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Remarks to the PLI Investment Management Institute – 2016

David Grim, Director, Division of Investment Management

New York, NY

March 3, 2016

Thank you, Paul, for your kind introduction. Good morning 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 view of the Commission, any of the Commissioners, or of my colleagues on the staff of the Commission.[1]

Almost exactly a year ago today, I addressed this conference about the initiatives we were working on. I think it’s fair to say that we’ve been pretty busy in the past twelve months.

Today, I am here to talk about the past, present and future of our industry, by discussing themes we heard from the retrospective look we took at the industry and regulation while commemorating the 75th Anniversary of the Investment Company Act and Investment Advisers Act.

Regulating the Asset Management Industry

Let’s begin by looking at the past 75 plus years of the two Acts that govern the asset management industry.

We start with the American investor. Americans invest in asset management products and rely on professional advice from investment advisers for critical and core reasons — to pay for a house, to invest for a college education or to provide income for retirement.

Back in 1940, SEC Commissioner "Judge" Robert Healy said to Congress that the Investment Company Act would “provide safeguards without undue restrictions so that those who desire to put their savings to work in this manner may do so with greater confidence."[2]

The leadership of the Commission and the adaptability of the Acts since then have resulted in rules and regulatory responses that protect investors even through substantial changes in the market and the asset management industry.

For those who were not able to make it there in person, I encourage you to take a look at the archive of our celebration of the 75 years of the Investment Company Act and Investment Advisers Act on the Commission's website--it was truly a historic gathering.[3]

In 1940, when the Acts were passed, industry leaders sat down with government representatives to think constructively about the solutions of the day. Last year's commemoration also included industry pioneers and government representatives, as well as academics and thought leaders.

The discussion was wide-ranging, but four topics really have stood out for me because they are topics rooted in the adaptability which the authors gave the 1940 laws governing the asset management industry. These topics continue to present vital issues in the present day, and pose considerations for industry and the Commission in the future: first, the role of exchange-traded funds (ETFs), second, the role of private fund advisers, third, the role of disclosure and reporting in our regulatory framework, and fourth, the role of the board in fund oversight.

Exchange-Traded Funds

The existence and growth of exchange-traded funds could not have been predicted by Judge Healy and others back in 1940. ETFs are permitted to operate by Commission orders granting exemptions from certain provisions of the Investment Company Act. Like mutual funds, ETFs issue shares representing interests in a pool of investments. However, unlike mutual funds, ETF investors buy and sell those shares on a national securities exchange at a market determined price.

ETFs have grown rapidly in recent years, with assets in ETFs increasing from $300.8 billion at the end of 2005 to $2.1 trillion at July 31, 2015, a more than 600% increase.[4] The asset classes and investment strategies offered within ETF structures have also expanded. While historically ETFs have tracked the performance of specific equity indexes, ETFs today track fixed income securities indexes and international securities indexes. In addition, over time, the indices that ETFs track have, in many cases, become narrower and more specialized, resulting in many niche funds that no longer reflect a broad cross-section of the securities market. And some ETFs are actively managed — that is, they do not merely seek to passively track an index, and instead seek to achieve a specified investment objective using an active investment strategy--with transparency of their portfolios. Current actively managed ETFs operate with full portfolio transparency.

ETFs are an area of focus for the Commissioners, the staff and industry observers. To give you some flavor:

First, they were a hot topic during our 75th Anniversary event. We heard at our 75th Anniversary event about the relatively quick growth of ETFs and questions as to how they fit in to the current regulatory regime. We also heard how ETFs serve as an example of how the adaptability of the Investment Company Act facilitates the creation of innovative products, even 75 years later, through the Commission's exercise of its exemptive authority.

Second, in June 2015 the Commission issued a request for comment to help inform its review of the listing and trading of new, novel, or complex ETFs and other exchange traded products.[5] Commission staff is in the process of reviewing comments received in response to the request for comment.

