Proposed Rule: Investment AdviserYear 2000 Reports
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
(Release No. IA-1728; IC-23293; File No. S7-20-98)
Investment Adviser Year 2000 Reports
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
SUMMARY: The Securities and Exchange Commission ("Commission") is publishing for comment a proposed new rule and form under the Investment Advisers Act of 1940 that would require most registered investment advisers to file with the Commission a report regarding preparations for the Year 2000 computer problem. The reports would inform the Commission about the steps that investment advisers have taken, and will take, to prepare for the challenges posed by the Year 2000 problem.
DATES: Comments must be received on or before August 10, 1998.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Stop 6-9, Washington, D.C. 20549. Comments also may be submitted electronically to the following E-mail address: email@example.com. All comment letters should refer to File No. S7-20-98; this file number should be included on the subject line if E-mail is used. Comment letters will be available for public inspection and copying in the Commissions Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549. Electronically submitted comment letters also will be posted on the Commissions Internet web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Arthur B. Laby, Special Counsel, at (202) 942-0716, Task Force on Investment Adviser Regulation, Division of Investment Management, Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 5-6, Washington, D.C. 20549.
SUPPLEMENTARY INFORMATION: The Commission today is requesting public comment on proposed rule 204-5 (17 CFR 275.204-5) and Form ADV-Y2K (17 CFR 279.9) under the Investment Advisers Act of 1940 ("Advisers Act") (15 U.S.C. 80b).
I. BackgroundThe Commission is undertaking a review of U.S. public companies and the U.S. securities industry to examine whether they will be prepared for the computer challenges associated with the Year 2000. 1 As part of this initiative, in March 1998, the Commission requested comment on proposed rule changes that would require certain broker-dealers 2 and transfer agents 3 to file with the Commission a report on Year 2000 readiness. The Commission today is requesting comment on a new rule and form that would require most investment advisers registered with the Commission under the Advisers Act to file a report on Year 2000 readiness.
Investment advisers ("advisers") manage approximately $13 trillion of savings of American families. These assets are managed on behalf of investors directly, as well as indirectly through financial institutions such as employee benefit plans, trusts, hedge funds and mutual funds. Mutual funds alone control over $5 trillion of assets, 4 35 percent of which are estimated to be retirement plan assets. 5 Thus, investment advisers play a key role in the economic life of America today.
Advisers manage these assets using computer systems that connect them with the markets, service providers and clients. In addition, advisers depend upon internal computer systems for various management, compliance and recordkeeping functions. 6 The development and growth of the Internet has made advisory clients more dependent upon their advisers computer systems to provide them with information about their adviser and their portfolios. The failure of the advisers or third parties computer systems to function properly as a result of the Year 2000 problem could threaten the ability of advisers to manage properly client assets, communicate information to their clients and comply with the federal securities laws.
Investment companies ("funds") also are highly dependent on sophisticated computer systems to communicate with their advisers and other third parties such as underwriters, brokers, transfer agents, custodians and sub-advisers. To manage their portfolios, calculate net asset values, keep accurate records, process shareholder purchases and redemptions, and timely deliver disclosure documents and account statements, funds and their advisers continuously must exchange information with each other and with their service providers. A breakdown in this exchange of information could interfere with the day-to-day management of fund portfolios, delay shareholder transactions and compromise recordkeeping and other compliance systems.
The Commission has identified six steps of preparation that advisers and funds can take to prepare for the Year 2000 computer problem. These steps are: (i) awareness of potential Year 2000 problems; (ii) assessment of steps advisers and funds must take to avoid Year 2000 problems; (iii) implementation of the steps to avoid Year 2000 problems; (iv) internal testing of software designed to avoid Year 2000 problems; (v) point-to-point testing of software designed to avoid Year 2000 problems (i.e., testing with service providers such as broker-dealers, custodians, transfer agents and distributors); and (vi) implementation of tested software that will avoid Year 2000 problems. By taking these steps now, advisers and funds more likely can solve potential Year 2000 problems well in advance of December 31, 1999.
The Commission has for some time recognized the challenges that the Year 2000 poses for advisers and funds. Since 1996, Commission examiners have raised Year 2000 concerns during adviser and fund examinations to increase awareness of, and encourage aggressive and timely action to address, Year 2000 problems. In 1997, Chairman Levitt sent a letter to all registered investment advisers warning of the consequences of not being Year 2000 compliant and urging them to make preparations for the Year 2000 their highest priority. In 1997, the staff provided guidance on the disclosure obligations of advisers and funds. 7 Commissioners and members of the staff have met with industry and professional groups to express these concerns.
