Regulatory Reform What It Means for Investment Management Firms September 23, 2010

www.investmentadviser.org

Regulatory Reform

What It Means for Investment Management Firms

September 23, 2010

David G. TittsworthExecutive Director

Investment Adviser Association



• Formerly the Investment Counsel Association of America

• Non-profit organization that represents the interests of SEC-registered advisory firms

• Focus: Investment Advisers Act of 1940• Advocacy: Capitol Hill, SEC, DOL, state

securities agencies & international regulators• Membership: About 500 investment

management firms that collectively manage more than $9 trillion (US) for individual and institutional clients

• www.investmentadviser.org


History of Reg Reform Legislation

• House passed bill Dec. 3, 2009– 223-202 (no Republican support)

• Senate passed bill May 25, 2010 – 59-39 (Brown, Collins, Grassley, Snowe joined all

Dems, except Feingold and Cantwell)• House/Senate conferees approved final compromise

June 25, 2010 (party line vote)• House passed conference report 237-192 June 30,

2010 (3 Repubs voted yes; 19 Dems voted no) • Senate passed conference report 60-39 July 15, 2010

(Brown, Collins, Snowe voted yes; Feingold voted no)• Bill signed by President July 21, 2010 (P.L. 111-203)


Dodd-Frank Overview

• 2,300 pages

• 250 rulemakings (~100 by the SEC)

• Scores of studies

• The legislation represents the most

far-reaching and significant financial services law since the New Deal


Dodd-Frank Overview

• What will it mean for advisers?– More regulations– More complex regulations– Heightened scrutiny (i.e., more frequent

and more intense examinations/inspections with potential for increased enforcement activity)

– Details will depend on SEC


Pillars of U.S. Regulatory Reform

• Systemic risk regulation

• Bureau of Consumer Financial Protection

• Reform credit rating agencies

• Regulation of derivatives

• Regulation of private fund managers

• Executive compensation


Impact on Investment Advisers

• Registration under Advisers Act for private fund advisers ($150 million AUM)– Accredited investor standard increased to $1 million

(excludes primary residence)• “Incentive-based” compensation rulemaking

– Disclosure of structure that provides executive with “excessive compensation, fees, or benefits” OR

– Could lead to “material financial loss” to firm– Applies to firms that have “assets” of $1 billion or more– Other provisions require disclosure of proxy votes on

executive compensation and golden parachutes• Systemic risk provisions

– Certain “non-bank financial companies” may be subject to regulation by Fed and Financial Stability Oversight Council



• Derivatives– Broad definition of “swap,” “swap dealer,” “major swap

participant”– Subjects OTC derivatives to SEC/CFTC jurisdiction

• Short selling regulations– SEC must adopt rules for public disclosure of short sale info

on monthly basis

• Securities lending rulemaking– SEC must adopt rules by July 2012 to increase transparency

• Volker Rule– Advisers affiliated with banks/bank holding companies may

be subject to restrictions on proprietary trading and investing in private funds (PE and hedge funds)



• SEC required to adjust “qualified client” standard (predicate for performance fees)

• SEC given authority to prohibit mandatory arbitration clauses

• Expanded enforcement powers for SEC– May bar adviser from associating with BD, transfer

agent, municipal securities dealer, etc.– Empowers SEC to collect monetary penalties in

cease-and-desist cases– Expands judicial jurisdiction over cases brought by

SEC involving foreign transactions– Expands SEC authority to persons who aided and

abetted violation of Advisers Act


Reg Reform: Investment Adviser Issues

• “Harmonization” of broker-dealer and investment adviser laws & regulations– Fiduciary duty issues

• Adequacy of SEC resources– Self-regulatory organization (SRO) issues


“Harmonization” – Background “Treasury recommends statutory changes to

harmonize the regulation and oversight of broker-dealers and investment advisers offering similar services to retail investors….In that vein, Treasury also believes that self-regulation of the investment advisory industry should enhance investor protection and be more cost-effective than direct SEC regulation…Thus, in effectuating this statutory harmonization, Treasury recommends that investment advisers be subject to a self-regulatory regime similar to that of broker-dealers.”

