The SEC’s Evolving Asset Management Agenda

This article by counsel David Tittsworth was published by Law360 on July 27, 2018. 

Early this year, I wrote about 10 things to watch at the U.S. Securities and Exchange Commission during 2018. This article will update where the SEC now stands and where it appears to be going in terms of rulemakings that affect the asset management profession. If you were expecting a boring year, the following demonstrates just the opposite.

Less Than a Full House

In January, Republican Hester Peirce and Democrat Robert Jackson were sworn in as new SEC commissioners, marking the first time since 2015 that the SEC had a full slate of five commissioners. But the novelty of having the commission at full capacity was short-lived. On July 6, Republican Commissioner Michael Piwowar left the SEC. This was a surprising development, as most observers assumed that Piwowar would remain at least until Democrat Commissioner Kara Stein’s term ends when the current Congress adjourns later this year. President Donald Trump acted quickly by nominating Elad Roisman as Piwowar’s replacement on June 4. Roisman previously served as counsel to former SEC Commissioner Daniel Gallagher and is currently chief counsel of the Senate Banking Committee, chaired by Sen. Mike Crapo, R-Idaho. The Senate Banking Committee held a confirmation hearing with Roisman on July 24. It is thus possible that Roisman’s nomination could proceed to Senate confirmation. The usual pattern established during the last two decades, however, is that the Senate generally considers “paired” nominations (i.e., one Republican and one Democrat). That has the advantage of giving both parties a nominee. Unless and until Roisman’s nomination receives Senate confirmation, it will be difficult for Chairman Jay Clayton to move forward with any rulemaking that is controversial, since Clayton will need at least one Democratic vote for every matter requiring commission approval.

Standard of Conduct Proposals

On April 18, the commission voted to approve a package of three proposals: (a) Regulation Best Interest (proposing a new “best interest” standard for broker-dealers who provide securities recommendations to retail customers); (b) Form Client Relationship Summary (a four-page form required to be delivered to retail investors by broker-dealers and investment advisers); and (c) a proposed commission interpretation of the Advisers Act fiduciary duty.

Clayton had previously said that a standard of conduct rule was one of his highest priorities and he was able to deliver a far-reaching set of proposals — each by a 4-1 vote. This was no small feat. Clayton and his staff deserve credit for moving the ball forward. But the hard work remains. Even setting aside Stein’s blistering criticisms of all the proposals, a favorable outcome on a set of final rules seems difficult at best. During the open meeting when the proposals were discussed, Jackson stated that he was “reluctantly” voting for the proposals and that he would not have voted in favor of them if they were final rules. Even Peirce expressed reservations about Regulation Best Interest, stating that it was “impossible” to determine from the proposal what “best interest” means. And with Piwowar’s departure before the Aug. 7 deadline for comments (which some groups have requested to be extended), the possibility that final rules could be approved before the end of 2018 seems extremely ambitious.

The stakes are raised even higher by the Fifth Circuit’s March 15 decision invalidating the U.S. Department of Labor’s controversial fiduciary rule. Opponents of the DOL rule had long argued that the SEC was in a better position to issue rules relating to standards of conduct for investment professionals. But with the demise of the DOL rule, their zeal for moving forward with SEC enhanced requirements may be diminished. As with the ill-fated DOL rule, the bottom line is that standard of conduct issues have been vexing the SEC for two decades and there’s no silver bullet to resolve them. Clayton’s professed desire to get the proposals to the finish line will test his patience and all of his considerable skills.

More Asset Management Regulations

At the start of 2018, the SEC had listed the following asset management rulemakings on its short-term Regulatory Flexibility Agenda (indicating that the commission would take action on each rulemaking within the coming year): (1) a final rule allowing optional internet availability of investment company shareholder reports; (2) standard of conduct rulemaking for investment professionals; (3) reproposal of rules allowing certain exchange-traded funds to operate without first obtaining exemptive orders from the SEC; (4) amendments to the Volcker Rule; and (5) harmonizing SEC derivatives rules with U.S. Commodity Futures Trading Commission rules. The SEC has made progress on all of these priorities:

• On June 5, the commission approved Rule 30e-3 under the Investment Company Act (first proposed in 2015) to allow mutual funds an optional method to satisfy requirements to transmit shareholder reports by posting those reports online under certain conditions. In order to rely on the rule, funds will be required to make their reports and other required materials publicly accessible, free of charge, at a website address specified in a notice to shareholders, among other conditions. This is a welcome development for mutual funds — and long overdue. At the same time, the commission approved requests for comments on two topics: fund retail investor experience and disclosure and processing fees charged by intermediaries for distributing certain materials.
• As noted above, the standard of conduct proposals have been approved for comment.
• The commission approved an ETF rule proposal by unanimous vote on June 28. This is a reproposal of the 2008 proposal that was sidetracked by the credit crisis. At the time of the 2008 proposal, the SEC had issued 60 exemptive orders covering about $580 billion in total ETF assets. Today, there are more than 1,900 registered ETFs with assets of more than $3.4 trillion. The atmospherics at the recent June 28 meeting were favorable. While Jackson expressed concerns about leveraged ETFs, the proposal before the commission is focused on “plain vanilla” ETFs. It would not be surprising to see SEC staff make relatively minor modifications to the ETF proposal to set the stage for a commission vote on a final proposal at or near the end of this year.
• In early June, the Federal Reserve Board and five other agencies, including the SEC, approved proposals to amend the so-called Volcker Rule that governs proprietary trading by banks. The proposals are designed to streamline compliance burdens under the Volcker Rule, rather than replace it or bring about significant changes to bank trading activities.
• Finally, harmonization of SEC and CFTC Title VII rules appears to be making some progress; while no proposal has yet been issued, the agencies announced a memorandum of understanding on June 28 that indicates they are working together on a number of fronts.

