No Summer Slowdown for the SEC as US Financial Regulation Heats Up

The SEC has continued to advance its vast regulatory agenda through the summer months. As temperatures remain high so too do US financial regulation demands.

While Washington’s sultry summers usually usher in a relatively quiet interlude at the Securities and Exchange Commission (SEC), with attention turning from review of detailed financial regulation drafts to beach reading, this year has proved to be a notable exception. There has been a spate of important regulatory matters that asset managers should keep in their sights as the summer winds down.

Regulation Best Interest

It’s particularly important to pay attention to some recent SEC personnel moves as well as an unusually busy summer agenda which raises several important questions about future policy. Two major items that the SEC is acting on currently are “Regulation Best Interest,” which is replacing the Department of Labor’s now defunct Fiduciary Rule, and Report Modernization. The SEC stepped into fray over best interest after the US Fifth Circuit Court of Appeals on June 21 killed the 2015 fiduciary rule, which required financial advisers to act in their clients’ best interest with their retirement accounts.

Instead, the SEC hopes the new best interest rules make it clear that a broker-dealer “may not put its financial interests ahead of the interests of a retail customer in making recommendations.” The trouble is, a lot of confusion remains over exactly what “best interest” actually means. So much confusion, in fact, that Hester Peirce, one of President Trump’s recent appointments as an SEC commissioner, felt compelled to give a speech entitled “What’s In A Name? Regulation Best Interest vs. Fiduciary,” in which she said that despite hundreds of pages of explanation about best interest, “not many people understand it.” Peirce said best interest suffers from the same drawback as the Fiduciary Rule, namely that the term is “wonderful for marketing purposes, but potentially misleading for investors.”

The quandary many US asset managers now find themselves in is the fact that they had brought to market certain investment vehicles based on compliance with the original DoL Fiduciary Rule. Now that the rule is dead, it is important for them to revisit the new SEC Best Interest standard and gauge whether or not their existing product lines and distribution channels remain fit for purpose or whether they need to reframe in light of the new definitions and requirements.

Reporting Modernization / E-delivery

The SEC’s Report Modernization, better known as the e-delivery initiative, has ushered in another important change for US asset managers. When the new regime takes effect, firms will be able to fulfill their requirements for annual shareholder reports and statements with electronic or digital versions. After years of debate, this was the first time the SEC conceded the point that in order to modernize, they need to move from paper-based forms to electronic forms. Now, investors can receive a notice to inform them that the shareholder report is available online for viewing. However, if a client still insists on receipt of a paper report, asset managers must comply.

ETF Approvals

At the end of June, the SEC proposed new ETF rules that will allow asset managers to bring to market certain types of ETFs without first obtaining explicit SEC approval, which is a sea change long sought by the industry. The proposed rule would effectively end the need for obtaining “exemptive relief” from the Investment Company Act of 1940. The proposed rule also would rescind all existing exemptive relief that had been granted to certain existing ETFs, making them liable to the new rules as well. Additionally, in a move long sought by many in the ETF market, the regulator included provisions that would permit qualified ETFs to use custom baskets with a fund’s authorized participants. Most ETF issuers who received exemptive relief after 2012 are not permitted to use custom baskets, creating an uneven marketplace in how managers can interact with APs, and manage funds’ tax efficiency and liquidity. Overall, the proposed rules have been well received by the market and the comment period closes October 1.

The SEC is also responsible for reviewing requests for approval of cryptocurrency ETFs. The most high-profile bitcoin application, that of the Winklevoss brothers, came before the SEC in late June. The application was rejected by a 3-1 vote. The agency said it was concerned about price volatility, manipulation, and liquidity in the bitcoin market. For most of the industry, the ruling was not a surprise. However what did stand out was that, once more, Peirce came forward to sound skeptical. In her dissent from the commission’s ruling, she said that the SEC should ensure that its rules are being complied with, but it should not attempt to pass a moral judgment on the underlying assets of an ETF, which she said they had done in the bitcoin case. Other cryptocurrency filings are in front of the SEC, which has just recently pushed out those decisions until September 30.

Liquidity Rule

The SEC has also been busy adopting significant amendments to the disclosure requirements of open-end investment companies relating to liquidity risk management programs. The liquidity rule forces funds to disclose details of the operational effectiveness of its liquidity risk management program in their reports to shareholders.

Most of the industry dialogue around the liquidity rule has related to the compliance challenge for asset managers. They must manage the requirement to class investments into the four-liquidity classification buckets as well as a new requirement to disclose cash and certain cash equivalents on Form N-PORT. The most welcomed concessions were delays to certain requirements for reporting and overall less publicly available information.

The scale and complexity of the SEC liquidity requirements will mean a lot of work and further dialogue on the specifics of the requirements in advance of the June 1, 2019 compliance deadline.

Commissioner Changes

Peirce’s dissent exemplifies the changing outlook of the SEC under appointments by President Trump. Last year, Wall Street lawyer Jay Clayton replaced Mary Jo White as SEC Chairman, and since then, the Trump Administration also appointed Peirce and Robert J. Jackson Jr. to the commission. Commissioner Michael Piwowar recently stepped down at the end of his 5-year term on the commission.

The White House Administration has nominated Elad L. Roisman, chief counsel to the Senate Banking Committee, to join the commission, but until Roisman is approved, the SEC will face a potential 2-2 tie on some key votes. Such deadlocks could slow regulatory approvals down considerably. Adding to uncertainty is the fact that Commissioner Stein is also due to step down shortly. Many expect former SEC enforcement attorney Allison Lee will be nominated.

How these personnel changes impact rulemaking is hard to gauge, however, it’s unlikely we see a slowdown of US financial regulation anytime soon. Regardless of the month or season, it appears that the temperature at the SEC will remain red hot for the rest of 2018 and beyond.