On June 15, 2022, the United States Securities and Exchange Commission (the Commission) issued a request for comment on whether certain providers of indices, models, prices and other information should be regulated in as investment advisers under the Investment Advisers Act 1940. The Commission suggests that further review is needed in light of changes in technology and market practice over the decades since these topics have been the subject of particular attention for the last time, especially given the continued expansion of index investing strategies. Responses to the Request for Comments are due no later than August 16, 2022 or 30 days after the publication of the release in the Federal Register.
The fact that the Commission is raising these issues now is not surprising, as the agency has shown growing interest in these service providers in recent years.1 However, it is worth noting that this is only a “request for information” and not a proposed rule. While the timing of next steps is uncertain — in this regard, the Commission is proposing rules at a record pace but must be constrained by a regulatory pipeline that can only handle a limited volume in a year — the release is a clear statement that the Commission intends to formalize some form of regulation for at least some suppliers.
That said, we also see significant barriers to new regulation. First, many providers rely on a statutory exclusion from the Advisors Act for publishers of financial information. To continue, the Commission will therefore have to review the way this exclusion is understood and will be limited, to some extent, by case law. Second, while there may be policy objectives encouraging the Commission to expand its jurisdiction, the wide range of people who may be regulated is striking. With an ever-increasing number of information-based business models, the Commission faces either difficult guidelines or practical limits on its ability to oversee and review a large population of newly regulated businesses, or both. Even estimating the costs and resources associated with regulation will be a daunting challenge. Finally, the Advisors Act and its rules in their current forms are clearly not designed for these businesses. All of these factors may leave the Commission with only a relatively narrow path.
The Advisors Act generally defines an “investment advisor” as any person who, for remuneration, engages in advising others, either directly or through publications or writings, about the value of securities or on the advisability of investing in, buying, or selling transferable securities, or any person who, for remuneration and within the framework of a current activity, issues or promulgates analyzes or reports concerning transferable securities. The definition generally includes three elements to determine whether a person is an investment adviser: (i) The person provides advice, or publishes analyzes or reports, concerning securities; (ii) the person is in the business of providing such services; and (iii) the person provides those services for compensation. Each item must be met for a person to be considered an investment advisor.
It is important to note that the definition does not require an investment adviser to exercise investment discretion. Simply providing reports or analysis may suffice. Given the breadth of the definition, Commission staff were repeatedly asked to consider the application of the Advisors Act to business models involving databases or analytics tools.
In response, staff offered advice in the form of ‘no action’ letters stating that regulation under the Advisers Act is not necessary where (i) the information concerned is readily available to the public in its raw state, (ii) the categories of information are not narrowly selective, and (iii) the information is not organized or presented in a manner suggesting the purchase, holding or sale of one or several titles.2 However, these directions have remained largely unchanged since the 1990s, meaning that the business models of these staff letters generally do not correspond directly to those of current internet-based, algorithmic and other services, and are not well suited to types of businesses, partnerships and layers of providers that make up a large part of the modern market for these services.
As noted above, Congress also provided a statutory exclusion from the definition of an investment adviser for a “publisher of any bona fide newspaper, news magazine, or business or financial publication of general and regular circulation.” This “publisher exclusion” is widely invoked by information-based companies, including index providers.
Questions from the Commission
To help inform its thinking, the Commission requested information on the following topics, among others:
- how industry participants apply the different parts of the definition of investment adviser to these businesses
- whether the factors described in the no-action letters are still appropriate
- how industry players enforce publisher disclaimer
- whether brokers rely on tailored exemptions specific to their regulated status
- whether consumers are confused by the status of these different types of businesses
- whether providers see themselves as having fiduciary duties
- if the customization and personalization of the services modify these analyzes
- whether general indices should be treated differently from more specialized indices
- the extent to which providers are transparent about the inputs and methodologies that underpin their services
- how providers are paid
- whether further advice is needed or desirable
- whether new exemptions from the Commission are necessary or desirable
The Commission has also asked for relevant information on what a registration regime for these companies might look like, including
- whether the provisions of the Advisers Act would be complex or operationally burdensome in this context and, therefore, whether exemptions from specific requirements would be appropriate
- whether registration would cause companies to change their business models, consolidate or exit the market
- what types of information should be required from registered companies and what information should be public or disclosed to regulators on a confidential basis
- whether Form ADV (the federal registration form for investment advisers) needs to be adapted for use in this context
- when a company should “review” an end user taking into account the nature of their clients for disclosure purposes and the substantive requirements under the Advisors Act
- whether a US approach to index provider regulation should be aligned or different from that of the European Union
The Commission then discussed how regulatory assets under management separate investment advisers who register with the Commission from those who are not eligible for federal registration and therefore must register with one or several states. These thresholds often mean that firms that do not provide discretionary investment advice (i.e. most of the types of providers discussed here) are only eligible for state registration. The Commission therefore requested information on these thresholds, in particular
- how industry participants are handling these state vs. federal registration issues today
- bases that allow companies to register with the Commission notwithstanding these limits on regulatory assets under management (RAUM)
- whether there should be special treatment for companies with a “national presence”
- whether Commission registration in this context should be mandatory or optional
Finally, the Commission asked specific questions when the end user is a registered investment company, including
- whether the provider of a bespoke index created for a single fund is to be treated as an investment adviser to the fund for the purposes of the Investment Companies Act 1940
- if so, whether the provider should comply with the relevant provisions of the law on investment companies
- how the compliance program requirements for investment firms might apply to these providers
- whether fund board approval from these providers is or should be required
- whether the structure of the relationship – including whether the supplier is hired directly by the fund or by another supplier to the fund – should change the analysis
1See, for example, William Birdthistle, Director, Division of Investment Management, Remarks at the IAA Investment Adviser Conference (March 3, 2022), available at https://www.sec.gov/news/speech/birdthistle-remarks-iaa- investment-advisor-compliance-conference-030322; Dalia Blass, Director, Investment Management Division, Keynote Address, ICI Investment Management Conference (March 19, 2018), available at https://www.sec.gov/news/speech/speech-blass-2018-03-19 ; Commissioner Hester M. Peirce, Statement on S&P Dow Jones Indices LLC (May 17, 2021), available at https://www.sec.gov/news/public-statement/peirce-statement-sp-dow-jones-indices-051721 .
2See, for example, Missouri Innovation Center, Inc.SEC No-Action Letter (October 17, 1995); General Media Financial Services, Inc.SEC No-Action Letter (July 20, 1992); Charles Street Securities, Inc.SEC No-Action Letter (November 28, 1989); Butcher & SingerSEC No-Action Letter (January 2, 1987).
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