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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks at the Global Challenge in Investment Management Regulatory and Legal Issues


Paul F. Roye

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

Suffolk University School of Law
Boston, MA
April 19, 2002

The SEC, 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 Mr. Roye and do not necessarily reflect the views of the Commission or the staff of the Commission.

I. Introduction

Good afternoon and thank you, Joe, for inviting me to speak today. I am first obliged to state that my remarks today represent my own views and not necessarily the views of the Commission, the individual Commissioners or my colleagues on the Commission staff.

I think it is important for all of us, regulators and private sector participants alike, to remember that we live and operate in a larger world. We cannot put on blinders and ignore the inevitable interaction that occurs with those who are outside our borders. Instead, we must be cognizant of the fact that we are part of a larger global economy, and we must pause periodically to reflect on what it means to be acting as part of a larger framework. That's why conferences such as this one organized by Professor Franco and Suffolk University School of Law are so valuable.

As the agenda for today's conference indicates, regulators are coming under increased pressure from global-oriented businesses. Businesses with an international focus understandably desire the harmonization of international regulations. This certainly seems true in the investment management arena, as more and more money managers seek to offer their services outside their home markets.

Recent years have seen tremendous growth in the number of cross border investment managers. We have seen increases in the number of U.S. managers offering their services abroad, as well increases in the number of foreign advisers offering services in the United States. We also have seen a large number of international mergers and acquisitions of U.S. advisers by large foreign financial services organizations. Interestingly, it recently was estimated that over 14% (or $980 billion) of U.S. mutual fund assets are managed by foreign advisers or their U.S. affiliates. Certainly, then, foreign advisers have been able to make significant inroads in the U.S. market, despite certain barriers that have prevented full harmonization with foreign regulations.

II. Section 7(d) of the Investment Company Act

The agenda for today's program refers to Section 7(d) of the Investment Company Act as "the obstacle to direct access" to the U.S. marketplace. Certainly Section 7(d) has prevented foreign advisers from directly offering their foreign funds to a large number of U.S. investors. Under Section 7(d), only funds organized under the laws of the United States, or any state, are permitted to offer shares in the United States. However, Section 7(d) authorizes the Commission to issue orders permitting foreign-organized funds to offer shares in the United States if the Commission finds that, by reason of special circumstances or arrangements, it is both legally and practically feasible effectively to enforce the provisions of the Investment Company Act against the foreign fund and that permitting the foreign fund to offer shares in the United States is consistent with the public interest and the protection of investors. Thus, Section 7(d) ensures that U.S. investors receive the same essential investor protection whether they acquire shares in a foreign fund or U.S.-organized fund. This standard has proved to be extremely difficult to meet, primarily because foreign funds are unwilling to submit to having all provisions of the Investment Company Act imposed on them, especially when the provisions of the Investment Company Act may conflict with-or at least be perceived as being more stringent than-the regulations of their home jurisdiction. In fact, only 19 foreign funds, most of them from Canada, have ever received orders under Section 7(d). The Commission issued the last such order in 1973.

Section 7(d) is statutory, rather than a Commission rule. Therefore, an amendment to Section 7(d) requires an act of the U.S. Congress, and there has been limited interest in effecting this change in recent years. The U.S. mutual fund industry generally has been reluctant to support efforts to relax Investment Company Act regulation to permit offerings of foreign mutual funds in the United States. In a 1992 study entitled Protecting Investors: A Half Century of Investment Company Regulation, the Division of Investment Management recommended that Section 7(d) be amended to authorize the Commission to enter into bilateral regulatory memoranda of understanding that would create a framework for regulatory cooperation and mutual recognition of investment company regulation. The Division further recommended that Section 7(d) be amended to give the Commission greater flexibility to permit foreign funds to register in the United States. Consistent with this approach some have argued that investment funds under the UCITS Directive, for example, provide under a completely different regulatory framework, for the same level of investor protection as funds under the 1940 Act. In other words, no specific issue should be singled out of a regulatory framework to gauge the level of investor protection; the framework must be evaluated as a whole. Again, there has not been sufficient impetus for embracing such an approach in the United States and revising Section 7(d).

In practice, however, the requirements of Section 7(d) have not posed a problem for foreign fund managers in penetrating the U.S. market. Many foreign fund managers have responded by acquiring U.S. investment management organizations or by setting up their own U.S. affiliates. A foreign investment manager may organize and register a U.S. mutual fund to be sold in the United States on the same basis as a U.S. investment manager. Moreover, it is relatively easy for a foreign firm to establish funds in the United States to replicate an existing foreign fund, which can be managed and administered outside the United States. I should also note that the SEC staff has shown flexibility in permitting performance information, such as that of a comparable foreign fund, to be included in prospectuses of the U.S. funds, greatly aiding foreign managers in marketing their U.S. funds. Also, the National Securities Markets Improvement Act of 1996 ("NSMIA") facilitated a true national market in the United States, eliminating substantive regulation of mutual funds by states, making it considerably easier for foreign firms to access the U.S. markets.

