More On Legal & Compliancefrom The Advisor's Professional Library
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
- Conducting Due Diligence of Sub-Advisors and Third-Party Advisors Engaging in due-diligence of sub-advisors isnt just a recommended best practice it is part of the fiduciary obligation to a client. An RIA should be extremely reluctant to enter a relationship with a sub-advisor who claims the firms strategy is proprietary.
During a recent rare Friday open meeting (on Nov. 19), the SEC approved several key proposals designed to implement provisions of the Dodd-Frank law that amend the Investment Advisers Act. While there were no big surprises, the new proposals will affect every investment advisory firm in some fashion.
When you start digging into the 300-plus pages of proposed rules, you quickly realize there’s something for everyone. As usual, the devil is in the details and these new proposals have lots of devils to watch for when the final rules are issued next year. Here are some highlights:
1) The Big Switch From SEC to the States
One of the biggest changes is the “switch” to state registration and regulation by thousands of smaller advisors. In 1996, Congress passed a law dividing regulatory responsibility for investment advisors between the SEC and the states. It established $25 million in assets under management (AUM) as the dividing line and preempted states from regulating SEC-registered investment advisors. The basic premise of the law was that smaller firms are essentially local in nature and are thus best regulated by the states, whereas larger firms tend to have greater potential interstate commerce implications and thus should be regulated by the Feds. In my view, this allocation of regulatory responsibilities has worked well.
The SEC has explicit authority to increase the $25 million level, but it has never exercised this authority. Dodd-Frank changes it in a big way: by increasing the $25 million level to $100 million (for some unknown reason, the new law refers to these small firms as “mid-sized advisors”).
The proposed rules create a framework for transitioning these “mid-sized” advisors from SEC to state registration. Somewhere in the neighborhood of 4,000 investment advisors will be directly affected by this significant change—they will be required to withdraw their SEC registration and switch to registration with one or more states. Under the proposal, each state must determine if it meets the requirements of Dodd-Frank, including whether the state has a registration program for investment advisors (all states except Wyoming do) and whether the advisor would be subject to examination by the state (this will be a more complicated determination for some states, including New York). The proposal contemplates that the “switch” to state registration will take effect during a 90-day period after July 21, 2011 (the one-year anniversary of Dodd-Frank’s enactment).
2) Registration of “Private Fund” Advisers
The other biggest change addressed by the SEC’s proposed rules involves the registration of so-called “private fund” advisors. Policymakers have been debating the question of hedge fund and other private fund advisors for many moons. When Bill Donaldson was chairman of the SEC, he championed a regulation that would have subjected many hedge fund advisors to registration/regulation requirements of the Advisers Act. That regulation (which was adopted on a 3-2 vote) was invalidated later when Philip Goldstein—the ever-quotable founder of Bulldog Investors—successfully challenged the SEC’s authority in a lawsuit.
Under Dodd-Frank, private fund advisors with AUM of $150 million or more (including hedge fund and private equity advisors, but not venture capital advisors) must register with the SEC under the Investment Advisers Act. The rationale for setting the threshold at $150 million AUM is unclear. No one knows for certain how many of these advisors exist (some have already registered voluntarily), but the best estimate is that the change in law will result in around 1,000 additional registrations with the SEC. While private fund advisors with less than $150 million in AUM will not be required to register under the Advisers Act (as well as other so-called “exempt reporting advisors”), they will be required to submit a fair amount of information to the SEC.
The profile of the SEC-registered investment advisor universe will change dramatically when these proposals go into effect later next year. In fact, when you combine these proposals with pending regulatory requirements (such as Form ADV Part 2) and other changes yet to come under Dodd-Frank (including whether FINRA will extend its jurisdiction to investment advisers), it’s clear that during the coming months we will witness seismic shifts in the regulatory landscape governing investment advisors.
I welcome your thoughts on the new SEC proposals.