The mutual fund and ETF question gets looked at from a regulatory standpoint

March 1, 2010 — 6:33 AM UTC by Elizabeth MacBride and Sara Hansard and Elizabeth MacBride


Brooke’s Note: A slide show of the conference can be seen on the jump page of this article.

In off years, a compliance conference might be considered, well, less than lively.

This year, with the RIA regulator world threatening to spin off its axis in Washington, D.C., the Investment Adviser Association’s annual compliance conference was abuzz with questions about the future of RIA regulation.

Will FINRA succeed in its bid to regulate hybrid RIAs, or even all RIAs? Are any ears on the Hill open to the RIA argument that a strong fiduciary standard is crucial to protect consumers? And everyone was listening to SEC Commissioner Elisse Walter for clues about what the SEC might do, in addition to or in lieu of legislation. And then, there were all the post-Madoff, post-crisis regulations that are taking effect no matter what happens on the Hill.

Attendance at the conference, co-sponsored by ACA Compliance Group, was up about 25% over last year, to about 200 attendees. About a dozen vendors filled a large alcove in the Crystal Gateway Marriott in Arlington, Va.

Here are a few things that RIABiz picked up, some topics we hope to return to in coming weeks with more in-depth articles:

1.) ETF may upset the suitability applecart

Exchange traded funds are a threat to the traditional active managed products, including mutual funds and separate accounts, Thomas Lemke, managing director and general counsel of Legg Mason Capital Management told the Investment Adviser Compliance Forum.

Actively-traded ETFs have much lower costs than actively managed funds, Lemke said. He listed several reasons for that: ETFs can not charge 12b-1 fees, they do not have some custodian fees that are typically a significant part of expense ratios for broker-distributed funds, and revenue sharing can not be paid on an active ETF.

“If I have an active ETF that is a clone of an actively-traded fund that I have in my regular portfolio, the expense differences are going to be material,” he said. “It’s going to place lots of suitability issues on anyone who sells those securities, because how can you justify with the exact same product significantly different expense ratios?”

The industry is trying to figure out how ETFs work through the traditional broker distribution channel. “I think for now the feeling is if it’s part of wrap program, they work. They don’t work as well as a free-standing product, because, again, no 12b-1 [fee], no sales load, no revenue sharing.”

But as the industry figures that out, “It’s going to be a challenge for those of us in the traditional market.”

A failing

Further, SEC Division of Investment Management Associate Director and Chief Counsel Douglas Scheidt added, because ETFs trade throughout the day, unlike traditional mutual funds, “ETFs have pointed out a failing in the structure of open-end funds.” Investors don’t have to wait while markets are falling to get their money out, he said. “It makes them more attractive.”

2.) Privacy laws, already tough, are likely to get tougher

Stringent privacy laws in Massachusetts are similar to those that the SEC is considering. Essentially, these laws require careful and stringent security measures for your clients’ data that may be stored on your network. This is one topic RIABiz hopes to revisit in the short term.

Here are some of the most prevalent weaknesses Securities and Exchange Commission examiners identified in exams of investment advisory firms over the last six months regarding their privacy practices, according to Kris Easter, assistant director of the SEC Office of Compliance Inspections and Examinations:

  • Surprisingly, despite the fact that SEC regulations have been in place requiring advisory firms to adopt procedures to protect customers’ private information, some firms still have not adopted policies.
  • Firms don’t always properly “scrub” electronic devices of personal information before they are sold or trashed.
  • Offices and file cabinets that contain customer personal information are not kept locked.
  • There are no password protections on computer systems to prevent unauthorized access.
  • Customers still use Social Security numbers or use PINs that contain identifiable personal information.
  • Computer systems have no automatic timeout feature, which could allow hackers to continue trying to access systems indefinitely.
  • No agreements are in place with vendors, such as janitorial services, to protect confidential information.

3.) Yes, social media is a problem

Social media for RIAs is trickier than it ought to be. RIA columnist Les Abromovitz told RIAs that they ought to be careful to supervise their employees use of LinkedIn profiles for business purposes. The point was reinforced by Mavis Kelley, assistant director in the SEC’s Office of Compliance Inspections and Examinations. “(Your employees) should be able to have personal lives and have Facebook accounts,” she said. “But what policies do you have in place?”

Some RIAs said they have policies prohibiting managers accepting invitations to link up from clients, because they could be seen as potential advertisements.

4.) Broker-dealer rules are a serious threat

Advocates for RIAs are taking the threat of harmonization very seriously – and they think it’s likely to be bad for RIAs because a melding of regulation will move RIAs close to broker-dealers.

IAA Executive Director David Tittsworth commented that FINRA as a self-regulatory organization for advisers “is definitely a possibility” for advisers under legislation Congress is considering. If that happens, he predicted FINRA would impose broker-dealer rules on advisers in the retail market.

Tittsworth brought up a speech Mary Schapiro gave to the Consumer Federation of America last December, in which she called for the same standards of conduct, the same licensing and qualifications, the same disclosure requirements, the same regulations and record-keeping requirements, as well as robust examination and oversight, for all securities professionals.

In the panel discussion Thursday, Buddy Donohue, director of SEC Division of Investment Management, indicated that, despite possible problems with common regulation, since brokers and advisers are providing the same services in many cases, there should be a “common approach” to regulating them in such cases.

No people referenced

Mentioned in this article:

Investment Adviser Association
Top Executive: David G. Tittsworth

Share your thoughts and opinions with the author or other readers.


rosa said:

November 12, 2010 — 5:35 PM UTC

Where can I find the list of the attendees to the last compliance conference?


Elizabeth MacBride said:

November 12, 2010 — 5:51 PM UTC

You should contact the IAA,

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