Guidance is No Substitute for Rulemaking, But Helpful When Used Correctly
When the Division of Investment Management or the Office of Compliance Inspections and Examinations issues a guidance update or a risk alert, it is usually meant as a means to help advisers, investment companies, broker-dealers and others comply with securities laws and regulations. But just what are the benefits and drawbacks of guidance?
When people think about guidance, they usually think about Division of Investment Management Guidance Updates, but it is really more than that, said Division director Dalia Blass at the Investment Adviser Association’s 2018 Compliance Conference. Staff guidance actually includes "the entire body of work that comes out of the Division," including no-action letters and other communications. They "are very important," she said. "If used judiciously and appropriately, they have a time and place. . . . It’s an important tool for you to hear what the staff is thinking."
She acknowledged that some guidance updates have "caught people by surprise, and some have raised more questions than they have answered." As an example, she pointed to the Division’s February 2017 guidance update on inadvertent custody (ACA Insight, 3/13/17), which, she said, "falls into that bucket."
The best way to avoid the problem of the agency issuing some form of guidance that catches those reading it by surprise is "to be as transparent as possible," and use engagement and industry outreach. "Through engagement, less surprises," she said.
Guidance v. rulemaking
Sometimes, it seems like there is a surfeit of guidance and yet a lack of rules on a particular subject. One example of that might be the topic of advisers and fiduciary responsibilities. There are numerous sources of information here, including the Advisers Act, court decisions, guidance updates, risk alerts, no-action letters and enforcement actions among them, but no one comprehensive authoritative source, said Stradley Ronon partner Lawrence Stadulis. "That’s one of the likely reasons for the SEC’s April 18 proposed interpretation of advisers’ fiduciary responsibilities," he said. "It put all of the sources on the subject and put them all in one place."
It is also relatively easy for the SEC staff to issue guidance, compared with the laborious and somewhat lengthy process of rulemaking. In addition, said Stadulis, "guidance is good because it provides flexibility on both sides. The SEC can issue new guidance when it feels necessary, and advisers can request relief through no-action letter requests. On the other hand, it’s very difficult to pull back a rule."
"Rulemaking is preferable in the abstract, but there are so many parties with vested interests that the rulemaking process becomes incredibly difficult and burdensome for the staff and Commission (not to mention the inevitable court challenges to controversial rules)," said King & Spalding partner Alec Koch.
Yet rules have their advantages. For one, they are authoritative, as they are voted on by the Commission. Those following rules, assuming they read and interpret them correctly, know they are on solid ground. Those relying on guidance are really relying only on the staff’s point of view, which does not carry the authority of a law or regulation.
While guidance can be helpful, it can also go too far, such as when it is perceived to be an attempt to take the place of rulemaking, particularly when advisers and their counsel feel they need to look at enforcement actions to determine what the SEC is requiring.
"Guidance is helpful, particularly when existing no-action letters are consolidated in one place and the current position is highlighted," said Mayer Brown partner Stephanie Monaco. "What I don’t like is when guidance goes beyond stated positions for the first time and articulates new concepts. That is tantamount to rulemaking without notice and an opportunity to comment."
Kirkland & Ellis partner and former Division of Investment Management director Norm Champ said that while "guidance by the SEC staff on complex topics can be really useful for regulated firms trying to navigate the thicket of rules and regulations, this guidance should be on how to comply with the rules, not changing the rules which can only be done by the Commissioners."
The need for rules and guidance
"The more rules we have, the more expensive they are to enforce," said Stern Tannenbaum partner Aegis Frumento. "But here’s the problem: It is impossible for a system of rules to cover every possible situation that might arise. This leads to two unintended consequences: first, tight rules lead to many good faith technical violations that don’t really pose a danger to anyone; and second, tight rules won’t cover every possible situation that really is dangerous. In other words, tight rulemaking leads to both absurd enforcement actions and the exploitation of loopholes. And loopholes lead you to playing whack-a-mole – generating more rules to cover more loopholes, which just makes the rules even more focused and more prone to being gamed."
"That’s why we inevitably have a hodgepodge of rules and guidance," he said. "There are general rules, then there are specific rules that implement the general rules in certain predictable situations, and then there is guidance to help people figure out how the general and specific rules apply to more unusual situations."
Frumento said that, in his view, "the real solution is to increase the professional status of compliance personnel – give them rigorous training and empowerment, and then trust them to make compliance decisions based on general principles, that is trust them to do the right thing. Most importantly, let them make judgment calls in the field, with the assurance that if they make a good faith mistake, they won’t get whacked."
"Another way to look at it is to apply to compliance personnel a standard very much like malpractice for doctors and lawyers," he said. "The test of any decision by a compliance professional should not be whether some regulator thought he or she got it ‘right,’ but whether in making that decision, the compliance officer acted in good faith, made a due investigation of the facts and made a reasonable judgment call. No compliance decision made in good faith should ever be punished. If good faith errors are made, it should be a teachable moment, not an excuse for some eager regulator to make his or her bones."