Remarks to the ICI 2014 Securities Law Developments Conference
Director, Division of Investment Management
Dec. 10, 2014
Good morning everyone, and thank you, David, for that kind introduction and for inviting me to speak here 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 other colleague on the staff of the Commission.
It is a privilege to be here today to deliver the keynote address at this important conference on regulatory and legislative issues affecting the fund industry. I am joined here today by two of my Investment Management colleagues — Diane Blizzard, who will be participating shortly in the “Discussion of Significant Regulatory Developments”, and Sarah ten Siethoff, who will be participating in the Money Market Fund reform panel late this afternoon. We are also joined by several of our colleagues from around the Commission, including Drew Bowden, Kevin Goodman and Jane Jarcho from the Commission’s Office of Compliance Inspections and Examinations (OCIE), and Julie Riewe from the Commission’s Division of Enforcement. It is truly an honor to be here today alongside some of the Commission’s most knowledgeable and talented staff.
As 2014 comes to a close, it is fitting for us to reflect upon our accomplishments and the lessons that we have learned during the past year. In this spirit, I would like to share with you this morning “The Division of Investment Management’s Top 10 Lessons Learned and Points to Remember from 2014.” I know that this “top ten list” may not be as entertaining as one you would see on Letterman, but I hope it will help you better understand the way that our division operates and the goals that we have for the future.
II. The Division of Investment Management’s Top 10 Lessons Learned and Points to Remember from 2014
10. An Organization is Only as Strong as its Staff; and the Division of Investment Management’s Staff is Strong and Committed
The Division of Investment Management is comprised of nearly 200 highly motivated and talented people with a depth of knowledge and experience in five offices — Washington, D.C., New York, Philadelphia, Fort Worth and San Francisco — who are committed to carrying out our critical mission to protect investors, promote informed investment decisions, and facilitate appropriate innovation in investment management products and services. The Division’s staff possesses a deep understanding and mastery of the more traditional work of the Division and has increasing expertise in specialized financial services and complex products. Over the past few years, as the legal and regulatory landscape has continued to change, we have added to our expertise by hiring quantitative experts; portfolio managers; PhD economists; industry experts, including experts in derivatives, ETFs, and Money Market Funds; examiners; lawyers; and accountants. This wealth and diversity of knowledge and expertise makes our policy recommendations that much more informed and nuanced, and we are extremely fortunate to have such intelligent people dedicated to protecting our country’s investors.
We strive to be a continuous improvement organization that constantly tests and adapts its processes and approaches; and not rely on the old standby that “we have always done it this way.” Last year, after undertaking a process to better understand our key strengths and areas where we could improve, the Division implemented a reorganization of our internal structure to better facilitate internal communication, broaden areas of responsibility for staff and establish an easier-to-access structure for the public. Last month marked the one-year anniversary of our new organizational structure, and I am proud to report that it has produced positive results. Among other things, the new structure has provided the staff with an opportunity to work on a larger breadth of issues, which brings fresh approaches and ideas to all matters.
9. The Division of Investment Management is Not a Regulatory Island, nor should it be
We are not alone in the global regulatory landscape. To effectively carry out our mission, we seek to encourage an inclusive, collaborative working environment within the Division, across the Commission, and with outside stakeholders. IM staff regularly collaborates with our colleagues throughout the Commission in connection with major initiatives and in response to questions from outside stakeholders implicating multiple divisions or offices. For example, we recently collaborated with the Divisions of Trading and Markets and Corporation Finance to publish updated guidance on the Volcker Rule, which took the form of answers to frequently asked questions. Commission staff, along with staff from the banking regulators and the CFTC, also continue to communicate on questions from market participants, on technical issues, and on supervision and examination approaches.
The Volcker Rule is not the only recent example of regulatory coordination that required thoughtful joint action. As you know, the Commission successfully adopted amendments to the rules that govern money market mutual funds in July. The adopted money market reforms are intended to make our financial system more resilient and enhance the transparency and fairness of these products for America’s investors. These reforms would not have been possible without the critical assistance we received from Treasury and the IRS in addressing the tax issues related to the floating NAV reform.
8. Risk Monitoring is an Important Area of Focus
Enhancing the Division’s ability to monitor and better understand the investment management industry has been a focus — both by launching new initiatives to monitor risk and by sharpening the existing tools at our disposal. We gather and analyze data and monitor risk through a number of avenues, including, but not limited to, (1) the routine review of disclosure filings, (2) our senior level engagement program, (3) our industry monitoring program, (4) our expert staff, and (5) coordination with other offices in the Commission. These efforts are an integral part of the entire Division’s work and together contribute to our ability to make better and more informed policy recommendations to the Commission and put out guidance to our stakeholders.