Third, while Commission staff members are considering a range of issues surrounding ETFs, the Commission also has incorporated ETFs into several rules advanced as part of the agenda to address the increasingly complex portfolios and operations of mutual funds and ETFs. The Reporting Modernization rulemaking proposal in May 2015, for example, proposed collecting more tailored data for ETFs.[6] The Commission also recently proposed rulemaking requiring mutual funds and ETFs to implement liquidity risk management programs and enhance disclosure regarding fund liquidity and redemption practices.[7] Most recently, the Commission proposed to limit the use of derivatives in registered funds, and discussed how the proposed rulemaking could affect certain alternative strategy ETFs. The release also asked commenters to weigh in as to whether certain types of ETFs should be subject to different limitations.[8]

Finally, ETFs also came to the forefront on August 24, 2015 when the equity markets experienced volatility, trading pauses were triggered, and certain ETFs, including some of the largest and most-liquid, traded at prices that diverged from the value of their portfolio holdings. This event raised questions among regulators and market participants. A Research Note released by staff in the Division of Trading and Markets assessed the operation of the equity markets under the stressed conditions on August 24.[9]

As you can discern from this list, we in the Investment Management Division have been thinking a lot about ETFs and the significant role they play in the marketplace. To that end, we’ve leveraged significant expertise into the ETF space with staff focused on keeping abreast of emerging ETF developments and designing appropriate policy recommendations.

As we move forward to formulate recommendations for these rules and as we consider our priorities for this year, we continue to remain focused on ETFs.

Disclosure and Reporting

Disclosure is one of the critical pieces of the Acts — the “safeguards” as Judge Healy called them. A core function of both the Investment Company Act and Advisers Act is to promote informed decision making by investors by collecting information on funds and investment advisers and making that information publicly available.

The amount of information available to investors about funds and advisers, through publicly available forms, disclosures in prospectuses and offering documents, and information from third party sources, has increased exponentially since 1940. Today, we have 65 people in the Division who work full-time to review filings that cover over 12,000 funds a year.

At the 75th anniversary event, we heard about successes with and potential improvements to our disclosure regime.

As originally enacted, the Advisers Act sought to create a compulsory census of the investment adviser industry. The Commission has enhanced reporting over time to address an evolving investment advisory industry, including the effort in 2000 to have Form ADV be electronically filed through IARD, the changes in 2010 to Form ADV to provide clients with and file electronically greater information about the individuals who provide them with investment advice, the creation of Form PF in 2011 to collect data about private funds, and the current rule proposal to enhance data collection about separately managed accounts.

Similarly, on the registered fund side, we have historically acted to modernize our forms and the manner in which information is filed with the Commission and disclosed to the public in order to keep up with changes in the industry and technology.

And we consistently look to other ways to improve disclosures. IM staff published guidance on staff’s observations from reviewing summary prospectuses and ways in which staff believe disclosure can be improved.[10] Staff have also provided guidance on fund names that could potentially be misleading to investors.[11]

As you know, in May, the Commission voted unanimously to propose new reporting forms, N-PORT and N-CEN. If ultimately adopted, the Commission staff would be able to use the data collected from these proposed forms to help better understand the industry and products; and the data could also be used by investors directly or those who service them as a supplement to traditional disclosures to help them better understand products and make more informed choices.[12]

I strongly believe in the data and disclosure mandate and we in the Division of Investment Management continue to think constructively about how to improve the effectiveness of disclosure. Meaningful information helps investors make informed choices, and that transparency benefits the entire industry.

Private Fund Advisers

The third hot topic at the 75th Anniversary Event was how Dodd-Frank changed the Commission’s authority over private fund advisers. Immediately prior to Dodd-Frank, the Commission had relatively limited insight into the business landscape of private fund advisers.

As a result of the Dodd-Frank Act, however, many private fund advisers registered with the Commission and filed Form ADV for the first time - advisers that before Dodd-Frank's passage had not either voluntarily registered or otherwise had a requirement to register. This new set of registered advisers gave the Commission a bigger and more complete picture of the industry. Since these rules required by Dodd-Frank were implemented, approximately 1,500 new private fund advisers have registered with the Commission.

