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Remarks at the 2015 Mutual Funds and Investment Management Conference

Commissioner Michael S. Piwowar

March 16, 2015

Thank you, David [Blass], for that wonderful introduction.  I appreciate the invitation from the Investment Company Institute and the Federal Bar Association to deliver remarks this morning.

As someone who went to high school in Southern California, it is always a pleasure to return.  For those of us coming here from the Midwest or the Northeast, this conference is a nice escape from the exceedingly cold winter that we have been enduring.  So I was happy to fly in yesterday, pick up a rental car, hit the open road in the California desert, and stop for a double-double at the nearest In-N-Out Burger.  Animal-style, of course.[1]

Driving around, you cannot help but notice the streets that are named after celebrities.  There are roads named after Dinah Shore and Bob Hope; and then there is Kirk Douglas Way, Frank Sinatra Drive, and Gene Autry Trail.  Gene Autry, of course, was known as the “Singing Cowboy.”  While a movie star in the 1940s, Gene Autry distributed what he called his “Cowboy Code,” which had ten principles.  Here are some of them: “The Cowboy must never … take unfair advantage; never go back on his word, or a trust confided in him; always tell the truth; respect … his nation’s laws.”[2]  Sounds like the Cowboy Code would also work pretty well for investment advisers and regulators, don’t you think?

Gene Autry learned business through a correspondence course he took while working as a railroad telegrapher.  After he quit show business in the early-1950s, he invested in radio and television stations, hotels, real estate, and oil.  He became the original owner of the Los Angeles Angels baseball club.  Ultimately, he rose to a level that would place him on the elite Forbes 400 list of wealthiest Americans for several years during the 1990s.[3]

With money earned in Hollywood, celebrities like Gene Autry had the means to hire experts and advisers to assist with investment decisions and to generate further wealth.  But that is not the case for the overwhelming number of Americans.  Instead, to build the wealth needed to fund retirement and a college education, most Americans have to rely, at least in part, on the investment management industry.  Through mutual funds, an individual can easily, and cheaply, assemble a diversified portfolio of investments that provides exposure to a variety of asset classes.  Mutual funds form the cornerstone for many 401(k) plans, individual retirement accounts, and 529 college savings plans. 

In short, mutual funds have helped make participation in the capital markets possible for all Americans.  Over the last three decades, mutual fund assets have risen considerably.  From merely having around $135 billion in 1980, mutual funds grew to over $15 trillion by the end of 2013.[4]

This year marks the 75th anniversary of the enactment of the Investment Company Act.  The Act originated from congressional concern that the Securities Act[5] and the Securities Exchange Act[6] were inadequate to protect purchasers of investment company securities.[7]  In 1935, Congress requested that the Commission undertake a study of the structures, practices, and problems of investment companies, which became known as the Investment Trust Study.[8]  The Study included a series of legislative recommendations to address the problems and abuses identified and, subsequently, the Investment Company Act was adopted.[9]

After the 50th anniversary of the Investment Company Act, SEC Chairman Richard Breeden requested then-Director of Investment Management Kathie McGrath to undertake a comprehensive and retroactive look-back at the effectiveness of the Act in serving its purpose.[10]  A number of the Commission staff involved in preparing that report are in this room today – Matt Chambers, Karen Skidmore, Diane Blizzard, Ken Berman, and Bob Plaze.  In the preface to the report, the staff wrote “[w]e have concluded that the regulatory system crafted a half century ago has worn well, providing the framework for the development of a dynamic industry.”[11]

Those sentiments remain as true today as they were back then – that the regulatory framework has not only worn well but provides sufficient flexibility to address past, present, and future concerns.  Recently, there have been misinformed efforts aimed at the investment management industry, suggesting that the current regulatory framework for their activities is inadequate and that the industry presents so-called “systemic risks” to the financial markets.  Thus, today, I would like to focus on the continuing efforts of prudential banking regulators at both the federal and international levels to “broaden the perimeter of prudential regulation”[12] to regulate the activities of non-bank participants in the capital markets. 

