Director, Division of Investment Management
U.S. Securities and Exchange Commission
Palm Desert, CA
March 18, 2013
Thank you, Karrie, for that kind introduction. Before I begin, let me remind you that the views I express are my own and do not necessarily reflect the views of the Commission, any of the Commissioners, or any of my colleagues on the staff of the Commission.
I am pleased to be here before such a large gathering, particularly since that gathering is comprised of professionals committed to serving the needs of America’s investors.
As you are aware, mutual funds are the investment vehicle of choice for retail investors. For many American families, mutual funds serve as a primary source of retirement investing in 401(k) plans and investing for college and higher education in 529 plans. Mutual funds also serve as a vehicle to invest for a down payment on a new home, or even as a “rainy day fund’ for unexpected home repairs or healthcare costs.
Survey data indicate that almost 54 million households, approximately 44 percent of all U.S. households, owned mutual funds in 2012.1 Based on data available from 2004, the typical shareholder had $120,000 invested in mutual funds, which represented 60 percent of the shareholder’s household financial assets.2
Mutual funds undoubtedly are woven into the fabric of many Americans’ lives.
It is essential that we all work together to protect those Americans’ investments. For regulators it is important to provide a rule set that protects investors and promotes full disclosure. The asset management industry has to do its part by offering responsible, cost-effective products; and giving investors the “fair deal” that they expect and deserve.
At the SEC, the Division of Investment Management has worked to refine how its mission fits in with the mission of the SEC to protect investors, ensure fair and orderly markets and promote capital formation. We do our part as the Division works to protect investors; promote informed investment decisions; and facilitate appropriate innovation in investment products and services through regulating the asset management industry. This mission statement was drafted with the help of the entire Division, and we are firmly committed to that mission.
Since becoming Director of the Division of Investment Management last year, I have launched a change program to help the Division develop a culture of continuous improvement. If we are to best serve investors, we need to continue what we are doing well and improve what isn’t working as well.
One area where we are seeking to improve is enhancing our eyes and ears. This effort involves getting a better and more first-hand understanding of the workings of the fund industry. It also involves expanding our source of knowledge so that it doesn’t come from sitting at desks in Washington, DC – but from interacting with you and your colleagues who are directly serving America’s investors.
Risk and Examinations Group
A primary vehicle for improving our eyes and ears is the Division of Investment Management’s new Risk and Examinations Group or “REG.”
The purpose of REG is to conduct rigorous quantitative and qualitative financial analysis of the investment management industry itself, strategically important investment advisers and funds and products. This work will inform the initiatives that the Division devotes resources to and help inform the rules we are drafting.
REG represents a new area of non-legal focus for the Division of Investment Management. And REG is expected to complement the work of the SEC as a whole. One of our goals with REG is to allow the staff to be proactive and get out in front of industry trends, rather than reacting to long-standing practices.
As part of REG’s early-stage work, REG staff and I have been meeting with senior managements and fund boards from some of the largest, or most strategically important, fund complexes. We intend to visit firms of all sizes. The Office of Compliance Inspections and Examinations, or OCIE, is doing most of these visits with us and is focusing its efforts on the largest firms.
As part of these discussions, our focus has been on getting outside of Washington and meeting with firms at their headquarters. That way, the staff can obtain a first-hand view of systems; controls; personnel; and even a sense of the culture of an individual firm. And we find we can learn more about their business operations by seeing them on their home turf.
What all of this underscores is the value of dialogue and two-way communication. We will be better regulators if we have a better understanding of your business. And you will hopefully have a better appreciation for the work we do as regulators if you see that we are willing to reach out to you and genuinely listen.
Some of our most important and most insightful in-person meetings will occur with fund directors. Given American investors’ reliance on mutual funds to serve their basic investing needs, fund directors serve an exceedingly important role.
Fund directors serve as the eyes and ears of fund investors. Directors even serve, in part, as the eyes and ears of regulators. Regulators, particularly regulators with limited resources, can’t be everywhere. We have to leverage gatekeepers and overseers like independent directors.
There is a lot of responsibility on the plates of fund boards. Given the critical oversight role of fund directors, we need to ask some tough questions. We would like to hear from directors about areas where directors believe they are adding value and, in contrast, about areas where they feel that their oversight is more difficult to manage.
There are a number of issues we hope to discuss with fund directors. Are fund directors overextended? Are fund directors’ responsibilities appropriately allocated? Do fund directors spend time on the issues where they can provide the most value?
Are fund directors asked to oversee too many funds? I understand the efficiencies of a single board for multiple funds within a fund family. But at some point, does it become too many funds? How many is too many? Is it 4? Is it 14? Is it 140?
Are fund directors equipped to ask the tough questions, and make difficult calls? For instance, do fund directors focus appropriately on the fees paid to sub-advisers versus the advisers that oversee them? Do fund directors examine whether an adviser’s fee is appropriate given the oversight function they perform, as opposed to the day-to-day portfolio management function?
Do fund directors focus on fee arrangements of securities lending agents, particularly if they are affiliated? Does that focus include flat fees as well as the so-called “fee-splits” for the return on investment of securities lending collateral?
And are fund directors able to focus on these and similarly important issues on a fund-by-fund basis? Many issues related to individual fund expense and fund performance do not lend themselves to consideration on an across-the-board basis. Fund investors in individual funds deserve independent director focus on the particular fund they own, not just a focus on the fund complex generally.