One important tool in these efforts is our Risk and Examinations Office, or “REO”, which since 2012 maintains an industry monitoring program that provides ongoing quantitative and qualitative financial analysis of the investment management industry. REO also conducts an examination program that gathers information from the investment management industry to inform the Division’s policy making. Although REO may conduct its own exams, where practical, REO will work together with OCIE to obtain information about OCIE’s examinations.
7. Data Plays an Important Role in Developing Policy and Regulations
The SEC of 2014 is an agency that increasingly relies on technology and specialized expertise. We recognize that the innovative use of data and analytical tools contributes to our ability to make better and more informed policy recommendations and enhances our investor protection efforts. The recent Money Market reforms are an excellent example of the importance of data. As you know, the failure of the Reserve Primary money market fund and the associated heavy redemptions from other money markets funds during the 2008 financial crisis prompted us to revisit the way money market funds are regulated. In 2009, the Commission proposed the first set of money market reforms, and final rule amendments were adopted in 2010. Following the adoption of these initial reforms, Commission staff continued to monitor and study money market funds. In November 2012, the SEC’s Division of Economic and Risk Analysis delivered an extensive economic study to the Commission addressing a series of Commissioner questions about money market mutual funds. Less than a year later, in June of 2013, the Commission proposed additional money market fund reforms based on this study, and the additional reforms were successfully adopted in July of this year. The data-based economic studies and analysis that DERA provided throughout the rulemaking process were essential in formulating these final reforms.
The Commission has also benefitted greatly from the monthly data that Form N-MFP provides us about money market fund holdings, which was the result of the 2010 money market mutual fund reforms. For example, the enforcement action against Ambassador Capital Management last year stemmed from an ongoing analysis of money market fund data by IM staff that involved a review of the gross yield of funds as a marker of risk.
Moving beyond Money Market Fund Reforms, in our efforts to be an effective 21st century regulator, we continue to pursue ways to analyze data to keep up to date with market trends, inform policy and rulemaking, and assist the Commission in its examination, enforcement and risk monitoring activities. Our expert staff, several of whom have PhDs with science backgrounds, are using their experience analyzing large quantities of data to help us better utilize the information that flows to us through various regulatory reports and filings as well as industry information we receive from third party providers. The Division is also reviewing and analyzing the information we obtain from sources such as Form ADV and Form PF. We are working on ways to report the findings of our data gathering and risk monitoring efforts to enhance our ability to make better and more informed policy recommendations to the Commission and to continue to put out meaningful guidance to our stakeholders. Our goal is to do more to inform our policy initiatives with real-world, contemporary data and information.
6. Regulatory Transparency Benefits the Public and the Regulators
It is also important for the Division to provide transparency into our work processes and enhance the public’s understanding of our view on critical issues. As a former General Counsel and Chief Compliance Officer, I appreciate that interpretive ambiguity is costly. We see Guidance Updates as a meaningful way to decrease ambiguity and improve the public’s understanding of the staff’s view on critical issues. For instance, after fixed income markets experienced increased volatility in June 2013, we examined developing trends in those markets and released an IM Guidance Update in January 2014 on risk management in changing fixed income market conditions, which suggests certain steps for fund advisers to consider with respect to risk management and disclosure matters relating to changing market conditions. During 2014, the Division staff has issued twelve Guidance Updates.
We believe that Guidance Updates serve as meaningful communications representing the staff’s thinking on discrete issues, but they are not substitutes for the Division’s established rulemaking, exemptive application and no-action processes. The Division’s role of reviewing requests for no-action and exemptive relief remains incredibly important and we have been increasingly focused on transparency and clarity during our review process. For example, the Commission has been considering several applications for actively managed exchange-traded products that propose to provide less transparency regarding their portfolio holdings than previously granted by the Commission. In reviewing novel requests for exemptive relief, we consider the benefits of new products but also the potential risks to investors and to the market. After careful evaluation of the potential risks associated with one of the proposed structures, the Commission issued a notice of its intent to deny the relief that was requested because the proposed structures lacked adequate transparency, fell short of giving investors a price consistently tied to investment value and did not provide sufficient investor protections. The notices, which are published on the SEC website, clearly articulate the reasons the Commission would deny such structure. This analysis is critical because it provides investors and the industry with a framework for how the Commission evaluated this novel product.
We have been working hard to be transparent about the Division’s goals and priorities, and communicate this information to the public. We believe that it is important for the industry to understand our focus and the areas we perceive to have heightened risks.
5. Appropriate Innovation is Necessary to Meet the Needs of Investors
I continue to believe that innovative investment products and strategies can help meet the needs and demands of investors, and the Division of Investment Management is working to become smarter, more strategic and more targeted in anticipating, identifying and monitoring the risks of the current investment landscape. While ingenuity and creative solutions are necessary tools to tackle the changing needs and demands of investors, they can also be self-serving, and provide benefits to the industry at the expense of investors. Therefore, the Division must identify the potential risks and benefits of such products and also formulate appropriate policies to ensure that we can effectively protect investors and facilitate appropriate innovation in investment products and services.
