Regulatory Reform What It Means for Investment Management Firms September 23, 2010

1. Regulatory Reform What It Means for Investment Management Firms September 23, 2010 David G. Tittsworth Executive Director Investment Adviser Association www.investmentadviser.org

2. Investment Adviser Association • Formerly the Investment Counsel Association of America • Non-profit organization that represents the interests of SEC-registered advisory firms • Focus: Investment Advisers Act of 1940 • Advocacy: Capitol Hill, SEC, DOL, state securities agencies & international regulators • Membership: About 500 investment management firms that collectively manage more than $9 trillion (US) for individual and institutional clients • www.investmentadviser.org www.investmentadviser.org

3. History of Reg Reform Legislation • House passed bill Dec. 3, 2009 • 223-202 (no Republican support) • Senate passed bill May 25, 2010 • 59-39 (Brown, Collins, Grassley, Snowe joined all Dems, except Feingold and Cantwell) • House/Senate conferees approved final compromise June 25, 2010 (party line vote) • House passed conference report 237-192 June 30, 2010 (3 Repubs voted yes; 19 Dems voted no) • Senate passed conference report 60-39 July 15, 2010 (Brown, Collins, Snowe voted yes; Feingold voted no) • Bill signed by President July 21, 2010 (P.L. 111-203) www.investmentadviser.org

4. Dodd-Frank Overview • 2,300 pages • 250 rulemakings (~100 by the SEC) • Scores of studies • The legislation represents the most far-reaching and significant financial services law since the New Deal www.investmentadviser.org

5. Dodd-Frank Overview • What will it mean for advisers? • More regulations • More complex regulations • Heightened scrutiny (i.e., more frequent and more intense examinations/inspections with potential for increased enforcement activity) • Details will depend on SEC www.investmentadviser.org

6. Pillars of U.S. Regulatory Reform • Systemic risk regulation • Bureau of Consumer Financial Protection • Reform credit rating agencies • Regulation of derivatives • Regulation of private fund managers • Executive compensation www.investmentadviser.org

7. Impact on Investment Advisers • Registration under Advisers Act for private fund advisers ($150 million AUM) • Accredited investor standard increased to $1 million (excludes primary residence) • “Incentive-based” compensation rulemaking • Disclosure of structure that provides executive with “excessive compensation, fees, or benefits” OR • Could lead to “material financial loss” to firm • Applies to firms that have “assets” of $1 billion or more • Other provisions require disclosure of proxy votes on executive compensation and golden parachutes • Systemic risk provisions • Certain “non-bank financial companies” may be subject to regulation by Fed and Financial Stability Oversight Council www.investmentadviser.org

8. Impact on Investment Advisers • Derivatives • Broad definition of “swap,” “swap dealer,” “major swap participant” • Subjects OTC derivatives to SEC/CFTC jurisdiction • Short selling regulations • SEC must adopt rules for public disclosure of short sale info on monthly basis • Securities lending rulemaking • SEC must adopt rules by July 2012 to increase transparency • Volker Rule • Advisers affiliated with banks/bank holding companies may be subject to restrictions on proprietary trading and investing in private funds (PE and hedge funds) www.investmentadviser.org

9. Impact on Investment Advisers • SEC required to adjust “qualified client” standard (predicate for performance fees) • SEC given authority to prohibit mandatory arbitration clauses • Expanded enforcement powers for SEC • May bar adviser from associating with BD, transfer agent, municipal securities dealer, etc. • Empowers SEC to collect monetary penalties in cease-and-desist cases • Expands judicial jurisdiction over cases brought by SEC involving foreign transactions • Expands SEC authority to persons who aided and abetted violation of Advisers Act www.investmentadviser.org

10. Reg Reform: Investment Adviser Issues • “Harmonization” of broker-dealer and investment adviser laws & regulations • Fiduciary duty issues • Adequacy of SEC resources • Self-regulatory organization (SRO) issues www.investmentadviser.org

11. “Harmonization” – Background “Treasury recommends statutory changes to harmonize the regulation and oversight of broker-dealers and investment advisers offering similar services to retail investors….In that vein, Treasury also believes that self-regulation of the investment advisory industry should enhance investor protection and be more cost-effective than direct SEC regulation…Thus, in effectuating this statutory harmonization, Treasury recommends that investment advisers be subject to a self-regulatory regime similar to that of broker-dealers.” • Blueprint for a Modernized Financial Regulatory Structure (March 31, 2008) www.investmentadviser.org

