SEC Office of Investor Advocate Releases FY 2019 Policy Objectives

The SEC Office of the Investor Advocate (“OIA”) set forth its priorities for protecting and promoting the interests of retail investors in a newly released FY2019 annual Report on Objectives. The OIA will focus on the following nine areas:

  • Public Company Disclosure: The OIA will continue to support SEC efforts to update and modernize disclosure requirements for public companies but noted that a “holistic” approach is needed to cultivate a healthy environment for public companies while protecting retail investors.
  • Equity Market Structure: The OIA will continue to work with the SEC and staff on proposed rule changes to Regulation NMS Rule 606 and proposed amendments to Regulation ATS. For example, in March 2018, the SEC proposed a rule to conduct a transaction fee pilot program for National Market System (NMS) stocks. The OIA explained that it will review elements of the pilot to determine whether it helps the SEC to evaluate potential equity market structure reforms.
  • Fixed Income Market Reform: The OIA will continue to monitor MSRB and SEC efforts to supervise the municipal securities markets while broadening its focus to fixed-income market reform more generally.
  • Accounting and Auditing: The OIA will work to close the gap between what investors expect from financial statements and what the statements actually communicate to investors.
  • Standards of Conduct for Broker-Dealers and Investment Advisers: The OIA will monitor closely the developments of the proposed rules on standards of conduct for broker-dealers and investment advisers. The OIA stated that it has been researching whether investors can distinguish between “different types of investment professionals, and how effectively investors navigate the market for financial advice, and the types of conduct investors expect from an investment professional.”
  • Exchange-Traded Funds (“ETFs”): The OIA will continue to support the SEC’s proposal permitting ETFs to operate without an exemptive order to the extent that the proposal does not sacrifice investor protection.
  • Enhanced Disclosure for Mutual Funds and Variable Annuities: The OIA will continue to conduct research intended to improve fund fee and expense disclosure. The OIA highlighted its support for the development of a summary prospectus for variable annuities that would divulge key information needed by investors to assess the benefits, risks and costs of their investments.
  • Transfer Agents: The OIA will focus on the importance of modernizing transfer agent rules in order to help strengthen investor protection as well as combat fraud in the microcap market. According to the OIA, transfer agent responsibilities have evolved significantly since the advent of transfer agent rules, so the rules need to be updated in order to account for the shifting landscape.
  • Impact of Kokesh v: SEC on Enforcement Actions: The OIA will examine potential solutions to mitigate the impact of the Supreme Court’s ruling in Kokesh (which “bars the [SEC] from obtaining disgorgement in actions brought beyond the five-year statute of limitations”). The OIA asserted that the ruling has had negative effects on retail investors.

Lofchie Comment: The OIA policy report fails to acknowledge the trade-offs of costs and benefits inherent in regulatory policy. For example, the SEC’s Best Interest proposal, which will effectively discourage broker-dealers from making recommendations to retail customers, will inherently disincentive broker-dealers from making public offerings available to retail customers. If the SEC is going to adopt a rule that makes it substantially more risky to recommend new offerings or start-up companies to retail investors, then start-ups are better off staying private because they already have access to institutional money without going public, and going public will subject them to material additional expense. The suggestions as to ETFs also fail any basic cost-benefit basic analysis.

Put another way, is there no reduction in regulation that might be worthwhile if it causes any reduction in investor protection? Who could disagree with the promulgation of even more rules that provide benefits without cost?

FRB Vice Chair Discusses Lessening Regulatory Burden on Community Banks

Federal Reserve Board (“FRB”) Vice Chair for Supervision Randal K. Quarles outlined the agency’s recent efforts to review and improve its regulatory framework now that implementation of major post-crisis reforms is largely complete.

In a speech before the 110th Annual Convention of the Utah Bankers Association, Mr. Quarles emphasized the importance of U.S. participation in the Financial Stability Board (“FSB”). He highlighted two supervisory improvements that the FSB and other agencies applied to reduce the regulatory burden on community and regional banks: (i) the FRB “Bank Exams Tailored to Risk” program and (ii) a joint action taken with other agencies to simplify the reporting responsibilities of smaller banks.

Mr. Quarles discussed the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Act”), which was recently signed into law. According to Mr. Quarles, the Act retains the most important post-crisis reforms while directing the FRB to make necessary changes to reduce the regulatory burden on regional banks. Additionally, Mr. Quarles said that raising the asset threshold for bank holding companies that are eligible for the Small Bank Holding Company Policy Statement allows the FRB to “tailor its rules for these firms moving forward while retaining the ability to protect the safety and soundness of the system.”

Mr. Quarles also underscored the importance of international regulatory communications, standard setting and assuming a comprehensive perspective on financial vulnerabilities when addressing global issues. Mr. Quarles argued that more accurate risk assessment in the broader financial system is integral to reducing the regulatory burden on community banks.

SEC Proposes Changes to ETF Approval Process

The SEC proposed a new rule that would modify the approval process for certain exchange-traded funds (“ETFs”).

Under proposed Investment Company Act Rule 6c-11, open-ended ETFs would be able to come to market without applying for an exemptive order. Certain ETFs would not be able to rely on the rule, including ETFs organized as unit investment trusts (“UITs”), leveraged ETFs, inverse ETFs and ETFs organized as a share class of a multi-class fund.

ETFs that qualify for the exemptive rule would be required to meet certain conditions, including:

  • posting daily portfolio transparency information on their websites;
  • using custom baskets only after adopting adequate written policies and procedures;
  • adhering to certain recordkeeping requirements; and
  • complying with certain website disclosure requirements.

The proposal would rescind previous exemptive relief for ETFs that are able to rely on the rule. The SEC recommended preventing the creation of new ETFs organized using a “master-feeder” structure.

The SEC also proposed amending disclosure obligations for funds organized as UITs.

The SEC will accept comments on the proposal for a period of 60 days after it is published in the Federal Register.

Lofchie Comment: The SEC’s proposed ETF exemptive rule is a recognition that ETFs have become a “plain-vanilla” form of transaction, even if any individual ETF may be based on a unique investment thesis.

Notably, leveraged ETFs cannot benefit from the exemptive rule (they still will be required to obtain individual exemptive orders). Commissioners Stein and Jackson issued statements expressing skepticism as to the benefits of such ETFs.