Today, the Commission is proposing to require most advisers registered with the Commission to complete and submit a report to the Commission on their preparedness for the Year 2000 problem. The reports will help the Commission evaluate the readiness of advisers for the Year 2000 problem, identify those advisers and funds that pose a significant risk to their clients and shareholders, and evaluate the adequacy of disclosure made by these firms regarding the Year 2000 problem. Finally, the proposed rule will permit the Commission to make the reports about Year 2000 preparations of advisers and funds available to the public and to fulfill Congressional requests for information regarding the securities industrys readiness for the Year 2000 problem.
II. DiscussionThe Commission is proposing new rule 204-5, which would require most investment advisers registered with the Commission to file with the Commission new Form ADV-Y2K. 8 Form ADV-Y2K would be filed by each investment adviser that (i) is registered with the Commission, and (ii) has at least $25 million of assets under management 9 or is an adviser to an investment company registered under the Investment Company Act of 1940. 10 The form would have to be filed no later than 30 days after the rule becomes effective, and an updated form would have to be filed no later than eight months from the date of the first filing. The second filing would reflect progress made in preparing for the Year 2000 problem up to that time.
Proposed Form ADV-Y2K has two parts. Part I would be completed by all respondents and would contain 11 questions about the advisers preparation for the Year 2000 problem with respect to all of the advisers clients. The questions all would be in multiple choice or fill-in-the-blank format, and advisers would be required to respond to each question. Part II would consist of questions similar to those in Part I and would be completed by advisers to a registered fund or a group of registered funds.
Investment companies are frequently organized into groups, called "complexes" or "families," that realize efficiencies by sharing administrative functions. The instructions to Part II of the proposed form specify that each adviser (or sub-adviser) to a fund must complete Part II with respect to an entire complex if the adviser advises a single fund (or a series) in the complex. An adviser, however, need not complete Part II for the complex or a fund (or a series) with respect to which another adviser is completing Part II. 11 The effect of the proposed approach would permit multiple advisers to funds in a single fund complex to decide among themselves which adviser will be responsible for completing Part II with respect to the complex, but would assure that the Commission receives Year 2000 information with respect to most funds. Comment is requested on this proposed approach.
The instructions are designed so that the reporting adviser for a fund complex would likely be the adviser that has administrative responsibilities for the complex and thus is in the best position to report on the Year 2000 readiness of the complex -- even if that adviser does not provide advice for all funds in the complex. 12 An adviser responding to Part II on behalf of multiple complexes would complete multiple versions of Part II, one for each complex. 13
The form would require each responding investment adviser to provide the Commission with information relating to the following areas: (1) the scope and status of the advisers Year 2000 compliance plan; (2) the commitment by the adviser of resources and personnel (including consultants) to address Year 2000 issues; (3) the systems that may be affected by the Year 2000 problem; (4) progress on each of the six steps of preparation identified above; 14 (5) contingency plans in the event that the adviser experiences Year 2000 difficulties after December 31, 1999; 15 and (6) the readiness of third parties upon whom the adviser relies for critical systems. The report would be required to be signed by an authorized person that participates in managing or directing the advisers affairs, but would not be required to be attested to by an independent public accountant. Comment is requested on whether an attestation by an independent public accountant should be required.
The Commission understands that an adviser or fund may rely on multiple systems that are at different stages of preparation for the Year 2000 problem. An adviser or fund, for example, may use separate systems for portfolio management, financial planning and client services. In those cases, the Commission is asking the reporting adviser to take a qualitative average and present the most accurate picture practicable of the preparedness of the systems of the adviser or the fund. In requiring a qualitative average, the Commission intends to be flexible and take a common sense approach. If an adviser, for example, uses two computer systems that are at different stages of preparedness, but one of those systems is more critical than the other, the adviser should base its responses primarily on the more critical system. Comment is requested on this approach, and on whether alternative ways to request information for multiple systems is desirable. Would it be preferable, for instance, to require advisers and funds to respond to questions about their preparedness for the Year 2000 problem on a system-by-system basis? Comment also is requested on what information advisers to funds underlying variable insurance contracts should be required to provide regarding systems supporting the contracts and the separate accounts and insurance companies issuing the contracts?
Advisers would be required to file Form ADV-Y2K by fax; a paper filing would not be accepted. Instructions in the form would direct advisers to use specified fax numbers. The Commission believes that all advisers have access to a fax machine and that, as a result, this filing method will reduce filing burdens. Comment is requested on the Commissions assumption that all advisers will be able easily to file the form by fax.
