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News January 1, 2018 Issue

2018: What Advisers Should Expect in the Year Ahead

Prognostication is always a bit of a guessing game. What may look like priorities in January may be replaced by other issues in the latter part of the year or may be driven by external and internal events, politics and the marketplace. Whatever may occur, 2018 is already marked as a year for change in the asset management industry.

"What we see for 2018 includes a continued focus on fiduciary duty, a hard look at market structure – both equity and fixed income markets, continued emphasis on cybersecurity, and a review of ways to streamline regulation to make it more effective and efficient," said Investment Adviser Association president and chief executive officer Karen Barr. "For example, the SEC may finally provide a way for exchange-traded funds to operate without first getting an exemptive order." On a more long term basis, she predicted, "the SEC will examine ways to improve the Advertising Rule – an effort that we have long advocated for."

When a new regime takes over at an agency like the SEC, said Willkie Farr partner and former SEC Director of Investment Management director Barry Barbash, "the first year usually is characterized by the new folks’ getting key staff in place and learning how the agency operates. By the second year, however, the new regime asserts far more influence over the agenda. We’ll start to see the new SEC take shape during 2018."

It is also likely that a final Fiduciary Rule will be enacted, he said. "We’ll finally get that sorted out."

Proskauer partner Robert Plaze agreed that there will be a proposal that attempts to address the fiduciary issue. "I’m not saying it will be adopted in 2018 (or ever), but Clayton appears to have just about promised some action on this."

As for enforcement, Barbash said that "while we’ll continue to see examinations conducted and enforcement actions commenced, the ‘broken windows’ of chair Mary Jo White won’t be followed." That said, Eversheds-Sutherland partner Brian Rubin suggested that firms "make sure their windows are clean and well-insulated, in case the regulators backtrack. It will be interesting to find out whether we see ‘kinder and gentler’ securities regulators."

Barbash also said he expects to see more merger and acquisition activity among investment advisers, as larger firms buy up smaller firms, or firms of similar size become one. This trend, he said, will be set by market forces that will necessitate advisory firms’ being bigger so as to continue to provide a variety of services to their clients.

"If there is a thematic point over the next few years, it’s technology," said Shearman & Sterling partner Nathan Greene. "How will disclosure and documentation be provided?" In addition, "the use of ‘big data’ is accelerating. It can be sifted and filtered by compliance officers who analyze trading, which is great. But then the compliance officers are visited by analysts who say, ‘I want to buy this new data set,’ and the compliance officer is left wondering what the compliance issues are."

Revised SEC rulemaking agenda

The SEC under new chairman Jay Clayton set a strong possible signal of its 2018 priorities with its December 14 posting on the Office of Management and Budget site of 26 proposed and final rules it plans to work on during the coming 12 months. It is a streamlined agenda, down from 33 posted this past Spring when Michael Piwowar served as acting agency chairman, and even further down from the 62 items listed in the second half of 2016 under White.

The SEC moved a number of items from the list of proposed and final rules to a second list of more than 50 longer term items, among them the final Derivatives Risk Management Rule.

"Some of the things that were important to White are lower on the Clayton priority list," said Barbash. "While you never know in advance what the SEC will adopt over the next year, Clayton has said that he wants the SEC’s list as published by the OMB to be a realistic estimate of what the Commission can accomplish during the year."

Clayton referred to the list in a November 8 speech he gave, in which he made it clear that he wanted the agency’s rule list to reflect work that could realistically be achieved.

In promising a shorter agenda, he said that past agendas had "swelled over the years. The Commission has limited resources, and rulemaking is, by its very nature, time- and resource-intensive. As a result, if all, or substantially all, of the rulemakings listed on previous near-term agendas were to evolve through to adoption, the process would take years." Over the past 10 years, he said, the SEC has completed, on average, "only a third of the rules listed on the near-term agenda."

The agenda’s shorter length "is rooted in a commitment to increase transparency and accountability," Clayton said. It will include, he said, the rules the SEC plans to pursue and have a "reasonable expectation of completing during the coming year."

Near-term agenda

Following are some of the items listed in the agency’s revised list of rules it plans to work during the coming 12 months:

  • Exchange-traded funds. This proposed rule would presumably allow brokers to trade ETF securities that meet a "plain vanilla" definition without having to first seek an exemption.
  • Personalized investment advice standard of conduct. Also a proposed rule, it will be the SEC’s take on a fiduciary rule for most financial institutions, and would possibly incorporate what is now the Department of Labor Fiduciary Rule, which applies only to financial entities recommending retirement investments. Clayton and DOL secretary Alexander Acosta have publicly said that the SEC should become involved in this process. Its inclusion on the list would seem to indicate that Clayton is serious about it.
  • Investment company reporting modernization/ option for website transmission of shareholder reports. A final rule in this area, if adopted, would require funds to provide additional information about their activities, not unlike what investment advisers now have to do under the reporting modernization rule that was adopted in October 2016 and is now in effect.

Long-term agenda

Here are some of the items listed as "long term" under the agency rule list. Just how long they will take to be completed, or if they will be completed at all, is unknown. It is also possible, of course, that the 2018 agency list will see some of these items moved back to near-term status.

  • Use of derivatives by registered investment companies and business development companies. The SEC issued a proposed Derivatives Risk Management Rule in October 2016, when it was considered a priority by the agency. Its move to the long-term list would seem to indicate that a final rule is unlikely to be
    adopted any time soon.
  • Stress testing for large asset managers and large investment companies. The agency planned to take this on in 2016, but was unable to. Looks like it may be some time longer now, if ever.
  • Accredited investor definition. The SEC apparently feels that this can wait.

"While it does not appear on the agency’s agenda for 2018, I don‘t think you can rule out the possibility that the Commission could consider amendments to the existing Liquidity Risk Management Rule," said Ropes & Gray counsel David Tittsworth. "Both the Treasury Department and the Investment Company Institute have recommended altering the buckets required by the liquidity rule."

He noted that two "significant potential rulemakings" that have fallen off both the near-term and the long-terms lists: the proposed Business Continuity and Transition Planning Rule, and a potential rule requiring investment advisers to have third-party compliance reviews.

The SEC is also likely, despite budget restraints, to continue to expand its examinations of investment advisers, said Sidley Austin senior counsel Jonathan Miller. "In just the past year," he said, "the agency reassigned approximately 100 Office of Compliance Inspections and Examinations staff to the adviser examination unit." Advisers can also expect the SEC to "continue to increase the use of data analysis as an examination tool, as well as in deciding which firms to examine and the appropriate scope of examinations," Miller said.

One topic that is not likely to be significant in 2018 that was a significant topic in past years was the drive to "prudentially regulate advisory firms," meaning to treat them like banks, said Greene. "It’s history at this point," he said. "The change in the Administration put the nail in the proverbial coffin. The recent report from the U.S. Treasury (ACA Insight, 11/6/17) talked about and agreed with those in the asset management industry that the correct way to regulate advisory firms is not to regulate them like banks, but through product and practice regulations."