The Division’s role of reviewing requests for no-action and exemptive relief is one way that we monitor new trends and their associated risks. We view the exemptive application process as the laboratory where we examine new ideas from market participants. As you may know, it was through the exemptive relief process that money market funds and ETFs started. A more recent example of this innovation is Exchange-Traded Managed Funds or ETMFs. An ETMF is a new type of investment fund that is a hybrid between a mutual fund and an ETF. Like an ETF, an ETMF would trade on a national securities exchange, directly issue and redeem shares only in creation units, and primarily utilize in-kind transfers of assets in issuing and redeeming such units. Like a mutual fund, an ETMF would be bought and sold at prices linked to NAV and would seek to maintain the confidentiality of its current portfolio holdings. After careful evaluation, the Commission concluded that ETMFs meet the statutory requirements for relief and approved this application.
4. Promote a Culture of Compliance - Reflecting on the 10th Anniversary of the Compliance Date for Rule 38a-1
This October marked the 10th anniversary of the compliance date for Rule 38a-1. As you know, Rule 38a-1 requires funds to adopt, implement and annually review compliance policies and procedures reasonably designed to prevent violations of the federal securities laws and also requires that funds designate a chief compliance officer. The rule, which was adopted against the backdrop of the late trading and market timing scandals, stresses the importance of strong compliance programs in preventing violations of law as well as the important role that compliance professionals play in ensuring a strong culture of compliance.
It is difficult to imagine a world today without fund CCOs or compliance policies and procedures. At the time of adoption, some may have questioned their necessity or been skeptical of the structure of the requirement. Now, however, these concepts are a defining characteristic of the fund industry. The issues that were originally highlighted by the rule, like the safeguarding of client assets, continue to remain important today; and there are also new and emerging issues to address, like cyber security and the proliferation of social media. As our markets become more complex and new technology evolves, the need for strong compliance policies and procedures becomes increasingly important. The compliance rule has been a win for clients, the Commission and for the investment management industry as a whole.
Many of you in the audience today stand on the front lines of upholding the compliance rule. I believe that we share a symbiotic relationship; you are key to the success of our mission to protect investors, and we could not achieve this mission without your efforts. We look to you to encourage a strong culture of compliance within your firms, and we value and respect the work that you do. When we meet with senior management and fund boards as part of our senior level engagement program, we want you to have a seat at the table. You play an invaluable role and it is critical for you to have the tools, resources and support that you need to carry out this important function.
One recent enforcement action should send a clear message to the industry that professionals have an obligation to adhere to compliance policies and procedures. Last August, the Commission brought an action that resulted in a Colorado portfolio manager being banned from the securities industry for five years for misleading and obstructing a chief compliance officer. I believe that this case stands for the proposition that the Commission will not tolerate interference with CCOs who enforce their compliance policies and procedures.
3. Open Communication with the Industry and the Public is Imperative
The Division has been working hard to enhance our communications with industry participants and with other members of the public. We believe that open communication results in better policy recommendations and helps us be proactive in our mission to protect investors and promote informed investment decisions. One way that we have enhanced our communication efforts is through our senior level engagement program. Through this outreach initiative, senior leadership within the Division has met and continues to meet with senior management and fund boards at several of the country’s large asset managers. These meetings are extremely useful in promoting two-way communication between the industry and the Commission staff, and we hope that by meeting with fund boards and senior leadership in a non-examination setting, we can talk openly about potential issues before they arise. These meetings also allow us to obtain a focused and informed view of the systems, controls, and personnel of an individual firm, which we can then share with our colleagues in the Commission. We believe that we will be better regulators to the extent that we have a better, first-hand understanding of the workings of the industry we regulate.
Communicating with the industry through our senior level engagement program and more broadly also helps us to identify Division policies that could benefit from greater clarification — many of the topics for our IM Guidance Updates arise from questions or comments that we receive directly from industry participants, and we encourage stakeholders to contact the staff with their questions or comments. For instance, it was through these industry conversations that we obtained additional information regarding bond funds that helped inform our IM Guidance Update in January 2014 on risk management in changing fixed income market conditions.
Another important avenue of communication is the public comments that we receive from investors, industry participants, and other parties in response to proposed regulatory initiatives. These comments provide invaluable information and insight, which help inform our recommendations to the Commission. In connection with the recent money market reforms, the Division received more than 1,400 comments. Division staff carefully considered the views expressed and the data put forth by all the commenters before formulating their recommendation for the final money market rule amendments and, as a result, the SEC’s rulemaking process was greatly enhanced.