Even More Asset Management Regulations

The SEC’s most recent Regulatory Flexibility Agenda released in mid-May adds even more asset management regulations to the short-term agenda:

• The commission has made various changes to the Investment Company Liquidity Risk Management Rule since the rule was initially adopted in October 2016. Most recently, the commission approved a new requirement that funds disclose information about the operation and effectiveness of their liquidity risk management program in their annual reports to shareholders, while rescinding current requirements in Form N-PORT that funds publicly disclose aggregate liquidity classification information about their portfolios.
• Amendments to the Investment Advisers Act advertising rule — which prohibits testimonials and past specific recommendations — has been moved from the SEC’s long-term list to the short-term list, along with the related cash solicitation rule. The brief description in the Regulatory Flexibility Agenda notes as follows: “The Division is considering recommending that the Commission propose amendments to rules 206(4)-1 and 206(4)-3 under the Investment Advisers Act of 1940 regarding marketing communications and practices by investment advisers.” This should be good news for asset managers that have long advocated for significant changes to these outmoded rules.
• The SEC also moved a reproposal of its controversial 2015 derivatives proposal from its long-term list to the short-term list, with the following notation: “The Division is considering recommending that the Commission re-propose a new rule designed to enhance the regulation of the use of derivatives by registered investment companies, including mutual funds, exchange-traded funds, closed-end funds and business development companies. The proposed rule would regulate registered investment companies’ use of derivatives and require enhanced risk management measures.” Even in opposing the 2015 proposal, then-Commissioner Piwowar voiced the sentiments of many industry participants when he stated, “Let me begin by stating my strong support for Commission action in this area. For too long now, the fund community has been left to navigate the complex world of derivatives without clear guidance from the Commission on the use of such products. Given the absence of specific current direction from the Commission, funds’ derivatives use is guided by a 1979 Commission General Statement of Policy (Release 10666), more than 30 staff no-action letters, and other informal staff guidance issued on an instrument-by-instrument basis. Without diminishing the good work staff has done to address issues in this evolving market, it is imperative that the Commission step forward and provide a clear framework for fund activities in this space.” The SEC is now moving forward to reproposing the derivatives rule. Expect consideration of a new proposal during the first part of 2019.
• A new item on the short-term agenda is titled “Fund of Funds Arrangements,” described as follows: “The Division is considering recommending that the Commission propose new rules and rule amendments to allow funds to acquire shares of other funds (i.e., fund of funds arrangements), including arrangements involving exchange-traded funds, without first obtaining exemptive orders from the Commission.”
• Apart from the items listed in its Regulatory Flexibility short-term agenda, the SEC’s Division of Investment Management has made progress on a number of other issues. For example, the division has issued helpful FAQs that address questions related to the Advisers Act Custody Rule. In addition, the SEC’s long-term agenda has added the Custody Rule to its list, stating that “[t]he Division is considering recommending that the Commission propose amendments to rules concerning custody under the Investment Company Act of 1940 and the Investment Advisers Act of 1940.” Other items of interest to asset managers on the long-term list include: expanding the definition of accredited investor, stress testing for large asset managers and large investment companies, business development company modernization, mandatory electronic submissions for orders under the Advisers Act and confidential treatment requests made on Form 13F, investment company advertising relating to target date retirement fund name and marketing, harmonization of private placement rules, and short-sale disclosure reforms.

Other Asset Management Initiatives

While not listed on the SEC’s Regulatory Flexibility agendas, two other items are worthy of note.

First, Clayton and the SEC’s divisions of Investment Management, Enforcement and Corporation Finance continue to address issues relating to cryptocurrency and initial coin offerings. Clayton has spoken on the subject numerous times, expressing his belief that blockchain technology holds great promise for the markets while expressing his deep concerns of potential risks involving ICOs. In January, Division of Investment Management Director Dalia Blass penned a letter to two major trade groups requesting detailed information about valuation, liquidity, custody, arbitrage for ETFs, and potential manipulation and other risks of cryptocurrencies. In the meantime, the cybersecurity unit in the Division of Enforcement — established by Clayton early in his tenure — continues to bring numerous cases against fraudulent ICOs. Last month, Division of Corporation Finance William Hinman delivered a speech in which he stated that bitcoin and ether are not “securities” within the meaning of the Securities Act of 1933, but that some ICOs may fall within the SEC’s jurisdiction. These issues are not going away.

Another priority of Blass is a fund board outreach initiative, including an effort to review responsibilities of mutual fund directors. As noted in various public speeches, division staff have been meeting with fund boards and groups of independent directors with the announced goal of understanding “where board oversight is most valuable.” The division has compiled a list of current board responsibilities and, while their work is described as in the “early stages,” this clearly will continue to be a priority for the division going forward.