May 22, 2000
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Mail Stop 6-9
Washington, D.C. 20549
Re: Commission File No. 4-433; Roundtable on Investment Adviser Regulatory Issues
Dear Mr. Katz:
These comments are submitted in connection with the SEC's upcoming roundtable on investment adviser regulatory issues. Pickard and Djinis LLP is a law firm specializing in securities regulation relating to investment advisers, broker-dealers and service providers thereto. Our investment adviser client base ranges from federally registered firms with billions of dollars of assets under management to state-regulated solo practitioners. We appreciate the Commission's examination of important regulatory issues affecting our clients.
MODERNIZATION OF ADVISER REGULATION
One of the most perplexing issues we are encountering is the application of the publishers' exemption to electronic publications that permit limited interactivity between author and investor. For example, some publications deliver screen-based, impersonal investment advice to subscribers who are also afforded the opportunity to call the securities analyst in question for further information about the subject of the article. Although these publications may recommend the purchase or sale of certain securities, recommendations are not targeted to a subscriber's particular situation.
The interactive communication component of such electronic services appears to render the publishers' exemption (as it is currently construed) unavailable. Nevertheless, many of the Advisers Act's regulatory requirements cannot easily or logically be applied in this situation. For example, the requirement under Rule 204-2(a)(7) that advisers maintain for a period of five years copies of all written recommendations to clients imposes an enormous burden on screen-based services that might post new recommendations every 30 minutes.
The CFTC recently expanded the scope of the publishers' exemption under the Commodity Exchange Act to include a commodity trading adviser that does not direct trading on behalf of client accounts and does not provide advice based on or tailored to specific clientcircumstances.1 The mere presence of interactive communications between the commodity trading adviser and clients does not destroy the availability of the exemption. The SEC should consider whether this approach should be adopted under Section 202(a)(11) of the Advisers Act.
A somewhat thornier question involves internet-based financial planning services. Here, a computer program delivers asset allocation models and other types of investment advice based upon an investor's answers to a series of screen prompts. The advice rendered by such services is "personalized" to the extent that different recommendations are given to different subscribers depending on their answers to the service's standard questions. On the other hand, the relationship between the adviser and investor in such a situation is hardly the type of fiduciary bond that requires all the protections of the Advisers Act.
It would be helpful for the Commission to address the applicability of the publishers' exemption to this type of advisory service as well.
There are at least three reasons why establishing a self-regulatory organization for investment advisers is a bad idea. First, it is unnecessary. The bifurcated regulatory regime created under NSMIA has done an excellent job of ensuring that all registered investment advisers are subject to some form of meaningful oversight. There is no evidence that the public cannot adequately be protected by the current regulatory regime. Second, subjecting investment advisers to regulation by a new, quasi-governmental body is completely antithetical to one of the most important goals of NSMIA -- reducing the cost imposed on advisers and their clients by overlapping and duplicative regulation.2
Finally, given the problems the securities industry is experiencing with broker-dealer SROs, this is a particularly inopportune time to consider creating an SRO for investment advisers. Existing SROs such as the NASD and NYSE are struggling to balance their role as securities law enforcers with their quest to act as commercial vendors in zealous competition with their members.3 Plans for demutualizing these organizations are in the works, and the effect of demutualization on the future of self-regulation is uncertain.
Nothing good would come from establishing a self-regulatory organization for investment advisers. The idea should be buried once and for all.
Rule 17j-1 under the Investment Company Act requires investment advisers to registered investment companies to maintain personal trading codes of ethics. In recognition of the broadvariations in investment advisers' operations, Rule 17j-1 is mostly process-oriented and does not mandate the substance of a particular code of ethics. The Commission recently amended this rule to enhance personal trading oversight by fund boards of directors.
Although there is no rule under the Advisers Act analogous to Rule 17j-1, all federally registered advisers already have an incentive to maintain personal trading procedures. Sections 203(e)(6) and (i) of the Advisers Act authorize the SEC to sanction an adviser who fails reasonably to supervise an errant employee. In order to reasonably supervise its employees, an adviser must: (1) establish procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect, insofar as practicable, any violation of the securities laws by the adviser's employees, and (2) reasonably discharge its duties and obligations under such procedures and system without reasonable cause to believe that the procedures and system are not being complied with. Furthermore, Rule 204-2(a)(12) already obligates advisers to maintain records reflecting their associated persons' personal trading activities. It is not clear what else a new code of ethics rule could do.4
It appears that the investing public would be better served by the Commission's issuing a release describing the types of personal trading conduct that could lead to violations of the Advisers Act's antifraud provisions, and reminding advisers of the risks they run under Section 203 if they fail to establish adequate policies and procedures to prevent such violations.
CONFLICTS OF INTEREST
The current requirement under Advisers Act Section 206(3) that advisers notify clients of and obtain consent to each and every principal transaction is unworkable. If advisers try to communicate with their clients before principal trades are executed, time-sensitive trading opportunities may be lost. If advisers rely on post-execution/pre-settlement notice and consent, they run the risk of having to absorb the losses on unprofitable trades that clients reject. The Commission should consider adopting a rule permitting prospective notice and consent for all principal trades.
ADVERTISING AND PERFORMANCE REPORTING
The current state of the law on investment adviser performance advertising cannot be divined from Rule 206(4)-1, but rather is an amalgamation of a number of no-action letters issued over the years. An adviser who endeavors to comply with this staff-created body of law winds up producing advertisements with an inordinate amount of detailed disclosure that often overwhelms the reader. If the adviser also tries to comply with AIMR's Performance Presentation Standards, the result is even worse.
To correct this situation, guidelines regarding clear and sensible disclosure of the limitations of portraying performance results should be incorporated into Rule 206(4)-1 after notice and opportunity for public comment.
TECHNOLOGY AND INVESTMENT ADVISER REGULATION
Although we will be submitting more detailed comments on the Commission's ADV and IARD proposals before the June 13th deadline, we submit the following points for discussion at the roundtable:
We appreciate the opportunity to comment on these important issues.
1 See 65 Fed. Reg. 12938 (March 10, 2000).
2 S. Rep. No. 293, 104th Cong., 2d Sess. 2 (1996).
3 See e.g., Miller, Sam Scott, "Nasdaq as a Competitor," Traders Magazine (August 1998) p. 15.
4 Rule 17j-1's approach to code of ethics oversight is particularly inapposite to non-mutual fund advisers where there are no "boards" for the advisers to report to. Putting the onus on advisory clients to monitor their adviser's personal trading practices is unwieldy and would serve no one's interests.
5 These include but are not limited to the fact that: (a) registrants must be logged onto the NASD's system in order to work on their registration documents; thus, they cannot draft or edit documents whenever the system is unavailable. They also run the risk of losing documents that are not finalized and filed within a certain period of time, because the system is purged periodically and all unfiled drafts are erased; (b) only a limited number of characters are permitted for answers to Form BD questions, and no provision is made for spillover; (c) Yes/No questions do not provide for N/A answers; (d) instead of receiving affirmative notification of deficiencies in their BD filings, brokers now must interrogate Web CRD to check the sufficiency of their forms, which wastes the brokers' time.