Address at Investment Company Institute’s 2017 Securities Law Developments Conference

Thank you, Dorothy [Donohue], for that kind introduction.  It’s a pleasure to be with you today.

Before I go further, I must state that the views I express today are my own, and not necessarily those of my fellow Commissioners or the SEC staff.

I would like to start out by thanking everyone in this room for what you do every day to help investors from all over the world save for retirement, college, and other important priorities. Although your client in the investment company space may be the fund sponsor, the investment adviser, or the fund itself—depending upon your role—the person who relies on all of you is ultimately the investor. Investors trust in you to design, operate, and service a product that gets them to where they want to go smoothly, and without problems caused by a design or compliance flaw. In many ways, you are like aircraft designers. Passengers need to have confidence in the safety and soundness of the aircraft. Likewise, investors need to have confidence in the safety and soundness of investment products. Of course, investor trust cannot be designed or manufactured. Trust must be earned—through diligence, through restraint, and through experience.

This conference is one of the ways we at the Commission can dialogue and talk to you about challenges and opportunities facing investment managers and investors.

As you all know, at the Commission, there has been a great deal of change. We have seen the arrival of a new Chairman and a new Director in the Division of Investment Management, Dalia Blass, who you heard from this morning. I thought for my remarks, I would briefly discuss three areas: ETFs, disclosure, and investor trust. All of these areas are important to the people in this room, but more importantly, they are critically important to everyday investors.

Our new Chairman has emphasized the need to place the interest of retail investors front and center in our policies. Focusing on the perspective and needs of retail investors is a view with which I strongly agree and believe will translate into positive progress in these areas.

ETFs

If you look at the Investment Company Act of 1940, you will find principles governing several different types of funds. You will not, however, find a complete blueprint for exchange-traded funds. These were products not familiar to the drafters of the Exchange Act and 1940 Acts. So, if they weren’t specifically written into the law, how did they come to exist? Part of the answer is that the Commission, working with market participants, used its general exemptive authority to allow the creation and trading of these innovative securities. The first ETF would not exist without the first ETF exemptive order.

Since their genesis over 25 years ago, many new chapters have been added to the exchange-traded product story. Many of the children born the year the first exchange-traded fund launched have now graduated from college and may have children of their own. We now see a market of impressive scale and breadth[1] that has arguably reached maturity. That means we have a new range of questions and potential challenges to confront. What do the scale and trading volume of today’s ETPs mean for the markets as a whole? What do we make of the interplay between the liquidity of funds and the liquidity of their underlying investments? Are market participants, and in particular, investors, focused on liquidity appropriately? How should the Commission respond to new product ideas when they offer a different tradeoff between investor protection and variety?

The challenge for the SEC in 2018 is to ensure that its approach to ETPs matures along with the maturation of the market. In 1993, there were no data on ETPs. Today, there are decades of data and observations. This information can help us answer key questions about ETP trading, volatility, transparency, arbitrage, and investor protection.

With data-driven answers to difficult questions, the SEC will be more equipped to respond to novel ETP requests. This means improving our ability to anticipate which developments support investor protection, capital formation, and fair and efficient markets—and which may not. We will also be in a better position to understand and respond to disruptions that may occur as the result of market stress.

In developing these analyses, we also need to avoid thinking about ETPs as a monolith. This umbrella term now encompasses a range of products that are very unlike each other. For example, an ETP promising a highly leveraged return, and an ETP tracking an established broad-based securities market index, are more different than they are alike. That should be consistently reflected in how we talk about these products, to whom they are sold, and the rules that apply. ETPs that seek to provide highly leveraged returns pose unique questions. On the other hand, the issues presented by ETPs that track a broad-based securities market index—so called “plain vanilla ETFs”—are entirely different. Much like in aircraft design, while a passenger jet may be created for retail customers, an F-16 fighter jet is not for everyone. Are there different protections and rules that are appropriate for one and not for the other?

Disclosure

Next, I would like to talk about disclosure. It’s nearly 2018. We’re more than thirty years into the personal computing revolution. How has the SEC’s approach to disclosure changed in that time? Well, instead of typing your disclosure forms and printing them out for filing, you now word process your disclosure forms and file them on EDGAR. In many ways, this is like the move from rotary dialing to touch tone—we went from analog to digital, but the phone we’re using is still basically just a plastic handle with a speaker and a microphone.

Earlier this year, the SEC’s Office of the Investor Advocate held an evidence summit to discuss how investors think, act, and save. One take-away from that summit was that technology is a key tool for enabling investors to make effective investment decisions. For example, we can envision a future where users query SEC data from their smartphones. Or, perhaps even through social media.[2] Can we give investors a quick way to comparison shop—for example, check the box on three companies and see a dynamically generated side-by-side comparison? What if the disclosures were customized for that investor? Why not?

