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Statement at Open Meeting on Investment Company Liquidity Risk Management Programs, Investment Company Swing Pricing, and Investment Company Reporting Modernization Releases

Commissioner Michael S. Piwowar

Oct. 13, 2016

Thank you, Chair White.

I want to start by thanking the staff who worked so hard on these rules. People outside the agency may not appreciate the amount of time and energy involved in a rulemaking, particularly when there are changes at the end of the process in response to Commissioner comments. Every change in the rule text requires corresponding edits throughout the release. Doing this for one rulemaking is daunting. Here, the staff was incorporating changes for three complex rulemakings at the same time, which required them to spend evenings and weekends turning around updated drafts within a tight timeframe.

Today’s recommendations continue a series of initiatives aimed at ensuring that the Commission’s regulatory program fully addresses the increasingly complex portfolio composition and operations of the asset management industry. Most recently, we adopted rule and form amendments intended to modernize and enhance data reporting for investment advisers to reflect current markets.

While I support one of today’s recommendations, I am unable to support the other two.

Investment Company Liquidity Risk Management Programs

The liquidity risk management recommendation illustrates what is best about the Commission’s rulemaking process. The final rule reflects the staff’s thoughtful consideration of the comments received on the proposal, and incorporates the public’s input. As a result, today’s recommendation makes a number of improvements. From my perspective, the most significant improvements are:

  • Shifting the focus of a fund’s liquidity risk management from the ability of a fund to meet redemption requests without materially affecting the fund’s net asset value (“NAV”) to a fund’s ability to meet redemptions without significant dilution of remaining investors’ interests in the fund;
  • Decreasing the number of liquidity classifications for fund investments from six to four;
  • Allowing a fund to classify its investments on an asset-class basis, instead of requiring a fund to classify each of its assets according to the liquidity categories in the proposed rule; and
  • Removing the prohibition on purchasing assets other than highly liquid investments if the highly liquid investment minimum is breached.

I am especially pleased with the removal of the prohibition on purchasing assets other than highly liquid investments if the highly liquid investment minimum is breached. Many of the market participants with whom I spoke stressed the importance of being able to acquire assets that the fund believes would benefit it and its shareholders, as long as the acquisition is consistent with the fund’s investment strategy. Market participants also noted that maintaining the ability to purchase less liquid assets would help prevent a deterioration of their liquidity.

The rule, however, still focuses on a fund’s ability to redeem shares within three days. For example, the highly liquid investment minimum requires a fund to set a minimum percentage for fund investments that must be convertible to cash in three business days or less without the conversion to cash significantly changing the market value of the investment. As I noted with the proposal, Section 22(e) of the Investment Company Act only requires that the fund make payment within seven days of the securities being tendered. Therefore, I still would have preferred that the rule use the seven-day statutory period as the default for the highly liquid investment minimum.

However, after consultations with staff in our Office of the General Counsel, I am comfortable that the Commission has the authority to adopt the liquidity risk management programs rule we are voting on today. We are no longer prohibiting funds from acquiring assets other than those that may be converted to cash within three days if the highly liquid investment minimum is breached. In addition, many funds, such as those that have arrangements with broker-dealers to redeem fund shares in less than seven days, already do so.

Therefore, I support the staff’s liquidity risk management programs recommendation.

Investment Company Swing Pricing

The recommendation to adopt swing pricing is intended to address the fact that the costs of providing liquidity to redeeming and subscribing investors are often borne by the other investors in the fund. Swing pricing aims to prevent the dilution of interests of non-redeeming shareholders by allowing the fund to adjust its NAV in order to pass on the costs to the redeeming or subscribing investors.

I have several investor protection concerns with the swing pricing recommendation. As I mentioned when swing pricing was proposed, and as is pointed out in the proposing and adopting releases, adopting a swing pricing threshold could open the door to harmful gaming behavior. For example, sophisticated investors could time their purchases and redemptions based on the likelihood that a fund would adjust its NAV. During my first tour at the Commission, I saw first-hand the substantial harm that short-term market timing strategies can inflict on long-term mutual fund shareholders. In addition, with swing pricing, funds could artificially enhance returns by swinging in an amount greater than the costs of redemptions or subscriptions.

However, my primary investor protection concern is that swing pricing will be used to conceal from investors the true costs they will incur upon the purchase and sale of their fund shares. As the Commission acknowledges in the adopting release, redemption fees are not widely used by funds because they “are viewed as unpopular with investors.”[1] The Commission further acknowledges that “[g]iven the limited swing pricing disclosures a fund must make, it may also be difficult for investors to determine if the swing factor has charged them in excess of true trading costs, and may make it difficult for investors to disentangle true fund performance from swing pricing effects.”[2] In other words, swing pricing grants regulatory approval for a fund to impose unpopular costs on investors in a non-transparent way.

Therefore, I cannot support the staff’s swing pricing recommendation.

Investment Company Reporting Modernization

Finally, while I support the overall goal of modernizing investment company reporting to enhance both regulatory and public transparency, I cannot vote to adopt the reporting modernization rule. A key component of the proposal was new Rule 30e-3 under the Investment Company Act, which would have reflected the evolving trends and preferences in Internet usage and permitted, but not required, website transmission of fund shareholder reports. Rule 30e-3 was the one component of the reporting modernization proposal that promised a reduction in costs for fund shareholders. In addition, it offered the hope that more investors would read and make greater use of fund disclosures. Unfortunately, Rule 30e-3 is not included in today’s rulemaking.

There is the possibility that Rule 30e-3 will be presented at a Commission meeting later this year. But with an already crowded agenda, I am concerned that timeline is not going to be met. We are currently actively considering two releases. In November, we will need to vote on a lengthy Consolidated Audit Trail (“CAT”) release. We also need to adopt final rules regarding capital and margin requirements for security-based swap dealers. Furthermore, in addition to rulemaking, our calendar for the rest of the year includes our weekly enforcement meetings, an Equity Market Structure Advisory Committee (“EMSAC”) meeting, a FinTech roundtable, and a Regulation S-K study required by section 72003 of the FAST Act.

Despite this busy calendar, I believe that Rule 30e-3 can be completed if we efficiently manage the Commission’s resources. To that end I commit to neither calling for, nor working on, any non-emergency rulemakings beyond the four I just mentioned until we vote on Rule 30e-3. And, if necessary, I will also agree to delay the Public Company Accounting Oversight Board (“PCAOB”) budget hearing, the issuance of the concept release on Industry Guide 3, and any other non-essential items until a final Rule 30e-3 rulemaking is complete.

In closing, I want to thank the staff again for the incredible amount of work they put into today’s rulemakings. They operated within a short window and expended great effort in navigating through the many comments from the Commissioners. Despite my inability to support all of the recommendations at this time, I am grateful for the staff’s dedication.

Thank you. I have no questions.

[1] See Investment Company Swing Pricing, Investment Company Act Release No. 32316 (October 13, 2016) at text accompanying n.33.
[2] See id. at section III.C.1.b.
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