It should also be noted that Section 7(d), as interpreted by the Division of Investment Management, does not prohibit private offerings of foreign funds to U.S. residents, as long as those offerings comply with the private offering requirements of the U.S. securities laws. Section 3(c)(1) of the Investment Company Act provides an exemption for privately placed funds with fewer than 100 beneficial owners and Section 3(c)(7) provides an exemption for privately placed funds sold exclusively to "qualified purchasers." The SEC staff has been flexible in interpreting these provisions, taking the position that a foreign fund may make a private U.S. offering under these exemptions concurrently with an offshore public offering. (See Goodwin, Procter & Hoar, (pub. avail. Feb. 28 1997); Touche Remnant & Co. (pub. avail. August 27, 1984)). Moreover, we have confirmed that a foreign fund remains eligible for these exclusions so long as it has 100 or fewer U.S. persons as beneficial owners or has U.S. investors who are qualified purchasers, regardless of the number or sophistication of its non-U.S. investors. (Goodwin, Procter & Hoar (pub.avail. Feb. 28, 1997)). I should also note that the SEC staff has permitted foreign funds to exceed the 100 U.S. beneficial owner limit or to have U.S. investors who are not qualified purchasers if this is as a result of independent actions of the fund's security holders. (Investment Funds Institute of Canada (pub. avail. March 4, 1996)).

III. Differences Between U.S. and Foreign Fund Regulation

As I mentioned, foreign funds have been reluctant to submit to full compliance with the Investment Company Act, in part because certain key requirements of the Act are substantially different from the regulatory requirements in their home countries. Two significant differences between U.S. and other fund regulatory schemes involve what many consider the two core provisions of the Investment Company Act: prohibitions on affiliated transactions and a fund governance system focused on independent directors. The Investment Company Act's affiliated transaction prohibitions prevent fund affiliates in part from purchasing securities from, or selling securities to, a fund and also prohibit affiliates from entering into joint transactions with a fund. Our exemptive rules do allow for certain affiliated transactions, such as mergers of affiliated funds, cross transactions and purchases of public offerings when an affiliate is part of the underwriting syndicate, if the parties follow certain conditions laid out in the rules.

Even though there are exemptive rules permitting certain types of affiliated transactions, the affiliated transaction prohibitions remain a central tenet of mutual fund regulation in the United States. I believe that the Investment Company Act's affiliated transaction prohibitions are a major reason why the U.S. mutual fund industry has been largely free of scandal over the past 60 years. I also believe that they have contributed to investor confidence in mutual funds. However, I understand that other regulatory regimes do not place the same importance on prohibiting affiliated transactions.

Another cornerstone of the Investment Company Act is the importance placed on the role of independent directors. Last year, the Commission reaffirmed the prominence of independent directors when it adopted rule amendments to enhance the independence and effectiveness of independent directors. The Commission, and the U.S. courts, consider fund independent directors to embody the role of "independent watchdogs," overseeing fund management and managing conflicts of interest. Independent directors to U.S. mutual funds perform a critical function as the representatives of shareholders in the boardroom, and I believe that investors are well-served by dedicated, vigilant and truly independent directors. I further believe that the U.S. fund governance system, featuring independent directors, has contributed to investor confidence in U.S. mutual funds.

I understand that the mutual fund regulatory systems in other countries are not premised on a strong independent director system but seek to place other controls on fund management. Interestingly, the Canadian Securities Administrators last month issued a concept proposal on a new framework for regulating mutual funds and their managers. The centerpiece of the proposed framework is a requirement for mutual funds to establish a governance agency to oversee the actions of the mutual fund manager. The so-called governance agency would be comprised of three or more individuals, a majority of whom are independent of the fund manager. The governance agency would be responsible for ensuring that the fund manager acts in the best interests of investors. The Canadians' proposed approach might signal a move among some securities regulators toward promoting an enhanced role for independent directors in mutual funds outside the United States.

With respect to independent directors of U.S. mutual funds, I should note that there is no residency requirement for directors. Thus, a foreign fund manager could establish a U.S. fund that has a board of all non-U.S. directors. In addition, there are several other areas where the Investment Company Act does not impose requirements in contrast to other countries. For example, the Investment Company Act does not impose high capital, staffing, residency or U.S. place of business requirements so that a U.S. registered fund can be administered outside of the United States.