However, as much as I believe in the potential for technology to improve investors’ access to, and use of, disclosure, not every use of technology improves the position of all investors. For example, debate has continued over a rule that would change the way investors receive important information from their mutual funds.[3] The proposed rule 30e-3 would, for the first time, allow funds to provide shareholder reports via the Internet even when investors do not actually choose e-delivery.[4]

This proposal is not about whether the Commission should allow e-delivery or not. I’m actually a big supporter of e-delivery and I think it can have huge benefits. However, as I’ve spoken about in the past, the approach in 30e-3, shifting the burden to investors, concerns me for several reasons. First, for those investors who prefer e-delivery, the electronic format may help them manage information. But some investors prefer paper. Others may not have access to a computer or the Internet. It would therefore be unrealistic to expect that we can impose this additional burden on busy investors without negatively affecting their engagement.

I recognize the potential for cost savings and environmental benefits that proponents of 30e-3 have pointed to. Those are worthy goals, and I support pursuing them, but the Commission is charged with balancing these goals with investor protection.

I do see a potential path forward here. Investors could benefit enormously from a compact and timely disclosure document that they actually look at and understand. In October, the Commission’s Investor Advisory Committee had a panel discussing these issues.[5] In fact, just this morning, the Committee unanimously approved a measure that would, first and foremost, recommend to the Commission that it “continue to explore methods to encourage a transition to electronic delivery that respect investor preferences and that increase, rather than reduce, the likelihood that investors will see and read important disclosure documents.”[6] Furthermore, the Investor Advisory Committee recommended the exploration of a summary document containing the most important details of shareholder reports to be delivered by mail or e-mail, depending upon the investor’s preference.[7] The summary document would then offer the investor a way to easily access additional information.[8] This layered approach would put something substantive in the hands of investors who have not chosen e-delivery. At the same time, it can offer many of the benefits of the proposal by reducing printing and delivery costs. To the extent the cost of delivery continues to reflect fixed costs of intermediaries based on outdated regulatory schedules, let’s work on fixing that. Those costs should not drive the conversation about disclosure affecting millions of Americans.

Investor Trust

Finally, I’d like to share just a few words on investor trust, given its importance in the securities industry.

Since the beginnings of our securities markets, individuals have helped investors buy and sell securities. And since that time, we have been talking about these facilitators’ responsibilities, their duties, and their loyalties. The standard of conduct applicable to broker-dealers and investment advisers has attracted an astonishing amount of comment and public debate. And, frankly, that is not surprising given how much is at stake. U.S. retirement savers represented more than $26 trillion in investments as of June 30, 2017.[9] Separately, households, non-profits, and small businesses held even more than that in non-retirement financial assets.[10] A significant number of these investors will seek the guidance of an adviser or a broker-dealer, and the quality (and cost) of that guidance could affect the well-being of the investors for the rest of their lives.

Moreover, establishing policy in this area is not straightforward because of the many interconnections among financial service providers, financial products, and investors. Despite this complexity and the range of opinions surrounding it, the debate over the standard of conduct comes down to a simple goal. How do we give investors who want investment advice the ability to obtain high-quality advice in the most cost-effective way for their particular situations? Ultimately, how do we help fortify the trust between an investor and his or her financial professional?

The main barrier to achieving these goals, and the concern at the core of the debate around standards of conduct, are conflicts of interest. Conflicts can result from a number of sources and relationships, but some of the most significant are those resulting from compensation arrangements. This is true whether compensation is transactional or fee-based. Each can incentivize certain behaviors that may not be in the best interests of a particular customer or client.

I recently had an incident at home that many of you can probably relate to. My family awoke one morning to an absence of hot water. So, naturally, I engaged the services of a local plumber. I rely on him to advise me on the problem and potential solutions. I will fully admit that I am not an expert in plumbing—I expect that I will have ample amounts of hot water whenever I need it. When he comes to diagnose the problem, I don’t want him to tell me to replace the entire hot water heater if only a part of it needs to be fixed. And if it really does need to be replaced, I don’t want him to sell me an overpriced hot water heater with a gigantic tank—one that heats more hot water than my family will ever need. And finally, I especially don’t want him to sell me an inferior hot water heater just because my plumber has a better wholesale rate from a particular brand. This example is somewhat trivial, but it makes the point.

Brokers and advisers should be required to mitigate these conflicts, and the standard of conduct by which they provide advice can help ensure that that happens. The question is not whether it is better to have multiple standards or one standard that fits all. The question ought to be whether the standard is appropriate for the conduct in which the person is engaging. And to say that any of the existing standards are perfect would be to advance the notion of precedent over what is ultimately right for those receiving advice.

Disclosure has always been an important piece of this puzzle for the Commission and the securities laws, and there are clearly existing models on both the broker-dealer and investment adviser sides. However, we all know that providing disclosure, and ensuring that those disclosures are effective, are very different things. Certain academic evidence notes that disclosure leads advisers to be even more biased by seeming to absolve them from paying attention to their advisees’ interests.[11] In effect, disclosure has limited utility for both the investor and the professional providing it to the investor.

Therefore, I would suggest that disclosure is just one piece of an important and complicated puzzle. It cannot be the only step we take when addressing conflicts of interest between a financial professional and his or her customer.

In closing, I want to thank the ICI for inviting me to come speak today. Investment companies are so important to millions of American households and I look forward to your continuing participation and dialogue on these important policy areas.