Simons Says: SEC Structure, DOL Fiduciary Rule & Chairman’s Goal

Timothy M. Simons, CFA, CIPM, CSCP
Focus 1 Associates LLC
October 30, 2017


Topics for Discussion:

I want to address three topics this month, all involving the U.S. Securities and Exchange Commissions (“SEC”). First, the structure of the top tier of the SEC; second, the SEC and the DOL Fiduciary Rule; and third, Chairman Clayton’s goal of increasing the number of investment adviser examinations conducted annually.


Top Tier at the SEC

The Securities and Exchange Commission has five Commissioners who are appointed by the President of the United States with the advice and consent of the Senate. Their terms last five years and are staggered so that one Commissioner’s term ends on June 5 of each year. The Chairman and Commissioners may continue to serve approximately 18 months after their terms expire if they are not replaced before then. To ensure that the Commission remains non-partisan, no more than three Commissioners may belong to the same political party. The President also designates one of the Commissioners as Chairman, the SEC’s top executive. There are currently two vacancies on the Commission and have been since 2015.


The Commisioners

Jay Clayton – Chairman since 2017, his term expires 2021 (R)

Kara M. Stein – Commissioner since 2013, her term expires 2017 (D)

Michael S. Piwowar – Commissioner since 2013, his term expires 2018 (R)


The Nominees

Hester Peirce (R)

Robert L. Jackson (D)

Ms. Peirce, (R) a senior fellow at the conservative Mercatus Center at George Mason University, has criticized the DOL regulation as believing that investors are not capable of choosing investments by themselves, and says the SEC should take the lead on a fiduciary duty rule.

Mr. Jackson, (D) a law professor at Columbia University, specializes in corporate disclosures. His bio on the school’s website says he chaired an effort to petition the SEC to require public companies to reveal their spending on political campaigns.

Confirmation hearings with the Senate Banking Committee started on October 24, 2017.

Meet the SEC Nominees Article can be found here


The DOL Fiduciary Rule

The Department of Labor (“DOL”), issued a rule regarding the practices of those selling products and services to retirement plans and the participants in those plans. The SEC has jurisdiction over the firms and individuals who not only sell products and services to those retirement plans and participants, but also sell products and services to those not involved in retirement plans. Portions of the DOL Rule have been delayed pending additional review by the DOL, now under new management. There are those in the financial services industry who believe that the SEC should be the regulator issuing rules pertaining to the conduct of business among providers registered with the SEC.

There have been indications from SEC staff that individuals at the SEC are working on a fiduciary rule, but that the process is complex since players involved include not only the SEC, FINRA (overseen by the SEC), the DOL, and the states (some of which have already started working on fiduciary rules for state registered financial service entities). Effective July 1, Nevada amended a law requiring financial planners to act in the best interest of their clients and comply with disclosure requirements, to also apply to broker-dealers and investment advisers. The SEC has been authorized to adopt a fiduciary rule since 2010, but has failed to do so.

A report on the Senate Banking Committee’s confirmation hearings for the two SEC Commissioner nominees indicated that the nominees considered an SEC fiduciary rule to be a priority, but not the top priority, stating that executive compensation, cybersecurity, and oversight of FINRA would be ahead of the fiduciary rule.

Article: Clayton: SEC Won’t Supplant DOL’s Fiduciary Rule

An article on Financial Advisor IQ stated that, “Some legislators and regulators argue a uniform fiduciary standard is the best approach to investor protection because it would be the most easily understood solution. Others disagree because of the challenges of coming up with an all-encompassing, uniform fiduciary standard. Yet others object because they believe the compromises required to reach uniformity would result in a weak and ultimately ineffective fiduciary standard.”

Article: Why Many Think a Uniform Fiduciary Rule Won’t Work


Increased Number of Investment Adviser Examinations

There are a number of articles discussing the intent of the SEC to increase the number of investment adviser examinations, from the roughly 11% in FY2016 to 20% over the next few years, so that every adviser will be examined on a five year cycle. An estimated 13% of all registered investment advisers (“RIAs”) were examined in FY2017 (final numbers have not been disclosed yet), which would be a 20% increase over the number of exams in FY2016. Yet, when we look at the numbers, we see how complex the situation is.

At the beginning of FY2016, which started on October 1, 2015, there were 11,986 RIAs, so 11% would equal 1,318 exams conducted in FY2016.

At the beginning of FY2017, on October 3, 2016, there were 12,201 RIAs, so examining 13% of them would equal 1,586 RIAs examined, a 20% increase.

At the beginning of FY2018, on October 2, 2017, there were 12,616 RIAs, so examining 18% (the additional 5%) of them would equal 2,271, a 43% increase in the number of exams, which seems an almost impossible goal.

Or does the additional 5% of examinations refer to the increase over FY2017, so the increase in the number of examinations in FY2018 would be 5% of the 1,586 conducted in FY2017, or the goal for total number of exams for FY2018 would be 1,665 or 13.2% of RIAs?

Examining 20% of the registrants every year is difficult because the number of RIAs has grown every year, so even if the growth in the number of investment advisers slows, you still have to conduct a larger number of exams each year, just to maintain the same percentage of the industry. Now let’s add in the fact that a number of these exams are going to be “cause” exams, firms typically not in the 5 year rotation, and there will be firms that have had problems in the past and are on a shorter cycle, maybe every year or every other year. In fact, if the SEC does conduct the number of examinations equal to 20% of the investment adviser population, they would not have examined 20% of the population.


My Perspective

First, the Congress needs to confirm the SEC nominees and let them get to work. The SEC can conduct more business with a full complement of Commissioners, and politics can be set aside for a goal of protecting investors (part of which would be examining more registrants) and the market to help get the economy flowing.

Second, the SEC and DOL need to set up a working group or task force, and beat out a fiduciary rule that will increase investor protection without forcing firms out of the market place because of increased costs. Maybe the North American Securities Administrators Association (“NASAA”) could send representatives for the states, or each state could send its own reps. There has to be a way for the SEC to push this process forward. The longer this goes on, the harder it will be to fix.

Third, the SEC has to continue to innovate with the exam process, more risk-based exams, more desk reviews (where the SEC requests documents from low-risk firms to be examined at the SEC’s offices), more use of data to target firms who say low-risk but the data identifies as outliers.

Cybersecurity continues to be a problem, and expensive to monitor. Is there a better cheaper path to security than piece-meal, the only viable for most of us? It is getting to be a problem even for the large firms that have money to throw at it, but very difficult for the smaller firms as the prices to fix systems goes up and the price we pay if the system fails become more than we can bear. We can only hope.

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