Before I continue, I need to provide the standard disclaimer that the views I express today are my own and do not necessarily reflect those of the Commission or my fellow Commissioners.

Baseless Criticisms of the Capital Markets by Prudential Regulators

Despite incontrovertible evidence to the contrary, there is a continuing false narrative that one reason for the financial crisis was “the expansion of a largely unregulated ‘shadow banking system’ rivaling the traditional banking sector in size.”[13]  Yet capital markets have always been about risk and, in the United States, where capital markets are subject to a comprehensive system of regulation overseen by the Commission and the Commodity Futures Trading Commission, capital market-based financing has dominated bank-based financing.   

Less than two weeks ago, the chair of the Board of Governors of the Federal Reserve System (“Federal Reserve” or “Fed”), delivered a speech about improving oversight of large financial institutions.  Such oversight would not be limited to banking entities.  She said “let me be clear about what I mean by ‘large institutions.’  Generally, I have in mind those firms whose financial distress would pose a significant risk to financial stability.”  She then identified three types of firms:  (1) U.S. banking organizations with large, complex, and often international operations; (2) foreign banking organizations with extensive U.S. operations; and (3) other large and complex financial firms.  Her comments come on the heels of a call by one Federal Reserve Governor for what he described as “prudential market regulation” of the financial markets.[14]

Notwithstanding the dire supposed need to have regulatory authority in the so-called “shadow banking” area, the track record of prudential regulators in identifying and acting upon systemic risks in the banking sector leaves much to be desired.  Prior to 2008, prudential regulators allowed many large banks to become heavily reliant on very short-term borrowing, at relatively low rates, to fund lending and other operations.  As the Fed has acknowledged, “[g]overnment agencies, including the Fed, failed to recognize the extent of the risks or how severely they could damage the financial system and the economy.”[15]

It is not only ironic, it is also tragic that, in their push for more oversight of the capital markets and non-bank participants, the prudential regulators are responsible for creating the dominant position of investment funds in providing liquidity in the fixed income market.  As our staff has observed, primary dealer inventories of corporate bonds appear to be at an all-time low, relative to the market size.[16]  This apparent reduction may be a permanent change, to the extent it results from fewer proprietary trading desks at broker-dealers and increased regulatory capital requirements at the holding company level.  A significant reduction in dealer market-making capacity has the potential to decrease liquidity and increase volatility in the fixed income markets.

Thus, last month’s Monetary Policy Report from the Federal Reserve observed “the growth of bond mutual funds and exchange-traded funds (ETFs) in recent years means that these funds now hold a much higher fraction of the available stock of relatively less liquid assets—such as high-yield corporate debt, bank loans, and international debt—than they did before the financial crisis.  As mutual funds and ETFs may appear to offer greater liquidity than the markets in which they transact, their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions.”[17]

It should come as no surprise that liquidity in the fixed income market has been affected by regulatory decisions discouraging banks from intermediating risk and the resulting concomitant decline in bank inventories of fixed income securities.  At the same time, the quantitative easing programs initiated by the Federal Reserve and other central banks have caused investors seeking yield to acquire debt securities with higher credit risk and generally lower liquidity.  In other words, the prudential regulators believe that since they have caused capital market activities to exit the banking sector and move into the non-banking sector, where asset managers play a significant role, it is now necessary for the prudential regulators to regulate the non-banking sector. 

The actions taken to date by the Financial Stability Oversight Council (“FSOC”) and the Financial Stability Board (“FSB”) seem to confirm that investment companies and their advisers are being targeted as being among those entities falling within the ambiguously-defined category of “other large and complex financial firms.”  Having concluded that funds and asset managers represent a preconceived “systemic risk” or “threat to financial stability,” the FSOC and the FSB have been relentless in attempting to find a post-hoc rationalization for their decisions.

After being appropriately chastised for the clumsily-drafted initial report on the asset management industry released by the Office of Financial Research (“OFR”) in September 2013,[18] the embarrassed FSOC returned last December with a new approach styled as a request for public comment.[19]  This time, FSOC raised questions that suggested its rethinking of so-called systemic risks subject to possible oversight could expand to cover risks that arise “collectively across market participants” even if the risk associated with any single firm were itself not systemic.[20]  Comments are due to FSOC on the latest notice by March 25.  I look forward to reading the public input.

