Advertising and Custody Rule Reform on SEC’s Latest Regulatory Agenda
It’s beginning to look like the next 12 months may be a period of wish fulfillment for advisers, funds and attorneys who have long called for the SEC to reform some of its existing Advisers Act rules, the Advertising Rule and the Custody Rule among them.
The Commission, in its Spring Regulatory Agenda, moved action on the Advertising Rule from planned "long-term actions" to the "proposed rule stage," which may not sound like much – but which takes reform of the much-criticized Advertising Rule (ACA Insight, 2/12/18) from a date uncertain to likely action within the next 12 months. Listed as "Amendments to the Marketing Rules under the Advisers Act," its inclusion as an expected proposed rule increases the chances that the existing Kennedy-era Rule 206(4)-1, the Advertising Rule, may be brought into the 21st century.
Also included in this item would be proposed changes to Rule 206(4)-3, the Cash Solicitation Rule.
As for custody, the Commission listed "Amendments to the Custody Rules for Investment Companies and Investment Advisers" in its list of long-term actions, meaning that reform of this rule is now higher on the SEC’s radar than it was in December 2017, when the Rule did not appear on the Fall 2017 Regulatory Agenda at all. The Commission is required to provide a new regulatory agenda every six months.
The custody reforms being considered would apparently go beyond simply reforming Rule 206(4)-2, the Custody Rule itself, and consider proposing "amendments to rules concerning custody" under both the Investment Company Act and the Advisers Act, according to the Regulatory Agenda listing.
"These proposals, depending on their substance, could introduce welcome improvements to some out-of-date (Advertising) and overly complex (Custody) rules," said Willkie Farr partner and former SEC deputy chief of staff James Burns. "Whether the proposals ultimately make it out of the building or not, it is reassuring to hear that a reassessment of these rules are in the Division of Investment Management’s sights."
"The updated rulemaking agenda is certainly ambitious," said Ropes & Gray counsel David Tittsworth. "While no one expects the SEC to adopt final rules in all these areas during the next year, one can expect that a number of amendments to Advisers Act and Investment Company Act rules will be set in motion during the coming months. For anyone who was thinking that the SEC would essentially be dormant during this year, they could not be more wrong."
The regulatory agendas
These two changes were among the more notable in the SEC’s Spring 2018 Regulatory Agenda. One thing that has not changed, however, is that neither the short-term list, which includes items in "prerule stage," "proposed rule stage" and "final rule stage," nor the long-term list, are significantly longer than they were in the fall. Agency chairman Jay Clayton at that time reduced the size of both lists considerably from what they were before he took office, saying that he wanted them to represent a realistic agenda of what would be doable.
The agenda’s shorter length, he said in a November 2017 speech, "is rooted in a commitment to increase transparency and accountability" and will include the rules the SEC plans to pursue and have a "reasonable expectation of completing during the coming year."
"The Commission has limited resources, and rulemaking is, by its very nature, time- and resource-intensive," Clayton said at the time. "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." He added that over the previous 10 years, the SEC has completed, on average, "only a third of the rules listed on the near-term agenda."
That said, the list of short-term agenda items increased from the 26 listed this past fall to 33 in the latest list, which is the same number of items listed in the Spring 2017 Regulatory Agenda, when commissioner Michael Piwowar served as acting agency chairman. It remains well below the 62 items listed in the Fall 2016 Regulatory Agenda, however. The long-term Spring 2018 agenda list, for which there is no expected enactment deadline, contains 54 items.
That said, advisers would be wise to view this year’s and future regulatory agendas not as a guarantee that the SEC will move on these and other items listed, but as a guide to what it plans to consider. Some items listed may not come up at all during the next 12 months, whether because of time and resource constraints or because of an agency change of view. On the other hand, other items not listed may be pursued. The SEC’s recent proposed amendments to its Liquidity Risk Management Rule, something not listed in the fall 2017 Regulatory Agenda, would be a case in point.
Reform of the Advertising Rule and the Custody Rule were not the only changes listed in the Spring Regulatory Agenda. Among the others were:
Use of derivatives by investment companies. Like the Advertising Rule and the Cash Solicitation Rule, this Rule was moved from the long-term agenda to the proposed rule stage. "The Division is considering recommending that the Commission re-propose a new rule designed to enhance the use of derivatives by registered investment companies, including mutual funds, exchange-traded funds, closed-end funds and business development companies," the agency’s listing for this agenda item states. "The proposed rule would regulate registered investment companies’ use of derivatives and require enhanced risk management measures." The SEC previously proposed a derivatives rule in October 2016.
Fund of funds arrangements. In the proposed rule stage, this would involve new rules and rule amendments that would allow funds to acquire shares of other funds, "including arrangements involving exchange-traded funds, without first obtaining exemptive orders from the Commission."
Fund retail experience and disclosure requests. This is the only item in the prerule stage section of the short-term items under the Regulatory Agenda. In other words, the Division is not even formally considering a proposed rule at this point. However, it is considering "recommending that the Commission seek public comment on enhancing investment company disclosures to improve the investor experience and to help investors make more informed investment decisions, " according to the agenda listing.
There are quite a number of items listed on both the short-term and long-term agendas that remain from the previous agenda. On the short-term list, these include some items that have already seen action, among them a personalized investment advice standard of conduct, which in fact was recently proposed along with a broker-dealer best interest standard and more by the SEC (ACA Insight, 4/23/18); and an exchange-traded funds rule that would allow most ETFs to operate without first having to obtain an exemptive order.
On the long-term side, items that continue to be listed include the accredited investor definition, under which the SEC would propose amendments that would expand the definition of an accredited investor under Regulation D of the Securities Act of 1933; stress testing for large asset managers and large investment companies; and proxy process amendments.