III. General Request for CommentAny interested persons wishing to submit written comments on the proposed rule and form that are the subject of this release, suggest additional changes, or submit comments on other matters that might have an effect on the proposal contained in this release, are requested to do so.
IV. Cost/Benefit AnalysisThe Commission is sensitive to the costs and benefits imposed by its rules, and understands that completing Form ADV-Y2K may impose costs on advisers and funds. 16 As discussed below, the Commission believes that the costs imposed by requiring advisers to complete Form ADV-Y2K are necessary and justified in light of the need to make information on the Year 2000 problem available to investors, Congress and the Commission.
The Commission believes that requiring advisers to report on their readiness for the Year 2000 problem would yield several important benefits, both direct and indirect. As discussed above, the Year 2000 reports required by the rule would yield direct benefits because they would help the Commission evaluate the preparedness of advisers and funds for the Year 2000 computer problem. The reports also would identify advisers and funds that may not be preparing for the Year 2000 problem and may pose a risk to their clients and shareholders. The reports also would identify disclosure by advisers and funds regarding risks associated with the Year 2000 problem that may be inadequate. Finally, the reports would permit the Commission to make information available to the public and to fulfill requests by members of Congress for information regarding the securities industrys readiness for the Year 2000 problem.
The Year 2000 reports also would yield important indirect benefits. By requiring the Year 2000 reports now, some advisers and funds, whose Year 2000 preparedness efforts to date have been inadequate, may be persuaded to accelerate their efforts, which would save them significant costs in the future if they failed to meet the Year 2000 challenge. 17 This indirect benefit is difficult to quantify because it is hard to estimate the costs that could be incurred if computer systems of advisers and funds fail to function properly after December 31, 1999. 18 Moreover, if the systems of advisers and funds were to fail after December 31, 1999, it could have negative effects not only for the advisers and funds themselves, but also for investors and third parties, such as underwriters, brokers, transfer agents, custodians, sub-advisers and other service providers.
Avoiding the harm to third parties may be one of most important benefits to proper preparation for the Year 2000 problem. Most firms computer systems today depend on the systems of many other firms and individuals. If even one of these systems were to fail, this could have negative repercussions on the systems of other firms with which its computers interface. The failure to address this interdependence may be one of the greatest harms stemming from the Year 2000 problem. 19 The benefit of avoiding this harm from occurring, although difficult to quantify, may be extremely significant to investors, firms and the economy in general.
The proposed rule would impose some additional costs on advisers and funds. Advisers may need to spend resources obtaining answers to questions in the form, completing the form and submitting it to the Commission. These costs may vary from adviser to adviser. Small advisers, for example, may spend comparatively little time completing the form because small advisers likely have fewer systems and one person may be responsible for all of the systems. This person is likely to have all of the information necessary to complete the form and can do so in a few minutes. Larger advisers may require more time. Larger advisers are more likely to have more computer systems and it is possible that the adviser would have to draw on the knowledge of several individuals to complete the form.
The Commission estimates that there are approximately 7,500 investment advisers registered with the Commission, approximately 6,500 of which would be required to file Form ADV-Y2K. Although the time needed to comply with the rule could vary from adviser to adviser, the Commission estimates that a respondent will devote approximately two employee hours of time to completing Part I of the form. In addition, approximately 891 registered investment advisers have registered investment companies as clients. Therefore, those 891 advisers may be required to spend an additional two hours completing Part II of the form on behalf of a fund or fund complex. These estimates are based on field-testing of the form by the Commissions Office of Compliance, Inspections and Examinations. The total annual burden will be 14,782 hours ((6,500 advisers x 2 hours) + (891 advisers x 2 hours)). The form will likely be completed by information technology professionals. The Commission estimates the hourly wage rate for these professionals to be $100 per hour. Therefore, the Commission estimates that the total annual cost of completing the forms is $1,478,200. The Commission believes that the proposed rule would not impose significant additional costs on investment advisers.
The Commission believes that the costs imposed by the rule are insignificant compared to the benefits. If advisers and funds are not prepared for the Year 2000 problem, the effect on advisers and funds, and their clients and third party service providers, could be very substantial. The chance of ameliorating the Year 2000 problem with respect to advisers and funds justifies the minimal costs involved.
The Commission requests comment on the effect of the proposed rule on individual investment advisers and on the profession as a whole. Commenters should provide data and analyses relating to the costs and benefits associated with the proposed rule. Comment is requested on the costs of filing Form ADV-Y2K by fax with the Commission. This information would assist the Commission in its evaluation of the costs and benefits that may result if the proposed rule is adopted.
