Remarks to the ALI CLE 2012 Conference on Investment Adviser Regulation: Legal and Compliance Forum on Institutional Advisory Services
Director, Division of Investment Management
U.S. Securities and Exchange Commission
New York, NY
Dec. 6, 2012
Good afternoon and thank you for inviting me to speak to you today. 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 of my colleagues on the staff of the Commission.
Since the passage of the Dodd-Frank Act1 over two years ago, the pool of advisers registered with the Commission has changed significantly. This change has made for interesting and challenging times for us at the Commission, as we go about the mission of protecting our nation’s investors. Today I would like to give you an update on the current work of the Commission staff on initiatives relating to investment advisers, the approach we are taking to determine potential future initiatives, and my priorities as Director of the Division.
I’ll begin with a snapshot of the investment advisers currently registered with the Commission. As of November 1, over ten thousand advisers were registered with the Commission, with over $49 trillion in assets under management.2 This represents a 6% decrease in the number of advisers since January 1, primarily due to advisers switching to state registration as a result of the Dodd-Frank Act, and a 14% increase in assets under management over the same period. Close to 40% of the registered advisers reported advising private funds, and 6% reported having their principal office and place of business outside the U.S. There are also over 2,200 exempt reporting advisers filing certain information on Form ADV with the Commission.3
II. Current Work of the Commission Staff
I would now like to review with you current investment adviser initiatives. The staff continues to work on several matters created by the Dodd-Frank Act. An example is the Volcker Rule, where the staff is working diligently on analyzing commenters’ concerns and collaborating with our fellow federal regulators to craft a recommendation for the Commission.4
One Dodd-Frank initiative that I suspect is near and dear to many of you is Form PF.5 Advisers with at least $150 million in private fund assets under management must periodically file Form PF. The type of information filed depends on the nature of the adviser’s clients and the amount of assets under management. The staff estimates that the Commission will receive filings from approximately 2,500 advisers reporting on behalf of over 23,000 funds. Most of the largest liquidity fund and hedge fund advisers filed their first reports over the summer. Most other advisers of private funds will file their first reports next year. I am pleased to report that the PFRD system that was built to accept Form PF filings is successfully accepting and processing a large volume of filings, and the Commission staff has answered numerous calls regarding Form PF. The Commission’s website also includes frequently asked questions about Form PF.6 The information filed by these advisers will be used by the Financial Stability Oversight Council (or FSOC) to monitor risks to the U.S. financial system and by the Commission to conduct risk assessments of private funds and their advisers. Based on feedback we have received from filers that have already filed, I would note a few observations. First, if you haven’t filed yet, hopefully you have already started to collect the necessary information. Second, you will likely need to work with others across your organization to gather information for the Form, because it requires data that you may not have filed or collected before. Finally, to the extent you are unsure about how to answer a question, you should take a reasonable approach to answering the question and then document that approach in Question 4 of the Form.
A panel this afternoon will be discussing private funds, and the staff of the Division has been working closely with staff from the Division of Corporation Finance on reviewing comments on the proposal to amend Regulation D that was required by the JOBS Act.7 The proposal would permit advertising and general solicitation as long as all purchasers are accredited investors and the issuer has taken reasonable steps to verify their accredited status. The comment period closed October 5 and the Commission received over 160 comment letters. Commenters have different views about the extent to which private funds should be permitted to advertise publicly, and the staff is carefully reviewing those comments and considering what recommendations to make to the Commission.
Another project of interest to investment advisers is the staff’s work related to the study of advisers and broker-dealers that was required by section 913 of the Dodd-Frank Act.8 The staff recommended in the study that the Commission engage in rulemaking to implement a uniform fiduciary standard of conduct for broker-dealers and investment advisers when they provide personalized investment advice about securities to retail investors. The staff also recommended that the Commission consider harmonizing broker-dealer and investment adviser regulation when it adds meaningfully to investor protection. The staff has been working on a request for information and economic data on this issue, and has met with industry participants, investor advocates and others to discuss the recommendations in the study.
Cancellation of Adviser Registration
The Dodd-Frank Act increased the assets under management threshold to be registered with the Commission from $25 million to $100 million.9 The Commission staff coordinated with state regulators to remind advisers of their obligation to withdraw from Commission registration if they are no longer eligible to remain so registered. On October 19th, the Commission issued a notice stating that it intends the cancel the registration of close to 300 investment advisers that either have not filed a Form ADV amendment with the Commission in 2012 or indicated on Form ADV that they are no longer eligible to remain registered with the Commission.10 Since the notice was issued, the staff continues to work with state regulators and answer questions from advisers regarding the cancellation process.