With registration, private fund advisers became subject to the full scope of the Advisers Act. Staff in IM’s private funds branch—specialized experts in this field-- reviewed the Act and its rules and provided guidance on their application to private fund advisers.[13]

We also have benefited from key data collection component of the Dodd-Frank Act was Form PF, which is filed confidentially by private fund advisers that each manage more than $150 million in private fund assets. Form PF, provides rich data about private funds to the Commission and is intended by statute to be a tool to inform the Financial Stability Oversight Council (FSOC) in its analysis of financial stability issues. We collect data from Form PF data, among other things, on private funds’ use of leverage, counterparty credit risk exposure, and individual hedge fund trading practices. We have used the information in various ways — for example, OCIE staff uses Form PF to understand an adviser’s business and investment strategy as part of its pre-examination evaluations, and Enforcement staff members obtain and review Form PF filings in connection with their investigations. IM staff also uses Form PF filings directly to monitor investment strategies among private funds and to understand the potential effects of certain market or global events. And we have now published on our website four quarters of private funds statistics that provide highly aggregated and anonymized census data and statistics derived from Form PF data.[14] These statistics include, for example, the distribution of borrowings, an analysis of hedge fund gross notional exposure to net asset value, and a comparison of average hedge fund investor and hedge fund portfolio liquidity.

I believe this new era of increased transparency about private fund advisers has been ultimately beneficial not only for the Commission and investors, but also for private fund advisers. The public availability of aggregated information should help to address persistent questions, and to some degree misconceptions, about the practices and size of the private fund industry. Also, when investors have this kind of information, they can make more informed choices and the transparency benefits the entire industry.

The Role of Fund Boards

And finally, a topic that is always at the front of my mind and one that was discussed at length at the 75th anniversary event: fund directors.

So, what is the role of a fund director? It’s the critical job of oversight. “Oversight” does not equal day-to-day management of a fund. I recognize that if directors are overly burdened with a management function, they can’t effectively serve in their intended capacity. But that role means overseeing those who provide essential services to funds. In crafting our policy recommendations to the Commission and guidance to the public, we on the staff are focused on providing directors with the tools they need to effectively oversee funds.

Our recent staff guidance update on fund distribution and “sub-accounting” fees is a prime example of this.[15] The guidance focuses on distribution—related issues that arise when funds pay intermediaries, like broker-dealers, who provide services for shareholders. The staff gave its views not only on the appropriate process a board should have in place to properly evaluate these fees, but also the responsibilities of a fund’s adviser and other service providers to provide sufficient information to boards of the overall picture of intermediary distribution and servicing arrangements for the funds.

Another example is our staff guidance on cybersecurity. Cybersecurity is clearly a timely issue. Our recent conversations with boards and senior management at advisers have stressed the need for firms to review cybersecurity measures. And our staff published guidance that outlined measures funds and advisers may want to consider as they think about cybersecurity risks.[16]

In the Commission’s recent rulemaking initiatives, the board’s role is yet again vital and focused on oversight. The recent rule proposal designed to promote stronger and more effective liquidity risk management across open-end funds would require a fund’s board to approve a liquidity risk management program, but this program would be administered on a day-to-day basis by the fund’s adviser or officers who the board has designated responsible for administering the program. The proposed rule also would require the board to review a report each year prepared by the fund’s adviser that describes the adequacy of the program. The Commission’s December proposal to provide a more comprehensive approach to funds’ use of derivatives also would require the board to play an important oversight role. The board would be charged with approving the portfolio limitation with which a fund will comply and approving policies and procedures to determine risk-based coverage. And for funds that use derivatives to a greater extent, the rule would require the board to approve a risk management program and designate a risk manager to oversee that program.

As we look forward to developing guidance and our policy recommendations, we continue to think critically about the board’s oversight function.

And to further make a point about our rulemaking initiatives — I can’t emphasize enough how important it is to receive thoughtful comments from stakeholders. When President Roosevelt signed the Investment Company Act and Advisers Act into law in 1940, he lauded the role of the industry in recognizing that a regulator "that has been given flexible powers to meet whatever problems may arise" would be a boon to investors and the industry alike.