IV. U.S. Open Market for Foreign Advisers

It is relatively easy for a foreign adviser to register as an investment adviser in the United States and to set up its own U.S. mutual funds. An adviser, including any foreign adviser that wants to manage a registered mutual fund in the United States, may register as an investment adviser under the Investment Advisers Act of 1940. It is no more difficult for a foreign adviser to register than for a domestic adviser to register under the Advisers Act. There are very few barriers to entry for investment advisers wishing to register in the United States. There are no residency requirements. Thus, an adviser can be located outside the United States and is not required to establish a U.S. subsidiary in order to register as an investment adviser in the United States. There are no minimum educational requirements, and there are no capital requirements for investment advisers, although advisers that sponsor a registered mutual fund must make sure that fund has the requisite seed money of $100,000. The main barrier to registration as an investment adviser in the United States would be if the adviser had been the subject of certain disciplinary actions. I understand that some other regulatory jurisdictions follow a different approach for investment advisers, conducting a pre-approval merit review of those that want to sponsor a fund or manage money in a jurisdiction to ensure that they are "fit and proper" or meet similar regulatory standards.

Many foreign advisers are exempt from registration as advisers in the United States if they have 14 or fewer U.S. clients, do not hold themselves out to the U.S. public as an investment adviser and do not serve as an adviser to an investment company registered under the Investment Company Act. The Advisers Act and its rules make certain accommodations for foreign advisers. In determining whether an adviser qualifies for the 14 or fewer clients exception from the definition of investment adviser, foreign advisers are permitted to count only U.S. clients, while U.S. advisers must count all clients. However, if a foreign adviser chooses, or is required, to register in the United States, it may do so with the Commission, regardless of the amount of assets it has under management. NSMIA amended the Investment Advisers Act so that advisers with $25 million or more in assets under management generally register with Commission, and advisers with less than $25 million generally register with the states. However, all advisers with principal offices outside the United States register with the Commission rather than the states, and this single regulator approach eases some administrative difficulties for foreign advisers. Additionally, although the Advisers Act places certain restrictions on advisory contracts, including limitations on performance fees, the Advisers Act excepts contracts with persons who are not U.S. residents. Congress added this exception in NSMIA, recognizing that the common use of performance fee arrangements in other countries placed U.S.-registered advisers operating in foreign countries at a competitive disadvantage.

V. Examination Cooperation

I should also mention that with the growth in the number of truly global money managers, we have entered into a number of arrangements with foreign regulators to coordinate our inspections of these firms. These examinations have been extremely useful to us, as well as the foreign regulators, since they allow us to have a truly "global" understanding of these businesses and how they operate and issues raised in their operations.

VI. The Internet

No discussion of global challenges in the area of securities regulation would be complete without mention of the Internet. The Internet has no borders and the growing importance of e-commerce in the financial services area, has made it necessary to reconsider traditional regulatory approaches. As a report of the Internet Task Force to the Technical Committee of the International Organization of Securities Commissions ("IOSCO") noted:

Electronic communications and interactivity may not fit neatly within the parameters of statutes, regulations and directives originally intended for a telephone- and paper-based environment, thus creating unnecessary regulatory burdens or unintended regulatory gaps. Moreover, the very qualities that make the Internet a valuable tool for investors and the securities industry may render it a convenient tool to perpetuate securities fraud and other violations. The Internet also provides for instantaneous cross-border communication and interactivity, which challenge traditional notions of jurisdiction and territoriality.

Securities Activity on the Internet, Report of the Internet Task Force to the Technical Committee of the International Organization of Securities Commissions, Sept. 19, 1998, at 2.

It is clear that increasing Internet use presents new challenges for securities regulators and self-regulatory organizations. Recognizing this, IOSCO created an Internet Task Force to examine and provide guidance on issues relating to the impact of the Internet on securities regulations, providing a report that identified Internet issues that should be addressed by each jurisdiction and providing guidance on how to approach these issues. Efforts like this have been successful in helping shape logical and consistent approaches to issues raised by the Internet.


While the task of harmonizing "laws" among various countries is a daunting task, given political and other considerations, we can probably have much greater success in working toward convergence of "regulations" in various countries through organizations like IOSCO. In the fund area, IOSCO has worked to address issues of significant interest among its members including:

  • Performance Presentation Standards
  • Delegation of Functions
  • Conflicts of Interests of Fund Managers
  • Decision-making by Fund Managers
  • Fund Pricing
  • Role of Investor Education in the Effective Regulation of Funds

These kinds of initiatives can assist regulators in analyzing key issues in the fund area and establish general principles and approaches that can lead toward convergence of regulation globally on significant issues of common concern.

VIII. Conclusion

It is clear that Governments and regulators can take additional steps to promote harmonization of securities regulations across international borders, and I hope that the first part of the 21st century is marked by significant movement in this direction. Working through organizations like IOSCO these efforts can be enhanced. In the meantime, conferences such as this one are important in diverting our attention away from our very demanding individual mandates--at least for a short while--so that we can focus on the larger, global picture.

Once again, Joe, thank you for organizing this conference, and I look forward to an interesting and lively discussion.



Modified: 04/23/2002