12. “Harmonization” of BD/IA Regulation "Securities professionals, regardless of what their business card says, should be subject to the same standard of conduct, the same licensing and qualification requirements, the same disclosure obligations, the same regulatory and recordkeeping standards and a robust examination and oversight schedule.“ SEC Chairman Mary Schapiro (Dec. 3, 2009) www.investmentadviser.org

13. “Harmonization” of BD/IA Regulation • There is a need for “enhanced regulatory consistency” between brokers and advisers, especially with respect to “licensing, advertising, sales practice, and disclosure.” FINRA CEO Richard Ketchum (Mar. 26, 2009) www.investmentadviser.org

14. Fiduciary Duty • Administration proposal (June 2009): Brokers that provide investment advice should be subject to same fiduciary standard as investment advisers • Broker and insurance concerns about fiduciary duty: • Commissions • Proprietary products • “Limited” advice www.investmentadviser.org

15. IAA Positions re: “Harmonization” • Fundamental differences exist between most brokers (“sell side”) and most investment advisers (“buy side”) • Imposing broker-dealer rules on advisers does not make sense (BDs are moving into advisory profession not the other way around) • Do not weaken or water down Advisers Act fiduciary duty; do not impose different standards for different types of clients • Advisers Act fiduciary duty should be extended to brokers and others who provide investment advice www.investmentadviser.org

16. “Harmonization” Legislation • House bill required SEC to issue rules on fiduciary duty (“personalized investment advice” to “retail customers”); permitted rules on other “harmonization” issues: disclosure, sales practices, conflicts of interest, and compensation schemes • Senate bill required SEC to study fiduciary duty and examination issues www.investmentadviser.org

17. “Harmonization” Legislation • Final Compromise (Section 913) • Essentially stapled together the two approaches with some modifications • SEC required to conduct study and to submit report to Congress (6 months) • SEC authorized to issue rules under ’34 Act and Advisers Act re: standard of care for BDs and IAs • Debate shifts from Capitol Hill to the SEC www.investmentadviser.org

18. Section 913 Study • SEC issued request for comments on July 27 (30-day period expired Aug. 30) • Study must be completed by January 21, 2011. SEC required to submit report to Congress with “findings, conclusions, and policy recommendations” and analysis of “regulatory gaps, shortcomings, or overlap” in BD and IA legal and regulatory standards. • See IAA Comment Letter (Aug. 30): www.investmentadviser.org www.investmentadviser.org

19. Section 913 – Rulemaking Authority • SEC authorized to issue rules under ’34 Act to impose Advisers Act fiduciary standard on BDs “when providing personalized investment advice about securities to a retail customer” • Receipt of commissions/sale of proprietary products are not per se violations of fiduciary standard • No continuing fiduciary duty after providing advice www.investmentadviser.org

20. Section 913 and “Harmonization” • SEC also directed to: • “facilitate…simple and clear disclosures to investors regarding the terms of their relationships” with BDs and IAs; and • to issue rules “prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes” for BDs and IAs that are contrary to the public interest and investor protection www.investmentadviser.org

21. Section 913 – Why Does It Matter? • SEC study will identify legal or regulatory “gaps, shortcomings, or overlap” in BD and IA regulations • Fiduciary duty rulemaking is likely • BDs will be subject to fiduciary standard when providing personalized investment advice to retail customers; but will Advisers Act fiduciary standard be altered? • Opens the door to wide array of other “harmonization” regulations (imposition of BD rules on IAs) • Fiduciary standard is an important distinguishing characteristic of the advisory profession • Investment advisers need to weigh in with SEC and Capitol Hill to educate policy makers… www.investmentadviser.org

22. SEC Resources • Growth in investment advisory profession has raised concerns about whether SEC has sufficient resources to oversee IAs • SEC has ~450 examination staff to oversee 11,000 IAs and 9,000 ICs • Average inspection “cycle” is about once every 10 years… www.investmentadviser.org

23. SEC-Registered Investment Advisers by AUM (April 2010) www.investmentadviser.org

24. SEC Resources • Potential options • Increase SEC’s annual appropriation • “Self-funding” (dedicated revenue stream) • User fees for investment advisers • Increase $25 million threshold for SEC jurisdiction • Self-regulatory organization (SRO) for advisers www.investmentadviser.org