Our goal should be to maximize the value of fund boards for fund investors. I look forward to this important dialogue with fund directors and hearing from them, and from fund investors, about ideas to enhance the eyes and ears of fund boards.
On-Boarding Staff with Practical Financial Services Experience
One way in which the Division of Investment Management has enhanced its own eyes and ears is by expanding the level of specialized financial services expertise among our staff. We benefit from the practical insights of staff who very recently were sitting where you are now.
These staff members have their fingers on the pulse of the latest industry trends. They bring fresh ideas and a genuine spirit to regulate from an informed perspective.
For example, our REG group includes Darau Johnson, a former Risk Officer with substantial market and data analytics experience. Our rulemaking team recently benefitted from the addition of Dan Townley, a law firm partner at Davis Polk, with over 20 years’ experience representing private funds and other financial entities. Additionally, our staff includes Sharon Pichler, a former money market fund portfolio manager who closely monitors money market fund data for purposes of analyzing trends and identifying outliers. We also have recently added attorneys who have worked on money market funds and derivatives issues at asset managers and in private practice.
Our recruiting efforts have included promoting David Grim to be my Deputy and Jennifer McHugh returning to the Division from the Chairman’s Office and bringing a wealth of experience.
Each of these professionals brings a unique and well-trained perspective, and they synergistically supplement the traditional work of the Division of Investment Management. And it’s not just the Division’s program that benefits. Their practical expertise enhances our examination and enforcement efforts as well.
Incorporating staff with practical financial services experience makes our regulatory efforts more informed, more relevant and more effective.
Need for Input on Division Initiatives
Another way to expand our eyes and ears is to look for ways to obtain and use helpful public input on regulatory initiatives. One area where I am particularly interested in obtaining public input relates to the mutual fund valuation process.
Mutual fund professionals work every business day to strike an NAV that accurately reflects a fund’s value. You have a wealth of knowledge and practical experience from which the staff can benefit. You also are aware of recent industry trends and best practices that are important to understand as we consider updated valuation guidance.
Recently we have met with accounting firms, ICI staff and ICI members concerning valuation. We are working on valuation guidance that we can recommend to the Commission and we would like as much of your input as possible before that recommendation. In particular, if there are best practices, or poor practices, in valuation that you think we should be aware of, please bring them to our attention.
The staff also has benefitted from the helpful input and insights that the public has shared regarding the Commission’s consideration of money market mutual fund reform. If the staff is to effectively inform the Commissioners, we cannot do so in a vacuum. We benefit from public input and expertise.
Improving Mutual Fund Data Collection and Analysis
One area where the Division of Investment Management very much needs to enhance our eyes and ears is our mutual fund data collection and analysis.
As you are aware, we now receive monthly data on money market fund portfolio holdings. These data have greatly improved our ability to monitor trends; understand funds’ holdings; check for outliers; and inform our rulemaking. These data have proved invaluable in protecting investors, including revealing matters that have been referred to Enforcement.
The Commission now is in the process of collecting the first full set of data about private funds under new authority granted in the Dodd-Frank Act. This data set similarly will enable staff to monitor trends in hedge funds and private equity funds and provide for improved regulatory understanding of these influential investment vehicles.
These data streams represent a different era in the Division. Just three years ago, we were not receiving any of this data. However, having the data and its usefulness, have made us focus on the area where we are not receiving detailed data.
What we are missing is the great swath of funds in between money market funds and private funds. We need a better dataset from the bread-and-butter mutual fund, closed end fund and ETF space. These are the vehicles that hold the bulk of retail investors’ investments. And therefore these are vehicles that deserve regulators’ focus.
Today, we have a hodgepodge of data collection and reporting forms. Many of them have bureaucratic sounding names and even more bureaucratic, outdated technology behind them. Incredibly enough one of them uses a DOS system that is essentially being kept alive only for the form. These forms only provide a patchwork of data that does not tell us detail about mutual funds but often allows rounding and summary information.
That is why we are pleased that the agency has been on a course of upgrading our technology and will be turning to mutual funds.
The Division staff is beginning an initiative to see if we can streamline the fund reporting forms. Our goal is to make them more useful for regulators and investors.
In addition, the staff also should endeavor to make reporting regimes workable, or at least minimally disruptive, with your systems. For instance, we understand that there may be issues with not all securities having an identifier and we would like to work with you on that issue. Funds need to be able to report quickly, efficiently and accurately.
I look forward to your insights and input on this ambitious, yet incredibly important project.
Now you have heard an overview of some of the Division of Investment Management’s initiatives to enhance our eyes and ears.
In addition to these efforts, we also continue to work to improve internal coordination with the on-site examiners from OCIE. These professionals are on the front-lines, on a daily basis, and serve as a tremendous source of information about the asset management industry, particularly with respect to the activities of mutual funds and other fund investments.
Mutual funds must be a critical focus of the SEC because of their importance to retail investors. An effective mutual fund regulatory regime is essential to assuring the confidence of the typical American investor.
We all share a joint responsibility for earning their confidence. That is why regulators are watching and why we are committed to continuous improvement of our efforts.
I look forward to going into more detail on these and several other initiatives and regulatory matters on the panels that follow.
And I thank you again for the opportunity to be with you this morning and for the opportunity for further dialogue as we work to serve America’s investors.
1 Investment Company Institute Research Perspective, “Ownership of Mutual Funds, Shareholder Sentiment, and Use of the Internet, 2012,” November 2012, Vol. 18, No. 6.
2 Investment Company Institute, “Profile of Mutual Fund Shareholders, 2011,” February 2012.