Similarly, the FSB, a shadowy, quasi-governmental entity dominated by prudential regulators and central banks, has launched its own efforts to expand oversight over investment managers.  The FSB describes itself as promoting international financial stability “by coordinating national financial authorities and international standard-setting bodies” with respect to regulatory, supervisory, and other financial sector policies.[21]  The FSB then enforces “member jurisdictions’ implementation of agreed commitments, standards and policy recommendations, through monitoring of implementation, peer review and disclosure.”[22]  It is a troubling notion that, without having undergone the notice and comment process required by the Administrative Procedures Act[23] and without adherence to any other applicable standards, such as consideration of efficiency, competition, and capital formation,[24] policies and other commitments can be agreed upon at the FSB with the expectation that all member jurisdictions, which includes the Treasury Department, the Federal Reserve, and the Commission, should follow.   

Through its ominously-titled “Workstream on Other Shadow Banking Entities,” the FSB has issued consultative documents with respect to non-bank, non-insurer global systemically important financial institutions (“G-SIFIs”).[25]  In a document devoid of economic analysis, the language of the most recent consultative document leaves no doubt that the FSB has already decided that the question is not whether investment funds and asset managers should be subject to prudential oversight, but rather which ones.

At the same time, it is curious that the FSB appears ready to summarily exclude public financial institutions, sovereign wealth funds, and pension funds from consideration as a G-SIFI[26] even though they engage in activities in the capital markets that appear substantially similar to investment funds.  The FSB bases its conclusion on the fact that they are owned and guaranteed by a government, but without any credit assessment of a given government’s ability to pay.  Irrespective of any final decisions on G-SIFIs, however, a recent letter from the FSB Chair to the G-20 finance ministers and central bank governors leaves no doubt as to the FSB’s intentions to prudentially regulate all asset managers in accordance with the activities.[27]

Another example of jumping to a conclusion without engaging in a deliberate analysis of available data is with respect to leveraged inverse ETFs.  Leveraged ETFs typically are designed to achieve their stated performance objectives on a daily basis.  To accomplish their objectives, leveraged ETFs pursue a range of investment strategies through the use of swaps, futures contracts, and other derivative instruments.  Over the past several years, regulators, sponsors, and brokers have engaged in efforts to convey to investors the understanding that performance of leveraged ETFs over longer periods of time can significantly differ from the underlying index or benchmark.[28]

But, there is a false narrative about leveraged ETFs being spread by the prudential regulators.  It is the unsubstantiated assertion that these products contribute to increased volatility in the financial markets because they must rebalance their portfolios in the same direction as the contemporaneous return on the underlying assets in order to maintain a constant leverage ratio.  In other words, these types of ETFs purchase assets when they go up and sell assets when they go down.  According to the prudential regulators, the added volatility can therefore be destabilizing to the markets, especially during periods of adverse stress.

A recent working paper, however, by researchers at the Federal Reserve and the Pennsylvania State University looked at actual data and the operations of leveraged ETFs.[29]  Their paper examined the effects of capital flows on leveraged ETFs and found that earlier criticisms about the contribution of such ETFs to market volatility are likely exaggerated.  The paper observed, empirically, that capital flows substantially reduce the need for leveraged ETFs to rebalance when returns are large in magnitude.  The capital flows thereby mitigate the potential for leveraged ETFs to amplify volatility.  In other words, one of the Fed’s own economists concludes that concerns about leveraged ETFs are overblown.

Notwithstanding the prudential regulators’ baseless criticisms, there are three areas of our regulatory regime that might warrant a closer look:  fund data reporting, in-kind redemptions, and temporary suspension of redemptions.

