Champ: Investment Management Division’s Top 10 Lessons Learned
David Letterman has nothing to worry about.
While Champís December 10 speech before the Investment Company Instituteís 2014 Securities Law Developments Conference in Washington, DC on the Divisionís "Top 10 Lessons Learned and Points to Remember from 2014" may not have been as entertaining as a typical Letterman top 10, it more importantly shed some light on Division thinking for 2015.
"The speech was inward-looking," said Shearman & Sterling partner Nathan Greene, noting that Champ addressed 10 lessons learned by the Division staff during the past year, rather than 10 lessons for advisers to learn. Those lessons nonetheless address a broad array of Division priorities, including maintaining a compliance culture, transparency, risk management, and the use of data analytics.
The list, while essentially reviewing what experienced compliance professionals might already know, may be helpful to new compliance officers, said Wilmer Hale partner and SEC Division of Investment Management associate director Matthew Chambers, particularly Champís comments on the importance of a compliance culture in lesson number 4 (see below).
Here, without further ado, is Champís top 10, which he himself said "may not be as entertaining as one you would see on Letterman," but which he nonetheless presented in Letterman-style reverse order:
10. Importance of a strong staff. The 500 Investment Management Division staff members, spread among five states, have evolved as the legal and regulatory landscape has continued to change, Champ said. "We have added to our expertise by hiring quantitative experts; portfolio managers; PhD economists; industry experts, including experts in derivatives, ETFs, and money market funds; examiners; lawyers; and accountants. This wealth and diversity of knowledge and expertise makes our policy recommendations that much more informed and nuanced." He also noted that the Division underwent a reorganization last year, with the result being that "the new structure has provided the staff with an opportunity to work on a larger breadth of issues, which bring fresh approaches and ideas to all matters."
9. Not a regulatory island. "We are not alone in the global regulatory landscape," Champ said, noting that the Division needs to work both with other SEC divisions, as well as other regulators and stakeholders, to be effective. For instance, he suggested, amendments to the rules that govern money market mutual funds that the Commission adopted this past July (ACA Insight 7/28/14) "would not have been possible without the critical assistance we received from Treasury and the IRS in addressing the tax issues related to the floating NAV reform."
8. Focus on risk monitoring. In making this point, Champ appeared to be reinforcing a point made by SEC chair Mary Jo White in her speech on coming SEC asset management initiatives (ACA Insight 12/22/14). "We gather and analyze data and monitor risk through a number of avenues, including, but not limited to, 1) the routine review of disclosure filings, 2) our senior level engagement program, 3) our industry monitoring program, 4) our expert staff, and 5) coordination with other offices in the Commission," Champ said. He noted the importance of the Divisionís Risk and Examinations Office, which "provides ongoing quantitative and qualitative financial analysis of the investment management industry."
7. Increasing role of data. The SEC has not been shy about its seemingly ever-increasing use of data collection and analytics, with White and other SEC officials speaking in a number of presentations of dataís value in enforcement. "We recognize that the innovative use of data and analytical tools contributes to our ability to make better and informed policy recommendations and enhances our investor protection efforts," Champ said. He again pointed to the July 2014 money market reforms as an example of where data analysis helped. The data-based economic studies and analysis that the SECís Division of Economic and Risk Analysis provided during the rulemaking process "were essential" in the creation of the final reforms, he said. In addition, Champ said the Division uses data analysis to keep up to date with market trends, inform policy and rulemaking, as well as to "assist the Commission in its examination, enforcement and risk monitoring activities."
6. Benefits of transparency. The Division is increasingly providing more transparency of its own work processes in order to "enhance the publicís understanding of our views on critical issues," Champ said. To this end, he spoke highly of the Divisionís use of guidance updates "as a meaningful way to decrease ambiguity and improve the publicís understanding of the staffís view on critical issues." Twelve guidance updates were issued during 2014. These included a January 2014 guidance update on risk management in changing fixed income market conditions, which specified steps advisers could take in such circumstances. Guidance updates have proved somewhat controversial, said Greene, in that they are simply "regulatory pronouncements" issued by the Division staff and did not go through the public hearings that formal rulemaking requires. Perhaps with this in mind, Champ noted that guidance updates "are not substitutes for the Divisionís established rulemaking, exemptive application and no-action processes." He also noted that one novel request for exemptive relief from registration requirements was turned down because "the proposed structures lacked adequate transparency," among other reasons.
5. Necessity of monitoring innovation. Champ spoke of the importance of innovative investment products and strategies to meet investor needs, but said that it was also essential for the Division to stay on top of these new areas. "While ingenuity and creative solutions are necessary tools to tackle the changing needs and demands of investors, they also can be self-serving, and provide benefits to the industry at the expense of investors," he said, adding that it is the job of the Division to "identify the potential risks and benefits of such products and also formulate appropriate policies to ensure that we can effectively protect investors and facilitate appropriate innovation in investment policies and services." The Division, he said, views the exemptive application process "as the laboratory where we examine new ideas from market participants."
4. Culture of compliance. October 2014 marked the 10th anniversary of the Investment Company Actís Rule 38a-1, which requires funds to put in place and annually review compliance policies and procedures. "It is difficult to imagine a world today without fund CCOs or compliance policies and procedures," he said, noting that "at the time of adoption, some may have questioned their necessity or been skeptical of the structure of the requirement." The SEC has been increasingly vigilant in policing violations of the rule and in bringing actions against firms, as well as some CCOs, for failure to either adopt needed compliance programs or enforce them. In August of last year, he said, the SEC took action against a portfolio manager for misleading and obstructing a CCO (ACA Insight 9/9/13). "I believe that this case stands for the proposition that the Commission will not tolerate interference with CCOs who enforce their compliance policies and procedures," Champ said. "Itís an important anniversary to note," said Greene, noting that the rule, along with its Advisers Act counterpart Rule 206(4)-7, has "changed the superstructure within advisory firms."
3. Open communication. Champ noted several initiatives that the SEC has underway "to enhance our communications with industry participants and with other members of the public." Among these, he said, is the senior level engagement program, in which senior Division leaders meet on an ongoing basis with senior management and fund boards at several of the countryís large asset managers. Among other things, the meetings allow the Division "to obtain a focused and informed view of the systems, controls and personnel of an individual firm, which we can then share with our colleagues in the Commission." The process also helps the Division identify policies that may need more clarification, such as the January 2014 guidance update on risk management in changing fixed income market conditions.
2. Primacy of investor protection. The Division, Champ said, has sought to be proactive in this regard, "rather than reacting when unanticipated issues manifest to the detriment of investors." Examples of the ways in which the Division staff seeks to accomplish this, he said, are actively monitoring risks and analyzing industry trends, publishing industry guidance, promoting clear and effective disclosure, and undertaking various rulemaking initiatives.
1. Progress and more. The number one item Champ named was "Recognizing Our Progress Ė Celebrating the 75th Anniversary of the Investment Company Act and the Investment Advisers Act," and it was here where he opened the door to potentially revisiting both Acts through "a day of roundtables and dialogue" (see related article this issue).