Engagement with industry stakeholders was crucial in the past when the Investment Company Act and Advisers Act were passed in 1940. It is irreplaceable in the present during our outreach to the industry. Hearing from stakeholders also helps us — the rule-writers and regulators — in the future by formulating better policies.

I appreciate the opportunity to share with you these areas of focus that were highlighted during the 75th anniversary celebration and the work of the staff in the Division of Investment Management. Thank you for your attention and I hope you enjoy the program.

[1] I would like to thank my colleague, Bridget Farrell, for her valuable assistance in helping to prepare these remarks. The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues on the staff of the Commission.

[2] See Investment Trusts and Investment Companies: Hearings Before a Subcomm. of the H. Comm. on Interstate and Foreign Commerce, 76th Cong. 58 (1940) (Statement of Robert. E. Healy, Commissioner, Securities and Exchange Commission). Judge Healy supervised the study of investment funds and investment advisory services that the Commission began in 1935 and testified before Congress in support of the Investment Company Act and Investment Advisers Act in 1940. See Investment Trusts and Investment Companies: Hearings before a Subcomm. of the S. Comm. on Banking and Currency, 76th Cong. 33 (1940) (Statement of Robert. E. Healy, Commissioner, Securities and Exchange Commission).

[3] 75th Anniversary of the 1940 Acts, U.S. Secs. and Exch. Comm’n,

[4] See David W. Grim, Dir., Div. of Inv. Mgmt., Testimony on “Oversight of the SEC’s Division of Investment Management” Before the Subcomm. of the H. Comm. on Financial Services (Oct. 23, 2015), available at

[5] See Request for Comment on Exchange-Traded Products, Release No. 34-75165 (Jun. 12, 2015), available at

[6] Currently, ETFs are subject to the same comprehensive information reporting requirements on Form N-SAR as are other open-end funds or UITs, and they are not required to report additional, more specialized information because Form N-SAR predates the introduction of ETFs to the market and has not been amended to address ETFs’ distinct characteristics. See Investment Company Reporting Modernization, Release Nos. 33-9776; 34-75002; IC-31610 (May 20, 2015), available at

[7] See Open-End Fund Liquidity Risk Management Programs; Swing Pricing; Re-Opening of the Comment Period for Investment Company Reporting Modernization Release, Release No. 33-9922; IC-31835 (Sep. 22, 2015), available at

[8] See Use of Derivatives by Registered Investment Companies and Business Development Companies, Release No. 34-76620 (Dec. 11, 2015), available at

[9] Staff of the Office of Analytics and Research, Division of Trading and Markets, Research Note: Equity Market Volatility on August 24, 2015 (2015),

[10] Guidance Regarding Mutual Fund Enhanced Disclosure, IM Guidance Update No. 2014-08 (June 2014), available at

[11]Fund Names Suggesting Protection from Loss, IM Guidance Update No. 2013-12 (Nov. 2013), available at

[12] See Investment Company Reporting Modernization, supra note 6.

[13] See Managed Funds Ass’n, SEC No-Action Letter, Managed Funds Association (February 6, 2014), available at; Guidance on Private Funds and the Application of the Custody Rule to Special Purpose Vehicles and Escrows, IM Guidance Update No. 2014-07 (June 2014), available at; Exemption for Advisers to Venture Capital Funds, IM Guidance Update No. 2013-13 (December 2013), available at; Status of Certain Private Fund Investors as Qualified Clients, IM Guidance Update No. 2013-10 (November 2013), available at; Privately Offered Securities under the Investment Advisers Act Custody Rule, Investment Management Guidance Update, No. 2013-04 (August 2013), available at

[14] Division of Investment Management Risk and Examinations Office, “Private Fund Statistics,” available at

[15] Mutual Fund Distribution and Sub-Accounting Fees, IM Guidance Update, No. 2016-01(Jan. 2016), available at

[16] Cybersecurity Guidance. IM Guidance Update, No. 2015-02 (April 2015), available at

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