The bold new era of regulation that Congress laid out in the Dodd-Frank financial reform law has not arrived — at least not for financial advisers.
The bold new era of regulation that Congress laid out in the Dodd-Frank financial reform law has not arrived — at least not for financial advisers.
Eight of the 400 rules that the Dodd-Frank bill requires from 11 different agencies are particularly important to advisers, and nearly all of the changes are still being formulated.
The two monumental issues on which advisers most need certainty seem the two furthest from being resolved: whether financial advisers need a self-regulatory organization and whether brokers and financial advisers should be allowed to continue providing clients with investment advice under two different standards of care.
In the end, it will be 2012 before advisers know the full effect of the reforms, which were meant to keep closer tabs on financial professionals and their interaction with investors.
But advisers who are clued in to the pending changes will be best able to structure their businesses and meet additional requirements for serving clients.
ADVISER SRO
What: In January, the Securities and Exchange Commission sent to Congress a report mandated by Dodd-Frank that explored how to boost financial adviser oversight, given that just 9% of the 11,800 SEC-registered advisers are examined by the agency each year. It offered three solutions: allow the SEC to charge a user fee so it will have the resources to conduct more exams, establish a self-regulatory organization for advisers or allow the Financial Industry Regulatory Authority Inc. to expand its reach to encompass investment advisers that also are registered as broker-dealers.
What's up: Finra is all for ex-tending its authority to hybrid advisers and spent $300,000 lobbying Congress during the first quarter — 42% more than the comparable period last year. Investment advisers and the Certified Financial Planner Board of Standards Inc., meanwhile, want the SEC to continue as the adviser regulator, which means they're going to have to convince Congress that a user fee isn't a tax.
What's next: The SEC met its obligation to deliver the report to Congress, so now it's up to lawmakers to legislate a solution. A congressional hearing this summer will shed light on where lawmakers stand on the issue.
FIDUCIARY DUTY
What: The SEC issued a report in January, as required by Dodd-Frank, that recommended a single fiduciary standard, requiring anyone giving retail investment advice to act in their clients' best interests. This is the standard of care followed by investment advisers but not brokers.
What's up: Investment advisers endorse the SEC report, while brokers argue that a universal standard would boost their regulatory costs and undercut their business model.
What's next: SEC Chairman Mary Schapiro has said that after July 21, the commission will explore creation of a proposed rule, the details of which could radically change the adviser marketplace. Meanwhile, influential Republicans are trying to delay any SEC move toward a universal standard by calling for more cost benefit analysis.
ADVISER SWITCH
What: Advisers managing assets between $25 million and $100 million were supposed to start the process of moving from SEC registration to the states beginning July 21, according to the Dodd-Frank measure. But neither the SEC nor some states were ready.
What's up: Last month, the SEC extended the deadline to June 28, 2012, and provided a buffer range of $90 million to $110 million so advisers don't have to switch back and forth.
What's next: Midsize financial advisers will have to determine by March 30 whether they are eligible to continue under SEC registration. About 3,200 advisers are expected to move to the states and, depending on the state, could face more scrutiny than they did under federal registration.
PRIVATE FUNDS
What: A Dodd-Frank provision was to repeal, as of this Thursday, the exemption that allowed certain private funds, such as private-equity funds and hedge funds, to avoid SEC regulation. In November, the SEC proposed private-fund registration rules, including what information they would have to disclose.
What's up: The SEC last month finalized the rules but extended the registration deadline to March 31, 2012. About 750 private-fund advisers are expected to have to file information about their investors and employees, the assets they manage, potential conflicts of interest and activities outside of fund advising. Exempted from registration were venture capital fund advisers, foreign advisers without a U.S. business and advisers with less than $150 million in assets under management.
What's next: The information that private-fund advisers must file will be made public, which will open hedge funds and private-equity funds up to unprecedented scrutiny. One hitch: Legislation is moving through the House that would exempt private funds from registration if they did not carry leverage at a ratio of greater than 2-to-1.
PERFORMANCE FEES
What: The Dodd-Frank law required the SEC to adjust for inflation the asset thresholds that must be met before investment advisers can charge customers performance fees. Those adjustments were issued July 12 and will be due every five years.
What's up: In May, the SEC proposed raising the asset amount that clients must have under management with an adviser to $1 million, from the current $750,000. The minimum-net-worth requirement would increase to $2 million, from $1.5 million. In a more controversial step, the commission proposed excluding the value of a person's primary residence from determination of the client's net worth, a change Dodd-Frank requires that the SEC make in determination of “accredited investors.”
What's next: The order boosting the thresholds is due any day and comments on the proposed change in calculating net worth were due July 11. The SEC's next move is to approve a final rule on the net-worth calculations, but its officials will have to decide whether to heed complaints that the change could keep some moderately wealthy individuals out of hedge funds and other private-investment vehicles.
BROKER-DEALER REPORTING
What: Dodd-Frank pushes the SEC to require broker-dealers to file more information about the custody of client assets. It also authorizes the Public Company Accounting Oversight Board to inspect public accounting firms that provide audit reports for broker-dealers and to enforce standards relative to the audits.
What's up: In June, the SEC proposed a rule to require broker-dealers to file quarterly reports outlining whether they maintained custody of client assets and, if so, to provide details of how they did it. Under the proposal, broker-dealers also would be subject to exams by a public accounting firm to make sure they were complying with SEC rules on net-capital requirements, segregation of customer and firm accounts, and routine reporting on securities they held for themselves and customers. Even broker-dealers that didn't act as custodians would be required to submit to periodic reviews by an independent public accountant.
What's next: Comments are due on the proposal by Aug. 26. Then the SEC must finalize the rules, which would affect about 300 broker-dealers that maintained custody of client assets. The concerns are that it would boost the time and money broker-dealers spent on custody reporting, thus boosting the cost of associating with a broker-dealer. If approved as is, the quarterly reporting requirement will go into effect in December and become an exam requirement in September 2012.
COMPENSATION DISCLOSURE
What: The SEC and other federal agencies are required under Dodd-Frank to write rules about compensation to prevent reckless financial decisions that could harm investors and potentially destabilize markets.
What's up: The SEC proposed draft rules in March that would require large investment advisers and broker-dealers with more than $1 billion in assets to disclose their incentive-based-compensation plans. Regulators could reject a plan believed to encourage too much risk or that could lead to substantial financial losses by offering “excessive compensation.” It's not expected to restrict upfront bonuses.
What's next: Other regulators, including the Federal Deposit Insurance Corp., the Federal Reserve and the Office of the Comptroller of the Currency, must approve the rules, and then they will be published and opened for 45-day public comment periods.
ACCREDITED INVESTOR
What: Dodd-Frank requires that the SEC change its net-worth standard for “accredited investors” to exclude the value of the investor's primary residence. The mandate is aimed at protecting investors who have seen the value of their homes appreciate over time but are relatively unsophisticated investors.
What's up: The SEC in January proposed that an investor's equity in a primary residence be excluded from the net-worth calculation and that additional indebtedness in excess of equity be factored in.
What's next: The exclusion of home value came into effect when Dodd-Frank was enacted July 21, 2010, but the SEC will have to approve its proposed changes if it wants to clarify the treatment of indebtedness secured by the primary residence.
E-mail Liz Skinner at lskinner@investmentnews.com.