• Blueprint for a Modernized Financial Regulatory Structure (March 31, 2008)


“Harmonization” of BD/IA Regulation

"Securities professionals, regardless of what their business card says, should be subject to the same standard of conduct, the same licensing and qualification requirements, the same disclosure obligations, the same regulatory and recordkeeping standards and a robust examination and oversight schedule.“

SEC Chairman Mary Schapiro (Dec. 3, 2009)


“Harmonization” of BD/IA Regulation

• There is a need for “enhanced regulatory consistency” between brokers and advisers, especially with respect to “licensing, advertising, sales practice, and disclosure.”

FINRA CEO Richard Ketchum (Mar. 26, 2009)


Fiduciary Duty

• Administration proposal (June 2009): Brokers that provide investment advice should be subject to same fiduciary standard as investment advisers

• Broker and insurance concerns about fiduciary duty: – Commissions– Proprietary products– “Limited” advice


IAA Positions re: “Harmonization”

• Fundamental differences exist between most brokers (“sell side”) and most investment advisers (“buy side”)

• Imposing broker-dealer rules on advisers does not make sense (BDs are moving into advisory profession not the other way around)

• Do not weaken or water down Advisers Act fiduciary duty; do not impose different standards for different types of clients

• Advisers Act fiduciary duty should be extended to brokers and others who provide investment advice


“Harmonization” Legislation

• House bill required SEC to issue rules on fiduciary duty (“personalized investment advice” to “retail customers”); permitted rules on other “harmonization” issues: disclosure, sales practices, conflicts of interest, and compensation schemes

• Senate bill required SEC to study fiduciary duty and examination issues


“Harmonization” Legislation

• Final Compromise (Section 913)– Essentially stapled together the two

approaches with some modifications– SEC required to conduct study and to

submit report to Congress (6 months)– SEC authorized to issue rules under ’34 Act

and Advisers Act re: standard of care for BDs and IAs

– Debate shifts from Capitol Hill to the SEC


Section 913 Study

• SEC issued request for comments on July 27 (30-day period expired Aug. 30)

• Study must be completed by January 21, 2011. SEC required to submit report to Congress with “findings, conclusions, and policy recommendations” and analysis of “regulatory gaps, shortcomings, or overlap” in BD and IA legal and regulatory standards.

• See IAA Comment Letter (Aug. 30): www.investmentadviser.org


Section 913 – Rulemaking Authority

• SEC authorized to issue rules under ’34 Act to impose Advisers Act fiduciary standard on BDs “when providing personalized investment advice about securities to a retail customer”– Receipt of commissions/sale of proprietary

products are not per se violations of fiduciary standard

– No continuing fiduciary duty after providing advice


Section 913 and “Harmonization” • SEC also directed to:

– “facilitate…simple and clear disclosures to investors regarding the terms of their relationships” with BDs and IAs; and

– to issue rules “prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes” for BDs and IAs that are contrary to the public interest and investor protection


Section 913 – Why Does It Matter?

• SEC study will identify legal or regulatory “gaps, shortcomings, or overlap” in BD and IA regulations

• Fiduciary duty rulemaking is likely – BDs will be subject to fiduciary standard when

providing personalized investment advice to retail customers; but will Advisers Act fiduciary standard be altered?

• Opens the door to wide array of other “harmonization” regulations (imposition of BD rules on IAs)

• Fiduciary standard is an important distinguishing characteristic of the advisory profession

• Investment advisers need to weigh in with SEC and Capitol Hill to educate policy makers…


SEC Resources

• Growth in investment advisory profession has raised concerns about whether SEC has sufficient resources to oversee IAs

• SEC has ~450 examination staff to oversee 11,000 IAs and 9,000 ICs

• Average inspection “cycle” is about once every 10 years…


SEC-Registered Investment Advisers by AUM (April 2010)

0

2,000

4,000

6,000

8,000

10,000

12,000

Nu

mb

er

of A

dvis

ers

Number of SEC-Registered Investment Advisers by AUM Category

>= $100b 45 52 48 52 56 62 75 82 61 65

$50 - < 100b 35 37 39 46 51 65 77 90 65 80

$10 - < 50b 231 237 221 250 285 334 367 409 346 363

$5 - < 10b 190 203 199 206 211 237 284 327 301 318

$1 - < 5b 705 708 727 828 915 1,149 1,173 1,235 1,096 1,176

$100m - < 1b 2,297 2,480 2,474 2,747 2,993 3,812 3,904 4,096 3,780 4,108

$25 - < 100m 2,381 2,875 3,020 3,036 3,068 3,492 3,489 3,720 4,259 4,228

< $25m 1,438 989 1,124 1,137 1,035 1,139 1,077 1,071 1,350 1,305

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010


SEC Resources

• Potential options– Increase SEC’s annual appropriation– “Self-funding” (dedicated revenue stream)– User fees for investment advisers– Increase $25 million threshold for SEC

jurisdiction– Self-regulatory organization (SRO) for

advisers


SEC Resources – Dodd-Frank

• No self-funding • No IA user fees• Section 35: Increases SEC authorized funding

from $1.3 billion in 2011 to $2.25 billion in 2015; establishes $100 million reserve fund

