Draft Bill to Establish Self-Regulatory Organization Oversight for Investment Advisers
September 13, 2011
This note summarizes a draft bill to establish self-regulatory oversight for investment advisers and today’s hearing of the House Financial Services Committee discussing the bill.
On September 9, 2011, House Financial Services Committee Chairman Spencer Bachus (R-Ala.) released a draft bill entitled the Investment Adviser Oversight Act of 2011, which would amend the Investment Advisers Act of 1940 (the “Advisers Act”) to create “national investment adviser associations” (“NIAA”) and require most SEC-registered or state-regulated investment advisers to become members of such entities. This bill, along with several other issues relating to investment advisers and broker-dealers, were discussed this morning at a hearing of the House Financial Services Committee.
Much like the analogous provisions establishing self-regulatory organizations (“SROs”) for broker-dealers and futures commission merchants in the Securities Exchange Act and Commodities Exchange Act, respectively, the bill sets out (i) the procedure for registration of an NIAA with the SEC, (ii) the requirements that an NIAA must meet in order to be eligible for registration, (iii) the procedures for SEC approval of NIAA rules and rule changes, including a mandatory public comment period, and (iv) the procedures for the disciplining of members, including SEC review of disciplinary and denial-of-membership decisions. Because these provisions largely mirror those establishing national securities associations and registered futures associations, we do not believe that they will be especially controversial.
The bill’s provisions relating to the membership requirement and exemptions from this requirement are a different matter, and we expect a great deal of debate on these. The bill requires both SEC-registered advisers and advisers regulated by state securities authorities to become members of an NIAA, even if the adviser is a registered broker-dealer and a FINRA member, i.e., dual membership is required. The bill provides an exemption from membership if 90 percent or more of the adviser’s assets under management (“AUM”) are attributable to one or more of the following types of clients: (i) investment companies registered under the Investment Company Act of 1940 (the “‘40 Act”); (ii) clients that are not U.S. persons, as defined in Regulation S; (iii) clients that in the aggregate own $25,000,000 or more in investments; (iv) certain charitable organizations and employee retirement plans exempt from ‘40 act registration; (v) private funds as defined in the Advisers Act; and (vi) venture capital funds as defined for purposes of their exemption from the Advisers Act (collectively, the “AUM Exemption”).
A few points to note with regard to the AUM Exemption:
- We expect that AUM for purposes of the AUM Exemption would be calculated pursuant to the SEC’s recently defined term: “R-AUM”. See CGSH Alert Memo, “SEC Adopts Final Rules under the Investment Advisers Act of 1940 Implementing Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act,” June 27, 2011.
- An investment adviser cannot take advantage of the AUM Exemption if it is also a registered broker-dealer.
- An affiliate of an AUM-Exempt adviser would also be exempt from the membership requirement if the SEC determines that the adviser and its affiliate are sufficiently integrated such that membership in the NIAA “would necessitate inappropriate duplicative examination” by the SEC or the NIAA.
- An adviser can aggregate clients from different categories to meet the 90% threshold, e.g., an adviser with 30% registered fund clients, 30% private fund clients and 30% venture capital fund clients would be exempt from the NIAA membership requirement.
- The bill permits the SEC to exempt other advisers or classes of advisers pursuant to its rulemaking authority.
There does not seem to be any consistent underlying principle for the categories of advisers included in the AUM Exemption as currently drafted. It could be that certain of the exempt categories are designed to give advisers who just miss qualifying for an exemption from SEC-registration relief from the additional burden of NIAA membership, e.g.
, an adviser with slightly less than all of its AUM attributable to private funds or venture capital funds. It is unclear, however, how the exemption for clients with aggregate investments of $25,000,000 or more
fits within this theory, or why this category would be included at all. The exemption for an affiliate of an AUM-Exempt adviser might be a drafting error—that exemption could instead be meant to apply to an affiliate of an adviser that is a member of an NIAA where the adviser and its affiliate are sufficiently integrated such that it would be duplicative to require both to become members. Finally, we note that, in its rulemaking for the new private fund and venture capital fund Advisers Act exemptions, the SEC rejected the notion that an adviser could advise different types of qualifying clients, e.g.
, private funds and
venture capital funds, and be eligible for those exemptions. The bill would permit advisers to aggregate these types of clients in determining eligibility for the exemption from NIAA membership.
At today’s hearing, FINRA chairman and CEO Rick Ketchum testified in support of the bill and explained why FINRA would be well prepared and best situated to serve as an NIAA if the bill became law. The chairman of the Financial Services Institute, William Dwyer, and the president of the National Association of Insurance and Financial Advisors, Terry Headley, also testified in support of the bill and in support of FINRA serving as the SRO for investment advisers. These witnesses argued that the SEC and state authorities did not have the resources to conduct the number of examinations necessary for proper oversight of advisers and that FINRA, in coordination with the SEC and state regulators, could help close this gap in oversight. SIFMA chairman and CEO, John Taft, testified that establishing an SRO would probably be the most practical option for increasing examinations, but he did not believe the membership requirement should extend to institutional investment advisers nor did he endorse FINRA as the SRO.
Pennsylvania Securities Commissioner, Stephen Irwin, testifying on behalf of the NASAA, adamantly opposed the bill, especially because the membership requirement would extend to state regulated advisers. Mr. Irwin, along with David Tittsworth, Executive Vice President of the Investment Adviser Association, highlighted several of FINRA’s shortcomings, including its lack of accountability, the inherent conflicts of interest that arise in the context of SROs, and its past failures. Mr. Irwin argued that it would violate principles of federalism to require state regulated advisers to join a national organization headquartered in New York or Washington because such an SRO would not be accountable to elected officials to the same extent as government agencies. Mr. Tittsworth stated that this bill appeared to be drafted with FINRA in mind, and he argued that better funding of the government agencies, through user fees, would be a better solution than requiring SRO membership.
The Representatives on the Committee were generally divided, with Republicans supporting some form of the bill and Democrats preferring additional funding for the SEC. Interestingly, while the bill would permit multiple NIAAs to register with the SEC and would only require membership with one such entity, the hearing today seemed to assume that FINRA would become the sole NIAA. There was also very little discussion about the details of the bill, such as the exemptions from the membership requirement, but even those strongly in support of the bill acknowledged that it was simply a good starting point for debate and that the bill would need to be revised.
Also discussed at today’s hearing was the SEC’s study, mandated by Section 913 of Dodd-Frank, regarding a unified fiduciary standard for investment advisers and broker-dealers when they provide personalized investment advice to retail investors. The Democratic committee members and witness Barbara Roper, Director of Investor Protection, Consumer Federation of America, supported the SEC’s recommendation of a unified standard analogous to the Advisers Act’s best interests duty. The Republican members and witnesses from trade associations representing broker-dealers opposed the SEC’s recommendation to varying degrees.