2. Investor Protection Remains Critically Important
Protecting investors is the fundamental principle upon which the missions of the Commission and Division are built. We at the Division of Investment Management have sought to be proactive in our mission to protect investors and promote informed investment decisions, rather than reacting when unanticipated issues manifest to the detriment of investors. Some of the ways in which we seek to accomplish our goal of proactive regulation include: (i) actively monitoring risks and analyzing industry trends, (ii) publishing guidance to the industry, (iii) promoting clear and effective disclosure, and (iv) undertaking various rulemaking initiatives. As part of these efforts, our staff has been proactive in monitoring events—such as geo-political, natural disaster, and market events — that may impact funds and advisers. When such events occur, we have focused on maintaining communication with affected asset managers and funds, reviewing disclosures to investors, and assessing the impact on investors’ ability to access funds or trade securities. Getting out in front of significant industry developments is, in my view, a key element of our mission of investor protection.
As part of our efforts to be proactive in our mission, the Disclosure Review and Accounting Office is refocusing its efforts to assess the consistency and effectiveness of staff comments on the many disclosure documents reviewed each year. This is intended to result in a number of beneficial outcomes, including identifying emerging disclosure issues, promoting consistency in staff comments, informing policy decisions, and providing improved guidance to registrants concerning disclosures to investors. This past June we released a Guidance Update regarding Mutual Fund Enhanced Disclosure to further our mission to promote informed investment decisions through clear and concise, user-friendly disclosure. The staff has observed that, for many funds, prospectus disclosure, including the summary section of the prospectus, is still complex, technical, and duplicative. The Guidance Update highlights certain rule and form requirements that, while not exhaustive of the disclosure requirements, are intended to focus funds on providing investors this clear, concise disclosure.
1. Recognizing Our Progress — Celebrating the 75th Anniversary of the Investment Company Act and the Investment Advisers Act
Next year marks the 75th anniversary of the Investment Company Act and the Investment Advisers Act. When President Roosevelt signed the Acts in 1940, he announced to the world his hope that such legislation would enable the industry “to fulfill its basic purpose as a vehicle to diversify the small investors’ risk.” Given the truly remarkable success of American traditional mutual funds, I think we can all agree that this hope has been fulfilled. Next year we will celebrate with a day of roundtables and dialogue, including opportunities to hear from industry pioneers, former regulators and bright lights from academia. While we are still in the early stages of planning, we hope that you will be able to join us for this exciting event.
This morning, I have focused on the important lessons that we have learned during the past year and how we plan to apply these lessons in the future. I hope I have been able to convey a sense of the dynamism currently at work in the Division, and the serious commitment the staff of the Division has to enhancing our effectiveness at accomplishing our critical mission. Please continue to approach me and the staff with your thoughts for areas where our guidance may be helpful, and continue to develop the innovative ideas that will meet the new challenges faced by investors in the twenty first century. Thank you again and enjoy the conference.
 I would like to thank my colleague, Jamie Walter, for providing invaluable assistance in preparing these remarks. The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author’s views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.
 Responses to Frequently Asked Questions Regarding the Commission’s Rule under Section 13 of the Bank Holding Company Act (the “Volcker Rule”), June 10, 2014 (Updated November 13, 2014) available at http://www.sec.gov/divisions/marketreg/faq-volcker-rule-section13.htm.
 Risk Management in Changing Fixed Income Market Conditions, IM Guidance Update No. 2014-01 (January 2014), available at http://www.sec.gov/divisions/investment/guidance/im-guidance-2014-1.pdf.
 See Precidian ETFs Trust, et al., Investment Company Act Release No. 31300 (Oct. 21, 2014), available at http://www.sec.gov/rules/ic/2014/ic-31300.pdf and Spruce ETF Trust, et al., Investment Company Act Release No. 31301 (Oct. 21, 2014), available at http://www.sec.gov/rules/ic/2014/ic-31301.pdf.
 See Eaton Vance Management, et al., Investment Company Act Notice No. 31333 (Nov. 6, 2014), available at http://www.sec.gov/rules/ic/2014/ic-31333.pdf and In the Matter of Eaton Vance Management, et al., Investment Company Act Release No. 31361 (Dec. 2, 2014), available at http://www.sec.gov/rules/ic/2014/ic-31361.pdf.
 In the Matter of Carl D. Johns, Investment Advisers Act Release No. 3655 (Aug. 27, 2013), available at http://www.sec.gov/litigation/admin/2013/ia-3655.pdf.
 IM Guidance Update 2014-08, Guidance Regarding Mutual Fund Enhanced Disclosure (June 2014), available at http://www.sec.gov/investment/im-guidance-2014-08.pdf.