For purposes of the Small Business Regulatory Enforcement Fairness Act of 1996, the Commission is also requesting information regarding the potential effect of the proposed rule on the economy on an annual basis. Commenters should provide empirical data to support their views.
Comment is requested on this cost/benefit analysis. Commenters are requested to provide views and empirical data relating to any costs and benefits associated with the proposed rule.
V. Summary of Regulatory Flexibility AnalysisThe Commission has prepared an Initial Regulatory Flexibility Analysis ("IRFA"), in accordance with the provisions of the Regulatory Flexibility Act, 20 regarding the proposed rule. As discussed more fully in the IRFA, few or none of the advisers that the proposed rule would affect are small entities, as defined by new Commission rules. 21 The IRFA states that the purpose of the proposed rule is for the Commission to ascertain what steps advisers and funds are taking to avoid Year 2000 problems.
The IRFA sets forth the statutory authority for the proposed rule. The IRFA also discusses the effect of the proposed rule on advisers that are small entities. An adviser generally is a small entity (i) if it manages assets of $25 million or less reported on Form ADV-T (17 CFR 279.3) or its most recent Schedule I to Form ADV (17 CFR 279.1), (ii) if it does not have total assets of $5 million or more on the last day of the most recent fiscal year, and (iii) if it is not in a control relationship with another investment adviser that is not a small entity. The Commission estimates that there are approximately 7,500 registered advisers, approximately 1000 of which are small entities. The Commission estimates that few or none of the small entities would be required to complete Form ADV-Y2K.
Under the terms of the rule, only an adviser that is (i) registered with the Commission, and (ii) has assets under management of not less than $25 million or is an investment adviser to an investment company registered under the Investment Company Act must file Form ADV-Y2K. Since the new definition of small entity establishes a threshold of $25 million under management, most or all small entities would be exempted from the rule by its terms. In addition, the Commission believes that few or no investment advisers that have less than $25 million under management have more than $5 million in assets or are in a control relationship with an entity that is not considered a small entity. Finally, the only small entities that still would be subject to the rule are those small entities that advise a registered investment company. The Commission is not aware of any small entity that advises a registered investment company. Comment is requested on the number of small entities that would not be subject to the rule. 22
The IRFA states that the proposed rule would impose new reporting requirements because most investment advisers would have to file with the Commission a new form regarding their readiness for the Year 2000 problem. The Commission estimates that, on average, a respondent would devote approximately two employee hours of preparation time to completing Part I of the form in 1998 and again in 1999. If the adviser is required to complete Part II, it would devote approximately an additional two hours to completing the form in 1998 and in 1999. The IRFA states that the Commission estimates that few or no small entities would be required to complete Form ADV-Y2K. The IRFA states that the proposed rule would not impose any other reporting, recordkeeping, or compliance requirements, and that the Commission believes that there are no rules that duplicate, overlap, or conflict with the proposed rule.
The analysis discusses the various alternatives considered by the Commission in connection with the proposed rule that might minimize the effect on small entities, including: (a) the establishment of differing compliance or reporting requirements or timetables that take into account the resources of small entities; (b) the clarification, consolidation, or simplification of compliance and reporting requirements under the proposed rule for small entities; (c) the use of performance rather than design standards; and (d) an exemption from coverage of the rule or any part of it, for small entities. The Commission has determined that it is not feasible to further clarify, consolidate, or simplify the proposed rule for small entities.
As discussed in the analysis, most or all small entities are exempted from the rule. The Commission believes that it would be inconsistent with the purpose of the rule proposal to further exempt small entities from the proposed rule or to use performance standards to specify different requirements for small entities. As discussed in the IRFA, investment advisers registered with the Commission would be required to file Form ADV-Y2K because they likely have substantial financial exposure to the market and investors.
In the IRFA, the Commission encourages the submission of written comments with respect to all aspects of the IRFA. In particular, the Commission is interested in comments that specify costs of compliance with the proposed rule, and suggest alternatives that would accomplish the objective of the proposed rule. A copy of the IRFA may be obtained by contacting Arthur B. Laby, Division of Investment Management, Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 5-6, Washington, D.C. 20549.23 and the Commission has submitted them to the Office of Management and Budget for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The title for the collection of information is: "Proposed Rule 204-5" and "Form ADV-Y2K."
