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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks Before the IA Week and the Investment Adviser Association 9th Annual IA Compliance Best Practices Summit 2007


Andrew J. Donohue1

Director, Division of Investment Management
U.S. Securities and Exchange Commission

Washington, D.C.
March 22, 2007

Good morning. It is a pleasure to be here and I want to thank IA Week and the Investment Advisers Association for inviting me. I always appreciate the opportunity to speak with compliance professionals. Having worked as general counsel in investment management firms for many years before moving into my current position, with both legal and compliance responsibility, I have the highest regard for the work you do. I appreciate the challenges you face and view your role as essential to achieving our mutual goal of protecting investors.

Today I'd like to review with you some of the Division of Investment Management's regulatory priorities for the investment adviser industry to let you know what you might expect in the upcoming months. I'd also like to offer a few of my observations regarding how I see the Division's work and the regulation of the advisory industry in the larger context. Before I begin, however, I need to state clearly that my remarks here today represent my own views and not necessarily the views of the Commission, the individual Commissioners or my colleagues on the Commission staff.

One of the many things I have learned in my years working in the regulatory arena of the Investment Management industry, and with over 30 of them now I certainly am racking those years up, is that the idea of the regulatory cycle is very real. For example, following the mutual fund scandals of 2003, there was an understandable build-up of regulations affecting investment companies. We are now in a period of refining and evaluating the regulatory inventory governing that industry. It struck me as I was preparing to speak with you by looking over the topics that are being covered here today and tomorrow, and reviewing our current priorities in the Division of Investment Management, that this period of review and refinement has spilled over to regulations in the advisory industry as well. As a result, much of my discussion on our current initiatives in regulation of this area focuses on rules that have not been updated in many years and that may not be quite as effective or relevant in light of the modern technological environment.

As compliance professionals, the regulatory cycle also plays an important role in your work as well. Rather than evaluating new or proposed regulations, you are currently refining your process of compliance with them. For example, the investment adviser compliance rule has now been in effect for over three years. Each of your firms now has a chief compliance officer whose role and responsibilities within your firm have changed and evolved. You have also now gone through the annual review process. As we in the Division learn of your experiences with different regulations we will be able to do our part in updating and refining them to allow them and you to be more effective.

I. Review of Current Regulatory Inventory

The idea of the cycle of regulation underlies the purpose of the first initiative in the Division that I'd like to talk about — and actually it is not an initiative at all, but rather an ongoing exercise. While the Investment Company Act area has many rules, the Investment Advisers Act is very principle-based and has very few regulations compared to our other area. Nevertheless, over the years, the regulations governing the investment management area, including those governing investment advisers, have accumulated as the Commission has responded to the important issue of the day. As time has passed and circumstances change, certain regulations may no longer be relevant or necessary or could be improved to adapt to modern practices. This year, and going forward on a regular basis, my staff and I will be reviewing the regulations governing both investment companies and investment advisers and considering whether any may need to be revised, updated or eliminated.

Part of the Division's objective in embarking on this review is to ensure that we achieve our regulatory goal of investor protection without overburdening you and your firms with regulations that may not be necessary. Your work is important and your time and resources are valuable — we want to ensure that they are used efficiently and effectively. Thus, it is my hope that you will consider yourselves as part of this process. After all, you are on the front lines, and no one knows better than you the regulations that are working and achieving their intended purpose and those that are simply not relevant in this modern age or that could be improved. I therefore ask that as you encounter different requirements that you feel could be more effective, you tell us. We want to hear from you.

I will now turn to the areas that we are currently focusing our time on in the Division of Investment Management.

II. Books and Records

When considering regulations that have not been updated in some time and that are in need of reform, the investment adviser books and records requirements pretty much jump out of the CFR. These requirements were adopted in the early 1960s, long before most of us were even involved with the investment advisory industry (even me, believe it or not). While seemingly mundane, in your role as compliance professionals, you understand that accurate and complete books and records are essential tools in assuring effective and efficient compliance. You also appreciate the importance of clear guidance regarding the requirements. With the technological advances of the current electronic age, these rules are in great need of reform. The Division is currently undertaking a comprehensive review and wholesale re-thinking of the advisers' recordkeeping requirements. I also want to briefly mention an item related to books and records, because I know that it is of great interest to this audience, and that is e-mail retention. While I believe this issue is a challenge, I know everyone could benefit from clear, e-mail-specific guidance, and I have asked the Division staff to continue preparing such guidance.

The Division is also going through a similar exercise with respect to the recordkeeping requirements for investment companies, which were also adopted in the 1960s. As we go through our analysis, we will look at the purpose behind each requirement and determine whether we can obtain the same information in a more meaningful and less obtrusive manner. We are also considering the technologies available today that may assist you and your firms in maintaining and producing records in a cost-effective manner. I don't want to rush this important initiative. I have asked our staff to use the time necessary to understand current practices and technologies that investment advisers are using to maintain and produce their records.

