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Navigating the Changing Regulatory Landscape: How Pending Regulatory Changes Impact Financial Professionals and Their Clients

By John Grady, co-chair, ADISA Legislative & Regulatory Committee; chief operating officer and general counsel, ABR Dynamic Funds

The alternative investments industry has long operated within a complex regulatory framework. In recent years, however, we have witnessed a surge in regulatory activity, presenting new and greater challenges for financial professionals seeking to leverage alternative assets for the benefit of their business and their clients’ goals. This new regulatory landscape can affect broker-dealers and registered investment advisers differently, while also having significant impact on investment sponsors and service providers, all of whom may, (or must), adjust their business practices as a result.

Currently, one of the most significant regulatory proposals is the Department of Labor’s Retirement Security Rule or, as it is more commonly known, the DOL fiduciary rule, which is presently under review by the Office of Management and Budget. This rule aims to redefine “investment advice fiduciary” under the Employee Retirement Income Security Act with the reported goal of ensuring that investment advice providers deliver recommendations that are in the investor’s best interest, particularly within retirement accounts.

The Securities and Exchange Commission has also exhibited an aggressive stance on rulemaking under its current leadership. The commission’s 2024 agenda includes adopting 25 rules, alongside the many rules that it finalized in late 2023, which are now beginning to take effect. Some of the most pertinent include the:

  • Private Fund Advisers Rule – Finalized in 2023, this rule mandates that quarterly private fund performance, fees, and expenses are disclosed to investors. The rule will also generally prohibit advisers from granting certain preferential treatment to specific clients and requires an annual audit for certain private funds.
  • Accredited Investor Rule – While the SEC staff report was non-definitive, the SEC has received comment to add additional measures of sophistication to the rule, such as adjusting the income threshold for inflation or adding additional experience requirements, which could greatly reduce the number of accredited investors.
  • Interestingly, members of Congress have, on an often (surprisingly) bipartisan basis, supported recent legislation that would enhance access to private investments through expansion of the accredited investor base. Just last month the House passed the Expanding Access to Capital Act, a package of bills that includes legislation loosening the definition of accredited investor for nonpublic offerings. The Senate has yet to act on the legislation, and may not, as some powerful Democratic leaders are less interested in expanding access to private investment offerings.
  • Cybersecurity Risk Management Rule – Another SEC rule finalized in 2023, this rule requires that public companies disclose material cybersecurity breaches within four days of an incident, along with annual disclosures related to cybersecurity risk management, strategy, and governance.
  • Custody Rule Changes – The SEC custody rule, which requires that advisers safeguard their clients’ assets with a broker-dealer, bank or other “qualified custodian,” may also be expanded to include real estate, physical commodities and crypto assets, among others.
  • Generative Artificial Intelligence Rules – The SEC also plans to finalize a rule intended to address conflicts of interest associated with the use of predictive data analytics and artificial intelligence. The rule would require financial professionals to eliminate conflicts of interest related to their use of AI-related technologies in investor interactions.

Similarly, the North American Securities Administrators Association has proposed an update to its Business Practices Rule, which NASAA claims will bring the rule more into alignment with the SEC’s Regulation Best Interest and provide enhanced clarity while prohibiting the misleading use of titles, such as “adviser.”

While this is an election year and the present political climate could lead to a change in administration, the existing regulatory landscape largely reflects the views of Gary Gensler, SEC chair, and the progressive policies of the Democratic Senate leadership and the Biden administration. It is important to note that these initiatives have prioritized enforcement over education, with the belief that more regulation will equate to smaller and/or fewer investor losses.

This regulatory burden, however, presents practical challenges for advisers. Compliance with these new rules necessitates a significant allocation of already limited time and resources, and this will likely detract from core client service activities. For example, data from FINRA indicates a 30% rise in arbitration filings during 2023, with a significant portion linked to alternative assets. This uptick in disputes poses not only financial challenges for firms but may also cause them to reevaluate their exposure to alternative investments.

Additionally, stricter regulations will also restrict access to alternative investments for a significant segment of the investor pool – specifically, smaller investors with lower net worth who could potentially benefit from the diversification and return potential offered by alternatives.  How might these rules change if control of Congress flips or a new president occupies the White House? That remains to be seen.

Regardless, the potential ramifications of these rules and proposals necessitate close attention from every member of our industry. The current regulatory and legislative landscape will be discussed in great detail tomorrow morning at the ADISA 2024 Spring Conference during the legislative and regulatory general session. In addition to my fellow ADISA Legislative & Regulatory Committee co-chair Catherine Bowman, (founder of The Bowman Law Firm), I will be joined for an important discussion on many of these matters by Thomas Rosenfield (president of Hillstaffer), and congressional reporter Caitlin Reilly, who covers tax and economic policy for Congressional Quarterly Roll Call. If you’re in Chicago for the conference, please be sure to join us.

While I of course understand and agree with the necessity of certain legislation and regulations – and I believe that many of these new rules and proposals are well-intentioned – it is crucial to acknowledge that many of these rules will actually harm the investors they are meant to protect and restrict access to the many potential opportunities that alternative investments may provide. We at ADISA will continue to monitor these rules and work diligently to protect the interests of our members and their clients.

With nearly four decades of experience within the investment management industry, John Grady serves as ABR Dynamic Funds’ chief operating officer and general counsel. The firm is a registered investment adviser, managing several mutual funds and UCITS (Undertakings for the Collective Investment in Transferable Securities) sub funds using proprietary volatility driven strategies, as well as certain private funds. Grady is also a member of the ADISA board of directors and the long-time co-chair of its Legislative & Regulatory Committee.

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