Collection of information by the Commission is contemplated by the proposed rule because registered advisers would have to file new Form ADV-Y2K with the Commission. Advisers would be required to file Form ADV-Y2K twice, first no later than 30 days after the rule is effective and again eight months from the date that the first filing must be made. The form is necessary for the Commission to assess the steps advisers are taking to manage and avoid Year 2000 problems.
The Commission estimates that there are approximately 7,500 investment advisers registered with the Commission, approximately 6,500 of which would be required to file Form ADV-Y2K. Although the amount of time needed to comply with the rule could vary from adviser to adviser, the Commission estimates that, on average, a respondent would devote approximately two employee hours of preparation time to completing Part I of the form, and an additional two employee hours to completing Part II of the form, if the adviser is required to complete Part II. This estimate is based on field-testing of Form ADV-Y2K by the Commissions Office of Compliance, Inspections and Examinations. The total annual burden will be 14,782 hours ((6,500 advisers x 2 hours) + (891 advisers x 2 hours)). It is important to note that this burden would be incurred only twice, once in 1998 and once in 1999. The rule would not impose an ongoing reporting requirement.
An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number. Filing of this form is mandatory. The principal purpose of this collection of information is to enable the Commission to address the Year 2000 problem faced by advisers and funds. The Commission would use the information, among other things, to assess the readiness of advisers and funds for the Year 2000 problem and make the information available to the public, to assist the Commission in its inspection and examination program and to report to Congress on the readiness of advisers and funds for the Year 2000 problem. Any member of the public may direct to the Commission any comments concerning the accuracy of the burden estimate of this form, and any suggestions for reducing this burden.
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits commenters to:
(i) evaluate whether the proposed collection of information is necessary for the proper performance of the functions of the agency, including whether the information will have practical utility;
(ii) evaluate the accuracy of the Commission's estimate of the burden of the proposed collection of information;
(iii) enhance the quality, utility and clarity of the information to be collected; and
(iv) minimize the burden of collection of information on those who are to respond, including through the use of automated collection techniques or other forms of information technology.
Persons desiring to submit comments on the collection of information requirements should direct them to the following persons: Desk Officer for the Securities and Exchange Commission, Office of Information and Regulatory Affairs, Office of Management and Budget, Room 3208, New Executive Office Building, Washington, D.C. 20503; and Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, and refer to File No. S7-20-98. OMB is required to make a decision concerning the collection of information between 30 and 60 days after publication of this release in the Federal Register, so a comment to OMB is best assured of having its full effect if OMB receives it within 30 days of this publication.
VII. Statutory AuthorityThe Commission is proposing new Rule 204-5 and new Form ADV-Y2K pursuant to the authority set forth in sections 204 and 211(a) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-4 and 80b-11(a)).
List of Subjects in 17 CFR Parts 275 and 279
Reporting and recordkeeping requirements, Securities.
TEXT OF PROPOSED RULES AND FORM
For the reasons set out in the preamble, Title 17, Chapter II of the Code of Federal Regulations is proposed to be amended as follows:
PART 275 - RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
1. The authority citation for Part 275 continues to read in part as follows:
Authority: 15 U.S.C. 80b-2(a)(17), 80b-3, 80b-4, 80b-6(4), 80b-6a, 80b-11, unless otherwise noted.
* * * * *
2. Section 275.204-4 is added and reserved and § 275.204-5 is added to read as follows:
§ 275.204-4 Reserved.
§ 275.204-5 Year 2000 reports.
Every investment adviser registered with the Commission that has assets under management of not less than $25 million or is an investment adviser to an investment company registered under the Investment Company Act of 1940 (15 U.S.C. 80a-1) must file with the Commission by fax in accordance with the instructions in the form:
(a) A completed Form ADV-Y2K (17 CFR 279.9) no later than (30 days after the rule becomes effective); and
(b) An additional Form ADV-Y2K, no later than (eight months from the date that the first filing must be made), reflecting information as of the date of the filing.
PART 279 - FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 1940
3. The authority citation for Part 279 continues to read as follows:
Authority: The Investment Advisers Act of 1940, 15 U.S.C. 80b-1, et seq.
4. Section 279.9 and Form ADV-Y2K are added to read as follows:
§ 279.9 Form ADV-Y2K.
This form must be filed pursuant to § 275.204-5 of this chapter by certain investment advisers.
Note: The text of Form ADV-Y2K will not appear in the Code of Federal Regulations.
By the Commission.
Jonathan G. Katz
Dated: June 20, 1998
(The text of Form ADV-Y2K will appear in the Federal Register and is available from the Commissions Public Reference Room)