Chairman Clayton’s Remarks on Policymaking Priorities Including Fiduciary Duty
Chairman Jay Clayton kicked off the event with prepared remarks about the Commission, after which he gave additional commentary about the SEC’s top policymaking priorities for the upcoming year. The Chairman stated that the SEC will focus on bringing clarity to the standards of care for broker-dealers and investment advisers, following through with already proposed equity market structure reforms,1 finalizing regulations mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act and carrying out the SEC’s streamlined Regulatory Flexibility Act agenda.
Regarding broker-dealer and investment adviser standards of care, the Chairman explicitly emphasized that the SEC will be making a “big effort” to create “regulatory harmony” between the two standards. The current regulatory structure mandates that brokers meet suitability standards when selling investment products to clients while investment advisers must meet a more onerous fiduciary standard that requires them to act in their clients’ best interests. The SEC requested comments on the issue last year and appears poised to work with the Department of Labor and potentially other agencies as the implementation date for the new rule approaches. The rule is scheduled for an implementation date of July 1, 2019.
New Commissioners Jackson and Peirce Describe Their Regulatory Approach and Commissioner Stein Warns About Complex Products
Commissioner Michael Piwowar held question-and-answer sessions with new Commissioners Jackson and Peirce, who were sworn in on Jan. 11. Commissioner Kara Stein gave a separate speech.
- Commissioner Hester Peirce explained her view that economic analysis should be one of the central elements of securities regulation. She also suggested that the SEC should create a separate regulatory framework for “finders” of capital, who currently must register as broker-dealers.
- Commissioner Robert Jackson agreed on the value of using empirical data to inform rulemaking and regulations, but he also noted that some regulations may be appropriate even when their utility may be difficult to precisely quantify, such as insider trading.
- Commissioner Kara Stein expressed concern about the proliferation of complex financial products that are difficult to regulate without market participants and regulators asking threshold questions about whether such products should be sold to investors to begin with.
Updates From the Division of Enforcement
Division of Enforcement officials described their emphasis on cryptocurrencies and the protection of retail investors and noted the following:
- The establishment of a cyber unit and retail strategies task force. The Cyber Unit will target cyber-related misconduct through coordination of information sharing, risk monitoring and incident response efforts throughout the SEC. The Retail Strategy Task Force will develop proactive initiatives, leveraging data analytics and technology to identify large-scale misconduct affecting retail investors.
- The Share Class Selection Disclosure Initiative, which allows brokers or advisers to self-report failures to disclose conflicts of interest associated with the receipt of 12b-1 fees by the adviser, its affiliates or its supervised persons for investing advisory clients in a 12b-1 fee-paying share class when a lower-cost share class of the same mutual fund was available for the advisory clients. In exchange for self-reporting and certain other action, including reimbursement of harmed investors, the division has agreed to endorse reduced sanctions to the cooperating brokers or advisers and not to seek a civil monetary penalty. The division emphasized that there are benefits to upfront cooperation and self-reporting in other areas of securities regulation and stated that it will continue to work on making those benefits clearer to market participants.
- Initial Coin Offerings (ICOs). The division emphasized its balanced approach related to ICOs. For example, in the Munchee Order issued last December, the SEC opted not to impose any civil penalties after the issuer accepted the SEC’s settlement offer. Enforcement officials noted that in multiple cases, issuers who were preparing for an ICO voluntarily decided to halt their ICO’s progress after coordination and discussion with SEC staff. While the staff expressed that movement toward greater sophistication in the ICO market was a welcome sign, they also stated that attorneys and other regulatory gatekeepers often needed to do a more careful job of advising clients preparing to launch an ICO.
Office of Compliance Inspections and Examinations Leveraging Big Data to Target Exams
The Office of Compliance Inspections and Examinations (OCIE) panels shared important insight into its data-driven strategy for its 2018 National Exam Program Examination Priorities, previously discussed here. OCIE will leverage data from public filings, including Form ADVs, Form BDs and supplemental statements of income as well as changes in firm manuals, representative disclosures and exam histories to create a framework for modeling risk in the industry.
The panelists described several characteristics that could draw examiners’ attention, including (1) firms with a higher percentage of representatives working as independent contractors, (2) firms that have onboarded representatives with disciplinary histories at other firms and (3) firms with unmanaged accounts resulting from representative departures.
In addition, OCIE remains focused on retail investors, with three particular priorities:
- Roboadvisers. Examiners will assess the suitability of digital and automated investing platforms based on their ability to tailor advice to the investor’s goals and financial situation.2 OCIE launched a national initiative to review compliance and governance for roboadvisers in areas such as financial modeling, supervision and marketing.
- Mutual Funds. OCIE is paying careful attention to the selection of share classes and, in particular, the disclosure of fees and potential conflicts of interest. Firms that do not take advantage of the SEC’s recent self-reporting initiative can expect more severe penalties than other firms have faced. Examiners will also target representatives using underperforming funds, funds with liquidity concerns, such as securitized auto loans and consumer debt, and bespoke indices where the adviser may be involved in selecting and weighting components.
- Exchange-Traded Funds (ETFs). OCIE has devoted more attention to ETFs as their popularity has continued to grow. Although most ETFs are self-selected, OCIE will examine advisers soliciting “deathwatch ETFs,” which raise disclosure issues related to liquidation costs and unsuitable asset spreads.
Updates From the Division of Corporation Finance
Officials from the Division of Corporation Finance discussed new rulemaking initiatives and current issues, with a focus on issues involving cryptocurrencies. The division identified various problems surrounding ICOs and blockchain technology. In particular, the division warned of a multitude of issues involved in the marketing of cryptocurrencies. One of these relates to a potentially false characterization of cryptocurrencies as “utility tokens” in the attempt to evade securities laws. The division warned that cryptocurrencies sold to individuals for the purpose of providing capital returns (with no other potential uses) may be securities even if marketed as utility tokens.
Updates From the Division of Investment Management
The primary topic in the Division of Investment Management discussion centered on cryptocurrencies. Officials noted that over a dozen cryptocurrency strategy funds submitted applications to become registered investment funds in the past year. As a response to put the industry on notice, the division issued a staff letter to the Investment Company Institute outlining the division’s concerns surrounding potential new registrations for funds executing cryptocurrency-related strategies. Division officials and members of the panel identified concerns of valuation, liquidity, custody, arbitrage (for ETFs) and potential manipulation as fundamental to the structure of investment companies that any potential registered fund must address.
In addition, officials from the division stated that they were working with the Division of Trading and Markets on standards of conduct for brokers and investment advisers. Panelists also noted that while certain funds may desire to use the term “blockchain” in their fund’s name, such a change may violate the SEC’s rule regarding misleading fund names, according to division officials.
Chief Accountant Advises on Reporting the Effects of Tax Reform
Wesley Bricker, Chief Accountant for the SEC, cautioned public companies against cherry-picking the effects of the Tax Cuts and Jobs Act of 2017 in their financial disclosures. The SEC expects that companies will face some uncertainty, but they should be prepared to report the full effects of the law by the end of 2018.
Until then, Bricker recommended a “triage” approach for reporting, by identifying (1) effects that have taken place, (2) effects that are reasonably likely to occur and (3) effects that have been assessed but have not been quantified. Investors (and the SEC) should be able to track affected items moving through these stages as they review the firm’s financial statements during the year.
1 This appears consistent with parts of the Department of the Treasury’s goals for equity market structure reform. See Sidley update here: https://www.sidley.com/en/insights/newsupdates/2017/10/us-treasury-outlines-initiatives.
2 OCIE cited the Division of Investor Management’s guidance on roboadvisers, available here.
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