Review of Funds’ Use of Derivatives
In March of 2010, the Commission announced that the staff was conducting a review to evaluate the use of derivatives by mutual funds, exchange-traded funds (“ETFs”), and other investment companies.11 The press release also indicated that, pending completion of this review, the staff would defer consideration of exemptive requests under the 1940 Act relating to actively-managed and leveraged ETFs that would make significant investments in derivatives. At the end of August last year, as a continuation of this ongoing review, the Commission approved the issuance of a Concept Release under the 1940 Act relating to derivatives.12 When the 1940 Act was enacted, it did not contemplate funds investing in derivatives as they do today. The use and complexity of derivatives have grown significantly over the past two decades and have given rise to many interpretive and policy issues under the 1940 Act. As a result, the Commission determined to solicit public comment — through the Concept Release — on the current regulatory regime under the 1940 Act as it applies to funds’ use of derivatives and on potential improvements to that framework. The Concept Release asked for information on how different types of funds use various types of derivatives as well as the benefits, risks and costs of using derivatives, among other things. It also asked for comment on several specific issues under the 1940 Act implicated by funds’ use of derivatives, such as how to measure the amount of leverage that a fund incurs when it invests in a derivative, how a fund should value derivatives for diversification purposes, and how funds determine the industry or industries to which they may be exposed through a derivative investment.
The Commission received almost fifty comment letters in response to the Concept Release from individual investors, fund groups, investment advisers, fund service providers, industry groups, stock exchanges, law firms, and academics. The comments included some expressing impassioned views pro and con, some providing technical statutory interpretation and detailed legal analysis, and others suggesting financial risk management techniques. Many commenters urged the Commission to defer adopting any new rules for funds’ use of derivatives until the regulatory framework for swaps and security-based swaps under the Dodd-Frank Act is developed. Since the comment period ended about a year ago, the staff has been actively analyzing the comments, following up with certain commenters on the issues or suggestions they have raised, and formulating initial recommendations for potential further guidance.
Although the Division continues its ongoing review of the use of derivatives by funds, Division staff will no longer defer consideration of exemptive requests under the Investment Company Act relating to actively-managed ETFs that make use of derivatives provided any such exemptive request includes two specific representations to address some of the concerns that led to the Division’s decision to defer consideration of these types of applications. These representations are: (i) that the ETF’s board periodically will review and approve the ETF’s use of derivatives and how the ETF’s investment adviser assesses and manages risk with respect to the ETF’s use of derivatives; and (ii) that the ETF’s disclosure of its use of derivatives in its offering documents and periodic reports is consistent with relevant Commission and staff guidance.13 Because of concerns regarding leveraged ETFs, however, we continue not to support new exemptive relief for such ETFs.
Given the complexity and significance of the issues relating to funds’ use of derivatives, both for the fund industry and for the protection of investors, we are taking a deliberate approach in our continuing review. I thank you for your patience and helpful input as we work through these very important issues.
IM Risk and Examination Group
A recent initiative in IM is the creation of the Risk and Examination Group, or REG. REG will conduct rigorous quantitative and qualitative financial analyses of the investment management industry, including detailed analyses of strategically important investment advisers and investment companies. REG has already started to work closely with the Commission’s Office of Compliance, Inspections and Examinations to make onsite visits to select strategically important investment management firms. These visits are designed to increase the staff’s understanding of firms’ risk management activities, generate an active dialog between REG and firms on key risks and issues facing firms and the industry, and help inform policy and the examination process.
III. Future Division Priorities
As you may know, I came to the Division of Investment Management from OCIE. In OCIE, we worked hard to implement a risk-based approach to examinations. What I’d like to do now is talk briefly about a similar approach the staff of the Division is taking as we consider our regulatory priorities.
In this era of limited budgets, one of my goals since taking the helm of the Division is to ensure that we are allocating our resources wisely. Toward this end, I asked the staff to take a fresh look at policy initiatives with a view to prioritizing those matters based on four factors. These factors also will be used to analyze policy initiatives going forward.
The first factor is identification of the risk to be mitigated or the problem to be solved. This is key to the discussion of any policy initiative. The second factor is the urgency associated with a particular initiative. Urgency may arise from risks to investors, registrants, efficient markets, and capital formation. Going forward, REG will help identify and assess these risks. The third factor is the potential impact of an initiative on investors, registrants, capital formation, efficient markets, and the Division’s and Commission’s operational efficiency. REG, in collaboration with the Commission’s Division of Risk, Strategy, and Financial Innovation, will help identify and assess many of these potential impacts. The fourth and final factor is the resources associated with a policy imitative. This issue will be considered by the senior staff in the Division. In essence, we’re applying a systematic cost-benefit analysis to the prioritization of our work. We’re looking at factors that further the SEC’s mission as well as the impact that various regulatory approaches would have on investors, capital formation, and efficient markets. Our bottom line is that we want to be smart, efficient, and effective when we devote precious staff resources to the problems facing investors and the markets. Our goal is to generate the best return on taxpayers’ investment.
