Advisers Continue to Face Mounting Challenges From the SEC, FINRA and Other Regulators
By John Grady, Co-Chair, ADISA Legislative & Regulatory Committee
As I noted earlier this year, the alternative investments industry has been facing a surge of regulatory activity. While disheartened, I am not surprised to see this trend persist, creating an increasingly complex landscape for financial professionals committed to providing high-quality investment solutions for their clientele.
First, the Department of Labor’s Retirement Security Rule, commonly referred to as the DOL fiduciary rule, was published in the Federal Register in April and was set to take effect on September 23, before implementation was halted by a federal court. The DOL has since appealed to overturn the stay, and it seems that this fight is far from over. The last similar litigation took years to resolve, so while it may be business as usual for advisers currently, they must be prepared for any possible revisions, as the department appears committed to this course of action.
This commitment comes from a core, permanent staff at the DOL who believe that the compensation model for broker-dealers drives a conflict of interests. This stance was further supported by a July report from the U.S. Government Accountability Office which suggested that funds sold with distribution costs underperform at a gross of fees level. It is crucial, however, to note that correlation does not equal causation. The GAO report relied on a concept of bundled versus unbundled funds that may not yield accurate data, much less support the conclusions drawn. The Investment Company Institute went so far as to state stathat the report’s conclusions may be “specious,” and we at ADISA are actively working to provide further context and highlight nuances not addressed in the GAO report.
Additionally, on August 28, the Financial Crimes Enforcement Network issued a final rule that imposes new anti-money laundering and countering the financing of terrorism (AML/CFT) requirements as amendments to the Bank Secrecy Act. These new amendments now require RIAs to establish and implement robust anti-money laundering programs, which must include policies, procedures, and internal controls to identify, assess, and mitigate money laundering risks. This rule follows closely on the U.S. Treasury National Risk Assessment reports published in February which are now seemingly considered foundational. In these reports, the Treasury concludes that because advisers “may not be directly subject to comprehensive AML/CFT regulations,” they are enabling terrorists and criminals. These reports imply that advisers operate in a regulatory vacuum, and the Treasury’s statements have the potential to negatively impact investor confidence due to the perception of increased risk.
Advisers, many of whom are small businesses, are not subject to these regulations because they do not typically have the same level of access to client funds as other financial institutions. Despite this, many advisers do have existing safeguards in place, which these reports ignore. Implementation and compliance with this new rule will require greater resources for advisers, strain relationships with new and existing clients, and provide increased potential for significant penalties, fines, and reputational damage.
Not to be outdone, the Securities and Exchange Commission continues its aggressive stance with the recent release of its Spring 2024 regulatory agenda. This agenda includes 34 total rules, with 15 at the proposed stage and 19 at the final rulemaking stage. Some of the most pertinent include:
- The Safeguarding Rule – This rule would expand the definition of “custody” to include certain activities related to alternative investments, such as possessing authority to dispose of client assets or directing their transfer. This would require more advisers to undergo surprise audits and potentially increase their compliance costs.
- Conflicts of Interest Related to Predictive Analytics – This re-proposed rule seeks to address conflicts of interest that may arise when broker-dealers and investment advisers use predictive data analytics or similar technologies to interact with investors. This could impact how alternative investment firms use data analytics for marketing and personalized investment recommendations.
- Fund Fee Disclosures – These disclosures reportedly seek to improve fee transparency and enhance investor protections for mutual funds, ETFs, and other registered investment companies. While these disclosures seem to be primarily aimed at traditional investment vehicles, some provisions could impact alternative investment funds that utilize similar fee structures or operate as feeder funds.
- Reg D – A proposed rule aims to modernize and improve the exempt offering framework, particularly for Regulation D offerings, including new filing deadlines, additional information requirements, and potential restrictions on general solicitation. These new updates could affect how alternative investment funds raise capital, especially through private placements.
Similarly, the SEC recently stayed approval of an amendment to Rule 2210, which would have allowed FINRA member broker-dealers to utilize projections of performance, similar to investment advisers, a move that would have greatly leveled the playing field between the two groups.
As we approach the upcoming presidential election, a change in administration is guaranteed, and, with it, a potential change in priorities. For now, however, the current landscape still reflects a sense of urgency from progressive policymakers to enact these rules and regulations while Democrats still control the majority of these agencies, along with an overall focus on enforcement over education, creating greater challenges for advisers.
The issues listed above are only some of the rules and regulations of which advisers must be aware.
The Federal Trade Commission has issued a final rule banning noncompete clauses, providing further possible retention challenges for firms; the Corporate Transparency Act and its updates and interpretations continue to be a minefield for advisers; and the North American Securities Administrators Association continues to propose new REIT guidelines.
To further explore these crucial regulatory developments, I invite you to attend General Session II: Legislative & Regulatory Updates at the 2024 ADISA Conference & Trade Show tomorrow morning in Las Vegas. The session will feature myself and Catherine Bowman, Esq. (ADISA legislative and regulatory co-chair and founder of The Bowman Law Firm), along with FINRA’s director of corporate financing, Gabriela Aguero, and Joe Sheirer, who is assuming leadership of corporate financing and advertising regulation later this year upon the retirement of Joseph Price.
While many of these regulatory proposals are undoubtedly well-intentioned, it is imperative to acknowledge their potential to inadvertently hinder industry professionals and limit investor access to alternative investments. ADISA remains steadfast in its commitment to advocating for policies that support the interests of our members and their clients, with the goal of fostering a balanced regulatory environment that protects investors while promoting industry growth.
With nearly four decades of experience within the investment management industry, John Grady is a noted securities attorney, as well as a member of the ADISA board of directors and the long-time co-chair of its Legislative & Regulatory Committee.
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