Fund Data Reporting

It is ironic that mutual funds have been characterized as being part of the so-called “shadow market” by the prudential regulators.  Full disclosure has been a hallmark of registered funds under the Securities Act and the Investment Company Act.  Mutual funds have long filed a schedule of their portfolio investments as part of their financial statements required by Regulation S-X. [30]  Since 2004, the Commission has required these filings to be made on a quarterly, rather than a semi-annual, basis.[31]  These disclosures are made on our EDGAR system and immediately available to the public.  Among other information, mutual funds must identify the name of the issuer, the title of the security, the number of shares or principal amount of debt instruments held at the close of the period, and the value of each item at the close of the period.[32]

Last December, Chair [Mary Jo] White announced her initiative to enhance data reporting for both funds and advisers.[33]  Chair White noted that evolving changes in the practices and strategies utilized by the investment management industry may have created reporting gaps, such as with respect to the use of derivatives and securities lending.  I fully support this review of current disclosure requirements to determine whether they continue to effectively capture material information needed by shareholders to make informed investment decisions.  To the extent that improvements are identified, the Commission should seek to take appropriate action.

Chair White suggested that changes were needed to the data reporting requirements so as to enable the Commission and its staff to better identify, monitor, and evaluate risks in the asset management industry.  But with over 16,000 registered investment companies alone,[34] not counting private funds and other unregistered vehicles, it will be difficult for the Commission staff to closely scrutinize each such registered fund for compliance with its own specified investment objectives and strategies.   

Therefore, the Commission should make the existing quarterly fund portfolio holding information available in an interactive data format that can be readily analyzed by investors, advisers, analysts, academics and other professionals.  In 2009, the Commission adopted rules requiring mutual funds to provide certain data contained in the risk/return summary information to be filed in interactive data format.[35]  But making quarterly portfolio holdings information available in interactive data will be significantly more helpful, particularly if this information is disseminated through third-parties. 

In-Kind Redemptions

Perhaps one reason for the continuing obsession by prudential regulators with mutual funds is the concern that a redeemable security held by a mutual fund investor effectively creates maturity transformation – in other words, financing the purchase of potentially long-term assets with shareholder equity that can be redeemed in short order at net asset value.  In their minds, the ability to redeem one’s investment in a mutual fund makes a mutual fund investor look very similar to a bank depositor and leaves a mutual fund vulnerable to a bank-like run.  Here is one description of what a potential doomsday scenario would look like:

[A] record-high stock market begins to go into a tailspin, resulting in mass exodus by mutual fund investors.  As fund portfolio managers seek the cash to pay off the sellers, they hurriedly dispose of the highest quality, liquid holdings, accelerating the downdraft.

That description was published in a New York Times article from 1993.[36]  Since that time, we have had numerous crises – the Asian financial crisis in 1997, the collapse of Long-Term Capital Management in 1998, the popping of the internet bubble in the early 2000s, the bankruptcy of Enron Corp., and the 2008 financial crisis – but the redemption feature of stock and bond mutual funds did not trigger a global panic by investors in such funds.  Investors in mutual funds are well aware that they are subject to risk of potential loss.

There are important legal and economic differences between a mutual fund and a bank.  The Investment Company Act defines a “redeemable security” as any security, other than short-term paper, under the terms of which the holder, upon presentation to the issuer, is entitled to a proportionate share of the issuer’s current net assets or the cash equivalent thereof.[37]  Because the assets of an investment company consist primarily of the securities of other companies, satisfaction of a redemption request could be made by delivery of a portion of those securities, otherwise known as an “in-kind redemption.”  Although in-kind redemptions are rarely made, the ability of an investment company to make redemptions in this manner is important because the sale of sizable blocks of securities to effect redemptions in cash would have the tendency to depress the market price of those securities.

