United States: Investment Management Director Offers Top 10 Lessons Learned In 2014

Last Updated: December 30 2014
Article by Kelley A. Howes

In a December 10, 2014 speech, Norm Champ, the Director of the SEC's Division of Investment Management, offered a glimpse at the top 10 industry lessons learned in 2014.  While admitting that his Top Ten list "may not be as entertaining as one you would see on Letterman," Champ said the list provides a view into both how the Division operates and its future goals.

Number 10:  An Organization Is Only as Strong as Its Staff.  Champ praised the staff of the Division for its commitment to the Division's mission to "protect investors, promote informed investment decision, and facilitate appropriate innovation in investment management products and services."  He reminded attendees that, over the last several years, the Division has added staff with significant expertise in specialized financial service and complex products.

Number 9:  The Division Is Not a "Regulatory Island." Champ said that the Division "seek[s] to encourage an inclusive, collaborative working environment within the Division, across the Commission, and with outside stakeholders."  He cited recently adopted amendments to the money market funds rule as an example of collaboration with the Department of the Treasury and the IRS.  Other observers may take a different view of the level of "collaboration" involved in getting the money market rule across the finish line (see our related blog post).

Number 8:  Risk Monitoring Is an Area of Focus.Champ said that the Division is gathering and analyzing data and monitoring risk through

  • routine review of disclosure filings;
  • its senior level engagement program (i.e., meetings with fund boards and management);
  • industry monitoring;
  • increasing the Division's expert staff; and
  • coordinating with other offices at the Commission.

Champ noted that the Division's Risk and Examinations Office (REO), established in 2012, provides ongoing qualitative and quantitative financial analysis of the industry.  "Although REO may conduct its own exams," Champ said, "where practical, REO will work together with OCIE to obtain information about OCIE's examinations." We think that means that there are multiple examination staffs to which the industry may be accountable, but there is limited transparency into what REO is doing.

Number 7:  Data Helps to Develop Policy and Regulation.We have heard this before, but Champ again emphasized that the staff gathers and crunches data from industry participants in an effort to help the Commission make "better and more informed policy recommendations." Champ cited the amendments to Rule 2a-7 as an example of such data usage in the regulatory process.  Data are also useful in helping the enforcement efforts, as demonstrated by a recent enforcement matter related to violations of Rule 2a-7 that stemmed, in part, from a review of funds' gross yields as a risk indicator.  Champ said that the staff analyzes data from Form ADV and Form PF; industry participants would be well served to keep in mind that upgrades to the Division's staff (see Number 1 above) means that the Ph.D.s on the Commission staff are looking for trends and risks indicated by such data.  Industry participants may want to implement front-end analysis of that data before that data go to the Commission in an effort to identify and proactively address any such trends and risks.

Number 6:  Regulatory Transparency Benefits the Public and the Regulators.Champ acknowledged that "interpretive ambiguity is costly" and said that the Division's increased use of Guidance Updates is a "meaningful way to decrease ambiguity and improve the public's understanding of the staff's view on critical issues."  He identified a January 2014 Guidance Update related to risk management in the fixed-income markets as an example of such transparency (see our related blog post).  While the Guidance Updates are "meaningful communications representing the staff's thinking on discrete issues," Champ said, they are not substitutes for rulemaking, the exemptive application process, or the no-action process.  He cited the recently published notice of the staff's intent to deny exemptive relief for non-transparent, actively managed ETFs as an example of the Division's attempt to increase transparency into the exemptive application process.

Number 5:  Appropriate Innovation Is Necessary to Meet the Needs of Investors.  Champ acknowledged the need for new and innovative investment products to meet the needs of investors, and said that the Division is "working to become smarter, more strategic and more targeted in anticipating, identifying the monitoring the risks of the current landscape."  He characterized the no-action and exemptive relief process as a "laboratory" enabling the Division to conduct this work.  Clearly, sometimes those experiments fail (as in the case of non-transparent, actively managed ETFs) but sometimes the experiments lead to new products (as in the case of exchange-traded mutual funds).

Number 4:  Promoting a Culture of Compliance – Happy Birthday to Rule 38a-1. The compliance rule is 10 years old, and Champ took the opportunity to reflect on the changes to the compliance landscape since the rule was adopted.  He noted that fund CCOs and compliance policies and procedures are now a "defining characteristic of the fund industry."  He also identified new and developing issues that should be addressed in fund compliance policies, including cyber-security and the proliferation of social media.  Champ also pointed to a recent enforcement action against a portfolio manager that misled and obstructed a CCO.  While we applaud the Commission for so strongly supporting a CCO on the front lines, we have also seen increased use of Rule 38a-1 in enforcement actions more generally.  Could the staff be hinting that it intends to broaden the rule without the transparency of the rulemaking process?  We hope that Division's intention to engage in a transparent and collaborative regulatory process extends to the use of this and other rules in the enforcement arena. 

Number 3:  Open Communications with the Industry and the Public Is Imperative. Champ focused on the Division's ongoing initiative to engage fund boards and senior management personnel as an example of its communications outreach.  Champ said, however, that this initiative has thus far focused on meetings with some of the country's "large asset managers."  We are concerned that this may skew the Division's view of the industry and its level of sophistication, particularly with respect to systems and infrastructure.  This could put smaller asset managers at a disadvantage as the Division develops guidance and new regulation.

Number 2:  Investor Protection Is Critically Important.  Protection of investors is one of the Commission's three key missions.  Champ referred to the Division's initiatives, including risk monitoring, data analysis, publishing guidance updates, and its various rulemaking initiatives as examples of its focus on protecting investors.  He also informed attendees that the Disclosure Review and Accounting Office is refocusing on the consistency and effectiveness of staff comments on disclosure documents, and reminded mutual funds of the need to provide clear, concise disclosure in fund prospectuses.

Drumroll, please . . .

Number 1:  Happy 75th Birthday to the 1940 Act and the Advisers Act. Champ anticipated the large celebration that will break out across the country in 2015 in recognition of the 75th anniversary of the two key statutes that shape the asset management industry.  Indeed, Champ indicated that the Division will be hosting a birthday bash in the New Year to include a day of roundtables and dialogue with industry pioneers, former regulators, and prominent academics.  But will there be a cake?

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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Kelley A. Howes
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