III. ADV Part 2

The next priority I would like to discuss is the proposed amendments to Form ADV Part 2. To provide some background, in 2000, the Commission adopted revisions to Part 1 of the form and deferred adoption of Part 2 to permit focus on the establishment of the IARD electronic filing system and the IAPD website that provides public disclosure of Form ADV information. However, in the time that has passed since the proposed amendments for Part 2, the nature of the advisory industry and the regulatory system governing it have evolved and, as a result, the Division expects to recommend that the Commission re-propose Form ADV, Part 2 so that we can receive a fresh set of comments on its form and content. The Division is also currently working on a re-proposal recommendation for the Commission, and, as with all proposed rules, I encourage your input, in the form of comment letters, when the re-proposal is issued.

IV. Investment Adviser / Broker-Dealer Study

I now would like to turn to one of the largest and potentially most consequential initiatives the Commission is now undertaking — the investment adviser/broker-dealer study. Last September Chairman Cox announced a Commission study that will analyze current industry practices and explore the levels of protection afforded retail customers of broker-dealers, regulated under the Securities Exchange Act and clients of investment advisers, which, as you know, are subject to the Investment Advisers Act.

The essential question underlying the study is how to address the rapidly changing and evolving broker-dealer and investment advisory industries in the context of a decades-old statutory scheme. As such, this regulatory issue fits squarely into the current period of updating and refining the Commission's regulations to be effective in light of modern industry practices.

With the introduction of fee-based compensation for broker-dealers almost 10 years ago, the traditional statutory delineation between broker-dealers and investment advisers, based on the type of compensation each of these service providers received, became blurred. As a result, the Commission faced the question of how to address the activities of broker-dealers, which traditionally fell outside the statutory definition of an investment adviser, but which have evolved closer to the advisory model, in order to ensure that investors receive the important protections they are entitled to under the Investment Advisers Act.

The IA/BD study, as it is called, is being conducted through a third-party, independent contractor and entails data and fact-finding to examine the ways in which broker-dealers and investment advisers market, sell, and deliver financial products, accounts, programs and services to individual investors. This data and information gathering should then enable the Commission and the staff to make more fully informed evaluations regarding the two regulatory schemes and how those schemes impact both firms and investors. The findings of the study should also assist the Commission staff in evaluating the legal and regulatory approach governing investment professionals in today's evolving marketplace.

The study is an exciting process and I look forward to examining the results along with my colleagues in other Divisions. I am also hopeful that the study will further the dialogue on these important issues, especially as the broker-dealer and investment advisory industries continue to evolve.

V. Hedge Fund Initiatives

Similar to the evolution of broker-dealers, investment advisers to hedge funds, and certain other pooled investment vehicles, also present the Commission with an influx of industry participants that may not have been fully anticipated and addressed by the Investment Advisers Act.

In addressing some of the consequences of the Goldstein decision, the Commission recently proposed two new rules. The first, an antifraud rule, would clarify the Commission's ability to bring enforcement actions under the Investment Advisers Act against advisers that defraud investors.

The second hedge fund related rule the Commission proposed follows in line with the other initiatives that I have discussed in that it involves updating a standard that is no longer as effective in the current environment. The proposal, under the Securities Act, would enhance the accredited investor criteria for hedge fund investors. As proposed, only a natural person who meets the current accredited investor standard and who in addition owns $2.5 million or more in certain investments could invest in a hedge fund. The comment period for both these rules closed on March 9th and the Division is currently evaluating the feedback we've received.

VI. Back to Basics and Conclusion

I would like to conclude with a topic that I believe goes hand-in-hand with the one I began my talk with today. While it is our job in the Division of Investment Management to periodically catalog, review and evaluate the regulations governing the investment advisory industry to ensure that current regulations are necessary and serve their intended purpose, it is your job, as compliance professionals, to ensure that your firms are compliant with all the regulations that currently exist. As certain issues receive a lot of attention during a particular period, such as the issues that may be highlighted at conferences such as this one, I know it is only human nature to focus your efforts on those areas and possibly, with limited resources and time, overlook more fundamental requirements. However, I would like to offer a suggestion that I have mentioned frequently since I arrived at the Commission 10 months ago: and that is to get back to basics. Focusing on basic and fundamental compliance obligations is the best way to achieve a culture of compliance in your firms.

As I have noted before, one of my goals for my tenure as Director of the Division of Investment Management is that it be marked by a healthy and productive dialogue with the investment advisory industry, as well as with its clients. You, as the compliance professionals, are key participants in this dialogue — you know what is working and what needs to be changed to best achieve our common goal of protecting investors. I value your knowledgeable and real-world perspective and encourage your feedback.

Thank you again for inviting me here today. I hope you enjoy the conference.



Modified: 03/22/2007