SEC Plans to Increase Focus on Asset Managers in 2015

In a speech given at The New York Times Dealbook Opportunities for Tomorrow Conference in New York at the end of 2014, SEC Chair Mary Jo White detailed an extensive plan to increase the agency’s scrutiny of asset managers. Her speech highlighted many of the important issues currently facing the SEC in regulating the asset management industry and its planned response to those issues.

Chair White began by noting the evolution of the asset management industry and the tools currently utilized to protect investors and their assets. In 1940, when the Investment Advisers Act was first passed, there were a total of $4 billion in assets under management at 51 firms, compared to the now over $63 trillion of assets under management at over 22,000 firms. Chair White also noted that almost half of all U.S. households own mutual funds. In addition to mutual funds, asset managers also increasingly recommend modern, sophisticated products like ETFs and derivatives. Registered funds have significantly increased the size and complexity of derivates used in asset management.

In order to deal with these changes in the asset management industry, Chair White identified three tools provided by the Investment Advisers Act and the Investment Company Act that provide means to address complex regulatory issues pertaining to asset managers. The first were the controls the SEC had placed on firms to identify and limit conflicts of interest and their associated risks to investors. The registration, reporting and disclosure regime were the second set of tools Chair White identified. Finally, were the tools put in place to control portfolio composition risk and operational risk. Chair White devoted most of her time to addressing the last set of controls.

Chair White defines “portfolio composition risk” as the risk related to the mix of investments in a fund, the risks associated with liquidity, and the risks pertaining to the leverage of a fund’s holdings. “Operational risk” is defined as failures from internal controls and processes. While current regulations have helped in minimizing portfolio composition risk and operational risk, more can be done, said Chair White. As a result, according to Chair White, SEC staff have been developing recommendations for three core initiatives to address portfolio composition risk and operational risk.

First, the SEC will seek to improve data gathering by expanding and updating the data requirements used to draw conclusions about the risks of the asset management industry. Chair White believes that reporting requirements to the SEC have not kept pace with the expansion of alternative investment techniques and products being used today. Possible updates might include enhanced reporting on the fund’s use of derivatives, liquidity, and securities lending practices.

Second, the SEC will make an effort to ensure funds have appropriate and adequate controls to identify and address risks related to the composition of modern portfolios. Two key areas already under SEC focus are the use of derivatives in ETFs and alternative mutual funds, and liquidity management. Not managing the liquidity risk in a portfolio could increase a fund’s inability to meet shareholder redemptions during periods of increased stress, subjecting the fund and even the financial market as a whole to more risk. SEC staff has also reviewed the possibility of updating liquidity requirements and limiting the amount of a fund’s leverage created by the use of derivatives.

Third, the SEC will work toward ensuring that firms have adequate procedures in place to transfer clients’ assets when needed. This would require firms to implement transition plans when winding down or preparing for other major disruptions in business.

Investment advisers should be aware of the SEC’s areas of focus in 2015 and be able to prepare themselves accordingly. Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds and issuers of securities, among others. Our attorneys can help assist financial service providers in complying with the complex issues that arise in the course of their businesses, including compliance with federal and state laws and rules.

Parker MacIntyre provides legal and compliance services to investment advisers, broker dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our website for more information.