At this point you are probably asking yourselves what specific future regulatory initiatives related to investment advisers came out of this process. We have identified several potential initiatives. I would like to discuss two today that are of particular interest to investment advisers. Please keep in mind that all initiatives are ultimately for the Commission’s consideration and may or may not come to fruition.
First, we have received a number of questions and suggestions from newly-registered advisers to private funds about how certain provisions of the Advisers Act and related rules apply to their businesses. For example, we have received inquiries regarding the application of the Advisers Act advertising rules and staff positions to private fund advisers, especially in light of the JOBS Act, and how certain provisions of the books and records rule apply to advisers of private equity funds. The staff is considering these and other issues raised by private fund advisers and considering what action, if any, should be taken or recommended to the Commission to address these questions. Although many advisers to private funds have been registered with the Commission for years, we now have close to 40% of total registrants advising private funds, and it is important that we conduct a broad review of how these regulatory requirements apply to private fund advisers.
Second, we believe there is a need to provide additional guidance on valuation of securities held by registered investment companies. The Commission’s website includes a bibliography of materials regarding valuation, including relevant provisions of the Investment Company Act and related rules, Commission and staff guidance, and enforcement actions in order to assist funds and their counsel in understanding and applying the valuation requirements under the Investment Company Act. We believe additional guidance in this area would be useful because much has changed since the Commission last issued guidance regarding valuation.
These are just two examples of initiatives that we are considering. We are interested in hearing from all of our constituencies and we welcome your input on issues of importance to investment advisers and their clients.
IV. Additional Priorities within the Division
I have shared with you one of my goals as Director of the Division, which is to take a consistent, risk-based approach in considering our regulatory priorities. Another theme that I believe is crucial is that of continuous improvement. In the Division and throughout the Commission we are striving to be a continuous improvement organization, looking for ways we can work smarter and work better. For example, as many of you know, we have undertaken at the Commission an ambitious initiative to develop more robust cost-benefit analyses in Commission rulemaking. This includes a more integrated analysis of economic issues in rule releases and earlier involvement of economists to analyze alternative policy options.
We are also equipping the Division with new expertise. We have acquired or are actively looking for business expertise in the areas of private funds, ETFs, derivatives, and financial analysis. In addition, as I previously discussed, we have established REG. We are also sending more staff from the Division on examinations to help them learn more about the business and to assist our examinations staff on questions that arise during exams.
More broadly, the staff has begun an intensive inquiry into the work of the Division to better understand what our strengths and areas for improvement are and what opportunities are available to exploit those strengths and improve our operations. This inquiry, which we refer to as “Moving Ahead” — comprises five broad categories, namely, people, processes, technology, structure, and strategy. While the staff is currently in the early phase of this initiative, I am excited about its prospects and hope that I will have more to report to you in the future.
I appreciate the opportunity to share my thoughts on the work of the Division. The Division is committed to working smarter and working better in its mission of protecting the nation’s investors. Thank you.
1 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).
2 IARD Data as of November 1, 2012.
4 See Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds, Exchange Act Release No. 34-65545 (Oct. 12, 2011), available at http://www.sec.gov/rules/proposed/2011/34-65545.pdf.
5 17 CFR 279.9. See Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Investment Advisers Act Release No. 3308 (Oct. 31, 2011), available at http://www.sec.gov/rules/final/2011/ia-3308.pdf.
6 Form PF Frequently Asked Questions, available at http://www.sec.gov/divisions/investment/pfrd/pfrdfaq.shtml.
7 See Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Securities Act Release No. 33-9354 (August 29, 2012), available at http://www.sec.gov/rules/proposed/2012/33-9354.pdf.
8 Staff of the U.S. Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011) (“Study”), available at www.sec.gov/news/studies/2011/913studyfinal.pdf. See also Statement by SEC Commissioners Kathleen L. Casey and Troy A. Paredes (Jan. 21, 2011).
9 See section 410 of the Dodd-Frank Act; 15 U.S.C. 80b-3a.
10 See Notice of Intention to Cancel Registrations of Certain Investment Advisers Pursuant to Section 203(h) of the Investment Advisers Act of 1940, Investment Advisers Act Release No. 3490 (Oct. 19, 2010), available at http://www.sec.gov/rules/other/2012/ia-3490.pdf.
12 See Use of Derivatives by Investment Companies Under the Investment Company Act of 1940, Investment Company Act Release No. 29776 (August 31, 2011), available at http://www.sec.gov/rules/concept/2011/ic-29776fr.pdf
13 Actively-managed ETFs are also subject to conditions with respect to their use of derivatives that may be imposed by the relevant listing rule of a listing exchange and also any applicable regulatory relief that may be granted by the Commission’s Division of Trading and Markets.