• Section 410: Increases $25 million AUM threshold to $100 million (will shift ~4,000 IAs from SEC to States)

• SRO issues to be studied…


Self-Regulatory Organization (SRO) Issues Under Dodd-Frank• Section 914: “Study on Enhancing Investment

Adviser Examinations”• SEC required to “review and analyze the need

for enhanced examination and enforcement resources for investment advisers.”

• SEC will examine: (1) number/frequency of IA exams during last 5 years; (2) extent to which SRO “would improve the frequency of examinations of investment advisers”; and (3) approaches to dual registrants/affiliated firms

• Report due in 6 months (including legislative recommendations)


Self-Regulatory Organization (SRO) Issues Under Dodd-Frank• Section 967: “Commission Organizational

Study and Reform”• SEC required to hire “independent consultant

of high caliber” within 90 days to look at variety of organizational issues, including:– “whether adjusting the SEC’s reliance on self-

regulatory organizations is necessary to promote more efficient and effective governance for the securities markets”

• Consultant report due in 150 days; SEC to submit report to Congress every 6 months for 2 years outlining implementation of recommendations


Self-Regulatory Organization (SRO) for Investment Advisers

• FINRA actively lobbying to expand its turf to investment advisers

“FINRA is uniquely positioned from a regulatory standpoint to build an oversight program for investment advisers quickly and efficiently.”

FINRA CEO Richard Ketchum Mar. 26, 2009


SRO for Investment Advisers

“…I believe that Congress should have authorized a self-regulatory organization, or SRO, for investment advisers. The presence of an additional national regulator or regulators, particularly one not dependent on funding by taxpayers, would enhance investment adviser oversight. That suggestion is quite unpopular in some circles, but it would be a step forward in my view.”

SEC Commissioner Elisse WalterJune 10, 2010


IAA Positions re: SRO/FINRA

• SRO for advisers is unnecessary and adds extra layer of bureaucracy and cost

• Inherent conflict of interest • IAA opposes FINRA as adviser SRO: lack of

transparency, lack of accountability (to Congress and the public), track record, costs, bias favoring broker-dealer model

• Better alternatives: (1) give SEC adequate resources; and (2) improve SEC inspection program


In the meantime…

• SEC approved final investment adviser custody rule (Dec. 30, 2010)– Advisers that have custody – or are

deemed to have custody of client funds – are required to obtain annual surprise audit (no small matter depending on number of accounts, custodians, types of securities)

• Deduction of fees by itself will not trigger annual audit, but adviser serving as trustee to client account is deemed to have custody


In the meantime…

• SEC approved final “pay-to-play” rule under Advisers Act (June 30, 2010)– If you advise state or local governments –

or if you want to – you need to understand this rule!

– Compliance dates: (1) March 14, 2011 for political contributions; (2) Sept. 13, 2011 for third-party solicitor restrictions

– “Death penalty” (two year “time out”) for violations


In the meantime…

• SEC approved final Form ADV Part 2 rule (July 27, 2010)– Requires ALL advisers to convert Form

ADV Part 2 to a Plain English narrative brochure

– 18 topics must be addressed:• Description of adviser’s business; fees and

compensation; disciplinary info, methods of analysis; investment strategies and risk of loss; brokerage practices, personal trading, etc.


Form ADV Part 2 (cont’d)…

– Advisers must give “brochure supplement” to new and prospective clients, describing qualifications of individuals who provide advice to that client

– Required for annual updates made after Jan. 1, 2011 (March 31, 2011 for most advisers)

– Form ADV Part 2 will be publicly available (www.adviserinfo.sec.gov)


Next Steps…

• SEC

• Congress

• Stay tuned

• Get involved…


Contact Information

David Tittsworth

Executive Director


[email protected]

202.293.4222

Regulatory Reform What It Means for Investment Management Firms September 23, 2010

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