.
1. The SEC Should Modify the Proposed Rule's Recordkeeping Requirements as Found in Proposed Section 275.204-2 (a) (17) (ii) and (e) (1).
The SEC should make two changes to the proposed rule's recordkeeping requirements. The recordkeeping provisions as currently proposed would require advisers to maintain "any records documenting" the annual reviews of its policies and procedures for a period of five years. It should be sufficient for advisers to maintain any final report(s) of the annual reviews. Numerous documents can be generated during the review process that would be difficult and costly to maintain and of little use to the SEC in evaluating a compliance program. Instead of requiring storage of all of these documents, the rule should require only that final reports be maintained. The proposed rule also should state explicitly that the reports may be stored in electronic form as long as they are made available to the SEC during an examination. This change would also reduce the administrative burdens and costs of storing large quantities of documents and still allow advisers to meet the SEC's regulatory needs.
2. The SEC Should Create an Exemption or Make Other Allowances for Small Advisers
Many investment advisers are small businesses that operate on small margins and have few employees. Recordkeeping requirements, internal compliance reviews and the appointment of a compliance officer would be quite burdensome for small advisers. The SEC should create an exemption from the proposed rule's requirements or make other reasonable allowances for these small advisers.
The preamble to the proposed rule recognizes that the proposal would impose larger relative costs on small advisers and funds. The SEC's expectation that the number of independent compliance experts will grow to meet the demand for their services by small advisers at competitive prices does not provide much comfort to small advisers that must create or revamp compliance policies to meet the requirements imposed by the proposed rule.
Larger investment advisers manager far more funds and deal with far more investors than small advisers and, therefore, the SEC has a greater interest in protecting those funds and investors from potential compliance problems. To qualify as a small adviser for the SEC's purposes, the adviser must manage less than $25 million and have less than $5 million in assets. These figures are dwarfed by the size of the industry as whole which the U.S. Census Bureau estimated made nearly $9.4 billion in revenues in 2002. In fact, the SEC estimates that only about 170 of nearly 7,800 registered investment advisers are small businesses. Creating an exemption for these small businesses would have a minimal impact on the SEC's regulatory goals and would avoid imposing undue burdens on small businesses and further weighting the competitive playing field against them.
If the SEC decides not to create an exemption for small advisers, then it should make some reasonable allowances for the burdens it would create on small advisers. For example, small advisers should be given greater flexibility regarding the location where they store records that they must maintain under the proposed rule. As long as the adviser can make the records reasonably accessible to the SEC, then that should be sufficient and would avoid a de facto requirement that some advisers increase their office space in order to store documents. The SEC also should not require the designation of a chief compliance officer. For very small advisers this requirement would be overly formalistic and would not increase compliance. It should be sufficient for small advisers to adopt and implement appropriate compliance policies and procedures. These operations are not large enough to require the designation of a compliance officer to administer those policies and procedures, communicate them and implement them. It would be more effective for the entire small business to share those responsibilities.
3. The SEC Should Not Require Periodic Compliance Reviews By Third Parties.
NAIFA urges the SEC not to require third parties or accountants to review the compliance policies and procedures of investment advisers. Many advisers have small businesses and the costs of annual reviews by outside professionals would be prohibitive. The requirements in the proposed rule that advisers review their policies and procedures on an annual basis and designate an individual as Chief Compliance Officer should be sufficient, particularly since the requirement makes clear that advisers must make an effort to keep their policies and procedures from becoming outdated. Advisers are fully capable of reviewing their policies and procedures internally and updating them as necessary.
4. The SEC Should Not Require Fidelity Bonds
The SEC should not require advisers to have fidelity bonds. There is no evidence in the rulemaking record that there are problems regarding fraud or embezzlement of client funds by advisers which is the primary purpose for which the bond would be pledged. Current regulations already limit events leading to losses of client funds and clients typically are adequately compensated when such losses occur. Imposing a fidelity bond requirement is therefore not necessary and would simply impose additional economic barriers to smaller investment advisers entering the market for providing advisory services. This would not only create problems for such advisers but likely would limit competition among advisers and raise the rates customers must pay for advisory services.
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In sum, NAIFA believes the proposed rule should be structured in a way that will enhance compliance with the federal securities laws without imposing unnecessary regulatory burdens on investment advisers. To that end, NAIFA recommends that the SEC: 1) Change the proposed rule's recordkeeping requirements so that advisers only need to maintain the final reports of compliance reviews (rather than any records documenting said reviews) and that they be able to maintain those reports in an electronic format; 2) Create an exemption or make other allowances for small advisers; 3) Not require third parties or accountants to review the compliance policies and procedures of investment advisers; and 4) Not require advisers to have fidelity bonds. Thank you for your consideration of our views on these issues.
Gary A. Sanders
Senior Counsel for Law and