Prior to the enactment of the National Securities Markets Improvement Act of 1996 (“NSMIA”)and preemption of blue sky registration of mutual funds,[38] some state securities administrators required, as a condition to doing business in their respective jurisdictions, that mutual funds agree, as to residents within their respective jurisdictions, redemptions will be effected in cash only, or that redemptions in-kind will not be effected unless specific approval for such redemption is first obtained from the securities regulator.[39]  However, an agreement by a fund to make payments to some shareholders in a manner different from payments to other shareholders, for example cash only rather than cash or in-kind, would be deemed to create a class of senior securities prohibited by Section 18(f)(1) of the Investment Company Act.[40]

Therefore, absent the exemptive relief provided by Rule 18f-1,[41] a mutual fund could not retain the ability to redeem in-kind and also sell its securities in jurisdictions that require limitations on in-kind redemptions.  Rule 18f-1 enables mutual funds to limit in-kind redemptions.  Under the rule, a fund may elect to commit to pay in cash all requests for redemptions by any shareholder of record, limited in amount during any 90-day period to the lesser of $250,000 or one percent of the net asset value of the fund at the beginning of such period.  The fund must file Form N-18F-1 to notify the Commission of its election to limit in-kind redemptions. 

Given that it has been nearly 20 years since the enactment of NSMIA and in light of current concerns, we should re-visit and consider eliminating these undertakings, particularly if that will further clarify the fact that a mutual fund is not a bank, and therefore, a mutual fund shareholder is simply not the equivalent of a bank depositor.

Temporary Suspension of Redemptions

Section 22(e) of the Investment Company Act generally prohibits mutual funds from suspending the right of redemption and prohibits funds from postponing the payment of redemption proceeds for more than seven days.  The provision was designed to prevent funds and their investment advisers from interfering with the redemption rights of shareholders for improper purposes, such as the preservation of management fees.[42]

Section 22(e) permits a fund to suspend redemptions for such period as the Commission may by order permit for the protection of security holders of the company.  Section 22(e) also permits a fund to suspend redemptions in two other situations.  First, a fund may suspend redemptions for any period during which trading on the NYSE is restricted, as determined by the Commission.  Second, a fund may suspend redemptions for any period during which an emergency exists, as determined by the Commission, as a result of which it is not reasonably practicable for the fund to (1) liquidate its portfolio securities, or (2) fairly determine the value of its net assets.  Commission staff has taken the position that when funds encounter difficulties in selling or pricing their portfolio securities due to, among other things, market breaks, trading restrictions, internal fund failures, or natural disasters, Section 22(e) does not permit funds to suspend redemptions in the absence of certain determinations by the Commission.[43]

In the immediate aftermath of the Reserve Primary Fund failing to maintain a $1 stable net asset value, the Commission adopted a temporary, then a permanent, rule under Section 22(e) that permits a money market fund to suspend redemptions during liquidation.[44]  In the June 2009 proposing release on money market funds, we asked whether such relief should be broadened to apply to all mutual funds.[45]  Although the Commission did not address that issue in the February 2010 adopting release, a number of commenters addressed the question.  The Committee on Federal Regulation of Securities of the American Bar Association recommended that the Commission consider broadening the application of the proposed rule to include all registered open-end investment companies.[46]  The Committee noted “that it is not always practical for the Commission or its staff to respond in a timely fashion on a case by case basis during a rapidly evolving financial crisis.  In such circumstances, we believe that the board of directors of each individual fund is in the best position to respond quickly to a developing emergency.”

Section 22(e) authorizes the Commission, by rules and regulations, to determine the conditions under which an emergency shall be deemed to exist.  Section 22(e) was drafted 75 years ago, when the asset management industry was very different.  If the Commission, as the regulator responsible for overseeing mutual funds, were to conclude that the redemption requirements under Section 22(e) could create broader market concerns, a far more appropriate response would be to consider what regulatory solutions can be constructed by the Commission to address such concerns, rather than for prudential regulators to designate funds and/or their advisers and/or their activities as systemically risky.


Thank you for hearing me out today on concerns about regulatory overreach by prudential regulators at both the national and global level.  The asset management industry plays a crucial role in helping realize the aspirational goals of all Americans.  I look forward to engaging with you as we address the regulatory challenges facing the asset management industry and, by extension, the clients and investors you serve.


[2] Gene Autry’s Cowboy Code, available at

[3] Myrna Oliver, “Cowboy Tycoon Gene Autry Dies,” Los Angeles Times (Oct. 3, 1998).

[4] Investment Company Institute, 2014 ICI Fact Book at 162.

[5] 15 U.S.C. § 77a et seq.

[6] 15 U.S.C. § 78a et seq.