25. SEC Resources – Dodd-Frank • No self-funding • No IA user fees • Section 35: Increases SEC authorized funding from $1.3 billion in 2011 to $2.25 billion in 2015; establishes $100 million reserve fund • Section 410: Increases $25 million AUM threshold to $100 million (will shift ~4,000 IAs from SEC to States) • SRO issues to be studied… www.investmentadviser.org

26. Self-Regulatory Organization (SRO) Issues Under Dodd-Frank • Section 914: “Study on Enhancing Investment Adviser Examinations” • SEC required to “review and analyze the need for enhanced examination and enforcement resources for investment advisers.” • SEC will examine: (1) number/frequency of IA exams during last 5 years; (2) extent to which SRO “would improve the frequency of examinations of investment advisers”; and (3) approaches to dual registrants/affiliated firms • Report due in 6 months (including legislative recommendations) www.investmentadviser.org

27. Self-Regulatory Organization (SRO) Issues Under Dodd-Frank • Section 967: “Commission Organizational Study and Reform” • SEC required to hire “independent consultant of high caliber” within 90 days to look at variety of organizational issues, including: • “whether adjusting the SEC’s reliance on self-regulatory organizations is necessary to promote more efficient and effective governance for the securities markets” • Consultant report due in 150 days; SEC to submit report to Congress every 6 months for 2 years outlining implementation of recommendations www.investmentadviser.org

28. Self-Regulatory Organization (SRO) for Investment Advisers • FINRA actively lobbying to expand its turf to investment advisers “FINRA is uniquely positioned from a regulatory standpoint to build an oversight program for investment advisers quickly and efficiently.” FINRA CEO Richard Ketchum Mar. 26, 2009 www.investmentadviser.org

29. SRO for Investment Advisers “…I believe that Congress should have authorized a self-regulatory organization, or SRO, for investment advisers. The presence of an additional national regulator or regulators, particularly one not dependent on funding by taxpayers, would enhance investment adviser oversight. That suggestion is quite unpopular in some circles, but it would be a step forward in my view.” SEC Commissioner Elisse Walter June 10, 2010 www.investmentadviser.org

30. IAA Positions re: SRO/FINRA • SRO for advisers is unnecessary and adds extra layer of bureaucracy and cost • Inherent conflict of interest • IAA opposes FINRA as adviser SRO: lack of transparency, lack of accountability (to Congress and the public), track record, costs, bias favoring broker-dealer model • Better alternatives: (1) give SEC adequate resources; and (2) improve SEC inspection program www.investmentadviser.org

31. In the meantime… • SEC approved final investment adviser custody rule (Dec. 30, 2010) • Advisers that have custody – or are deemed to have custody of client funds – are required to obtain annual surprise audit (no small matter depending on number of accounts, custodians, types of securities) • Deduction of fees by itself will not trigger annual audit, but adviser serving as trustee to client account is deemed to have custody www.investmentadviser.org

32. In the meantime… • SEC approved final “pay-to-play” rule under Advisers Act (June 30, 2010) • If you advise state or local governments – or if you want to – you need to understand this rule! • Compliance dates: (1) March 14, 2011 for political contributions; (2) Sept. 13, 2011 for third-party solicitor restrictions • “Death penalty” (two year “time out”) for violations www.investmentadviser.org

33. In the meantime… • SEC approved final Form ADV Part 2 rule (July 27, 2010) • Requires ALL advisers to convert Form ADV Part 2 to a Plain English narrative brochure • 18 topics must be addressed: • Description of adviser’s business; fees and compensation; disciplinary info, methods of analysis; investment strategies and risk of loss; brokerage practices, personal trading, etc. www.investmentadviser.org

34. Form ADV Part 2 (cont’d)… • Advisers must give “brochure supplement” to new and prospective clients, describing qualifications of individuals who provide advice to that client • Required for annual updates made after Jan. 1, 2011 (March 31, 2011 for most advisers) • Form ADV Part 2 will be publicly available (www.adviserinfo.sec.gov) www.investmentadviser.org

35. Next Steps… • SEC • Congress • Stay tuned • Get involved… www.investmentadviser.org

36. Contact Information David Tittsworth Executive Director Investment Adviser Association david.tittsworth@investmentadviser.org 202.293.4222 www.investmentadviser.org