K&L Gates Global Government Solutions ® 2011: Mid-Year Outlook
July 2011
Financial Services
Developments in the Investment Management Industry
The future course of investment management regulation is currently in the hands of
the regulators responsible for implementing the myriad of rulemakings called for
by the Dodd-Frank Act enacted just one year ago. Not surprisingly, the most farreaching regulatory overhaul of the financial services industry in 70 years has met
with resistance from many quarters and raised unexpected complexities, and the
balance of several dynamics currently in play will determine the overall impact of
Dodd-Frank in the long term. Some of the key dynamics that play a role in shaping
future regulation are discussed below.
Securities and Exchange
Commission (“SEC”) Resources
As expected, the newly-elected
Republican majority in Congress this
year has made it a key objective to roll
back the Democrat-driven Dodd-Frank
reforms. Congressional divisions over the
federal budget deficit have hit the SEC
particularly hard, as the agency seeks to
carry out the monumental responsibilities
tasked to it by Dodd-Frank. Over the
spring of 2011, given Congress’s failure
to approve a federal budget, the SEC’s
already stretched resources were diverted
from the agency’s core responsibilities to
managing administrative matters relating
to a potential government shutdown.
Although government offices ultimately
were not forced to close, skirmishes
over more fundamental SEC budgetary
issues resulted in the SEC failing to
secure a significant portion of the budget
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reform. For the most part, the SEC has
remained on track with the important
Dodd-Frank mandated initiatives,
although funding issues into the end of
2011 and early 2012 may impair its
ability to meet the aggressive Dodd-Frank
timetable, without compromising its other
core responsibilities.
Unintended Consequences
increases authorized by Dodd-Frank.
SEC Chairman Schapiro has testified that
current SEC staffing is at approximately
2005 levels, and have not kept pace
with enormous growth in the size and
complexity of the securities markets.
Among other things, the SEC has
been unable to invest in state-of-the-art
technology systems comparable to those
in the industries it regulates.
Although the SEC is essentially selffunded—its expenses are paid from
transaction fees and assessments—it
remains beholden to Congress to
set its annual budget, which leaves
the agency’s ability to properly staff
its initiatives subject to the whim of
Congress. Congressional debate over
the federal budget deficit will continue
in earnest this fall, and SEC funding is
a likely target as Congress continues to
debate the basic direction of financial
K&L Gates Global Government Solutions ® 2011 Mid-Year Outlook
Irrespective of the SEC’s budgetary
issues, Dodd-Frank significantly increased
the SEC’s long-term workload by adding
several major new areas of oversight,
including regulation of hedge fund
advisers. Although conceptually DoddFrank sought to require registration of
a fairly distinct set of advisers, in fact,
the statutory language does far more by
removing a major catch-all exemption to
investment adviser registration—that for
persons who do not hold themselves out
as advisers and have provided advice
to fewer than 15 clients in the previous
12-month period.
The unintended consequence of this
change has a stunningly broad impact,
particularly because many interpretive
questions relating to the definition of
“investment adviser” have never previously
been explored. With Dodd-Frank’s
removal of the 15-client exemption, there
Financial Services
is no longer a de minimis exclusion,
so that any advice provided to others
for compensation about investments in
securities will require SEC registration.
Many asset managers are puzzled and
alarmed to find themselves, for the first
time, apparently within this definition, and
without further SEC or staff guidance, the
ranks of registered investment advisers
may swell beyond anyone’s reasonable
expectations. In recognition of some of
the compliance burdens, the SEC has
extended the Dodd-Frank July 21, 2011
deadline for investment adviser registration
to March 30, 2012, although many
broader, related issues remain unresolved.
Other areas likely to develop in ways
not originally intended or expected
include the creation of a comprehensive
regulatory regime for the derivatives
market. SEC Chairman Schapiro has
recognized that applying new rules
to this existing market may prove
to be very disruptive, and she has
stated that the SEC is “determined to
thoughtfully consider how to sequence
the implementation of rules so that
market participants have sufficient time
to develop the infrastructure they need
to comply.” This cautious approach
would seem to be appropriate to other
areas as well, such as the SEC’s study
and possible rulemaking regarding the
establishment of a uniform fiduciary duty
for retail investment advice.
Industry participants are quickly learning
the benefit of scouring all Dodd-Frank
initiated activities for possible impact on
their business—before SEC regulations
are finalized—to permit them the
opportunity to comment on proposed
regulations, or even address issues with
the staff before regulations are proposed,
or to consider the potential need to
modify their business activities to comply.
The newly-elected
Republican majority in Congress
has made it a key objective
to roll back the Democrat-driven
Dodd-Frank reform.
Jurisdictional Skirmishes
A professed goal of Dodd-Frank was to
better resolve gaps and overlaps in the
jurisdiction of various regulatory agencies,
and the Financial Stability Oversight
Council (“FSOC”) was created to, among
other responsibilities, facilitate information
sharing and coordination among the
financial services regulators. Nonetheless,
evidence of competitive maneuvering
persists among these regulators, which
adds a degree of uncertainty to the
direction of regulatory reform.
This is particularly the case with regard
to the SEC and the Commodity Futures
Trading Commission (“CFTC”), which
have a long history of taking different
approaches to the regulation of similar
financial instruments under their respective
jurisdictions. To be sure, Dodd-Frank
interlocked them for purposes of
coordinating swaps regulation. Yet,
in other areas, inconsistent regulatory
treatment still creates opportunities for
regulatory arbitrage.
For example, the SEC has placed a
moratorium on the issuance of leveraged
ETFs under the federal securities laws,
while the CFTC has permitted sponsors
to launch leveraged ETFs that invest
in commodities, currencies and other
non-securities. On the other end of
the spectrum is the CFTC’s recent
reconsideration of a long-standing
exemptive rule for mutual funds investing
in commodity futures, commodity options
and swaps that would newly subject
those SEC-registered funds to duplicative
regulation by the CFTC. So far there seems
to have been no consideration of involving
FSOC in an attempt to harmonize existing,
duplicative, and conflicting statutes and
CFTC and SEC regulations, although it
would seem that Dodd-Frank offers this
option should these issues escalate.
FSOC continues to mull over its authority in
several areas and could potentially attempt
to assert itself more actively. Two areas to
watch are its continued involvement in the
consideration of further reform of money
market funds and its authority to designate
systemically significant non-bank financial
services companies.
As we are about to pass the 1-year
anniversary of the passage of DoddFrank, several dynamics affect the
way the statute will be interpreted by
regulatory agencies, the industry, and the
courts. Looking ahead, these dynamics
will play a role in shaping the evolution of
future rules and complicate the landscape
as firms work to incorporate the new rules
into their activities.
Diane E. Ambler (Washington, D.C.)
diane.ambler@klgates.com
K&L Gates Global Government Solutions ® 2011 Mid-Year Outlook
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