[7] See U.S. v. National Association of Securities Dealers, Inc., 422 U.S. 694, 704 (1975).

[8] Id.

[9] Id.

[10] Division of Investment Management, Protecting Investors: A Half Century of Investment Company Regulation (May 1992).

[11] Id. at v.

[12] Daniel K. Tarullo, Rethinking the Aims of Prudential Regulation (May 8, 2014) available at

[13] Janet L. Yellen, Improving the Oversight of Large Financial Institutions (Mar. 3, 2015) available at (“Yellen Speech”).

[14] Daniel K. Tarullo, Advancing Macroprudential Policy Objectives (Jan. 30, 2015) available at

[15] Yellen Speech.

[16] Division of Investment Management, Guidance Update 2014-01, “Risk Management in Changing Fixed Income Market Conditions” (Jan. 2014).

[17] Board of Governors of the Federal Reserve System, Monetary Policy Report 24-25 (Feb. 25, 2015) available at  

[18] Office of Financial Research, Asset Management and Financial Stability (Sep. 2013) available at

[19] Financial Stability Oversight Council, Notice Seeking Comment on Asset Management Products and Activities (Dec. 18, 2014) available at

[20] Id. at 4.

[21] FSB Website, About the FSB, available at (last accessed Mar. 10, 2015).

[22] Id.

[23] 5 U.S.C. §§ 501 et seq.

[24] See, e.g., 15 U.S.C. §77a(b).

[25] Financial Stability Board Consultative Document, Assessment Methodologies for Identifying Non-Bank Non-Insurer Globally Systemically Important Financial Institutions (Jan. 8, 2014) available at; Financial Stability Board Consultative Document (2nd), Assessment Methodologies for Identifying Non-Bank Non-Insurer Globally Systemically Important Financial Institutions (Mar. 4, 2015) available at (“2nd Consultative Document”). 

[26] 2nd Consultative Document at 5.

[27] Financial Stability Board, FSB Chair’s Letter to G20 on Financial Reforms – Finishing the Post-Crisis Agenda and Moving Forward (Feb. 10, 2015).

[28] Office of Investor Education and Advocacy, Investor Alert on Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors, available at

[29] Ivan T. Ivanov and Stephen L. Lenkey, Are Concerns About Leveraged ETFs Overblown?, Working Paper 2014-106 (Nov. 19, 2014), available at

[30] 17 CFR 210.12-12.

[31] Investment Company Act Rel. No. 26,372 (Feb. 27, 2004).

[32] 17 CFR 210.12-12.

[33] Mary Jo White, Enhancing Risk Monitoring and Regulatory Safeguards for the Asset Management Industry, available at

[34] 2014 ICI Fact Book at 164.

[35] Investment Company Act Rel. No. 28,617 (Feb. 11, 2009).

[36] Susan Antilla, “Wall Street; In the Fact of a Fund Panic . . . ,“ New York Times (Jun. 27, 1993).

[37] 15 U.S.C. 80a-2(a)(32).

[38] Public Law No. 104-290, Sec. 102 (Oct. 11, 1996).

[39] Investment Company Act Rel. No. 6,561 (Jun. 14, 1971).

[40] 15 U.S.C. 80a-18(f)(1).

[41] 17 CFR 270.18f-1.

[42] See Investment Trusts and Investment Companies: Hearings on S. 3580 Before a Subcommittee of the Senate Committee on Banking and Currency, 76th Cong., 3d Sess. 291 (1940) (statement of David Schenker, Chief Counsel, Investment Trust Study, SEC).

[43] Letter to the Investment Company Institute from the Division of Investment Management (Dec. 8, 1999).

[44] Investment Company Act Release No. 28,487 (Nov. 20, 2008); Investment Company Act Release No. 29,132 (Feb. 23, 2010).

[45] Investment Company Act Release No. 28,807 (Jun. 20, 2009).

[46] Letter from the Committee on Federal Regulation of Securities, Section of Business Law of the American Bar Association (Sep. 9, 2009) available at .  Also in support of broadening the provision to all mutual funds was a letter from Bankers Trust, available at

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