Thank you for that introduction, William. I am pleased to welcome everyone to the Division of Investment Management’s inaugural Conference on Emerging Trends in Asset Management.
As is customary, I’d like to note that my views are my own as Chair of the Securities and Exchange Commission, and I am not speaking on behalf of my fellow Commissioners or the staff.
Later this month marks 90 years since President Franklin Roosevelt signed the first of the federal securities laws, the Securities Act of 1933.
Roosevelt and Congress knew, however, that their work wasn’t done.
That’s why they passed the Securities Exchange Act of 1934, which covered intermediaries such as exchanges and broker-dealers as well as established our agency to oversee the securities markets.
They knew, however, there still was more work to be done.
In 1935, Congress mandated that the newly formed SEC conduct a study of investment trusts and investment companies, report to Congress on their findings, and make recommendations.
The Commission subsequently reported to Congress that investment trusts should provide everyday investors with an ability to participate in diversified pools of securities while making capital available to issuers.
They identified, though, a set of failures with the funds of those days. Despite the investor protections recently enacted under the ’33 and ’34 Acts, there still were specific risks to investors who were dealing with investment advisers and investment companies.
SEC Commissioner Robert Healy told Congress in 1940 that, left unchecked, these risks and conflicts had produced a “shocking” number of abuses.
Fundamentally, when someone manages other people’s money, there are opportunities for conflicts of interest between advisers and investors. Moreover, for investors, it can be harder to evaluate a fund than to understand, for example, what a car company does.
“Too often, investment trusts and investment companies were organized and operated as adjuncts to the business of the supervisors and insiders to advance their personal interest at the expense of and to the detriment of their stockholders,” Healy said.
As Healy described it, failures at funds included 1) disregard of fiduciary standards, 2) lack of regulation of investment advisers, 3) complicated capital structures, 4) inadequate accounting, and 5) lack of supervision of mergers and consolidations.
He added: “It is perhaps not too much to say that the disregard of fiduciary standards lies at the root of many investment company problems.”
In response to the Commission’s reports, FDR and Congress enacted the Investment Company Act and the Investment Advisers Act of 1940.
In the decades since, we’ve seen rapid growth in the asset management field. Today, registered investment advisers manage over $110 trillion in assets across more than 50 million clients. Further, business models and technology continue to rapidly evolve—just the most recent of which includes artificial intelligence and robo-advising.
Throughout, though, investors and issuers alike have benefitted from these Acts and the SEC’s oversight, whether for private funds, registered funds, or separately managed accounts.
It was nine years after the ’40 Acts were enacted that Alfred Winslow Jones created the first private fund. Today, nearly 75 years later, the private fund industry has grown to $25 trillion in gross asset value amongst tens of thousands of funds—larger than the entire $23 trillion commercial banking sector.
Private fund advisers playan important role in each sector of the capital markets, whether it’s equities, treasuries, corporate bonds, mortgages, municipals, private credit, loan origination, or many other markets.
Private funds playan important role for investors, including retirement funds and endowments. Standing behind those entities are a diverse array of teachers, firefighters, municipal workers, students, and professors.
Though private funds didn’t even exist when Healy spoke to Congress in 1940, something he said at the time regarding these funds resonates today: “Many individual investment companies have total assets equal to those of the larger savings banks.” Though I’m not suggesting that such individual funds areas large as today’s largest banks, as noted in the Federal Reserve’s recent Financial Stability Report, the largest hedge funds by gross asset value have at times on average exceeded 20-to-1 leverage.
Given that these funds touch so much of our economy, the SEC is working to enhance their efficiency, integrity, and resiliency.
We’ve proposed a rule that would require private fund advisers to provide detailed reporting to investors of fees, expenses, performance, and preferential treatment, such as in side letters.Efficiency and competition amongst these funds is important for issuers and investors alike.
Further, we recently adopted rules requiring, for the first time, private fund advisers to make current reports of events that may indicate significant stress or otherwise signal for systemic risk and investor harm. In addition, working with the Commodity Futures Trading Commission, we proposed enhanced periodic reporting for large hedge funds.
If Healy were with us today, he’d likely be amazed that registered investment funds have grown to become over $30 trillion, with more than 16,000 funds.
He’d also be amazed at the significant innovations within this space, with new kinds of funds emerging nearly every decade.
To focus on just one of those innovations, I think Healy would have tipped his fedora to exchange-traded funds (ETFs). ETFs bring diversification to investors with even greater efficiency. The number and scale of these ETFs has ballooned in recent years. Since 2017, the number of ETFs has grown by more than 50 percent to roughly 3,000, and the amount of assets in these products has more than doubled to approximately $7 trillion.
We’ve also seen significant innovations around money market funds and open-end funds. We have seen, though, particularly in times of stress, that these funds’ underlying structural liquidity mismatch can contribute to instability.
Thus, we have made two separate proposals with regard to the liquidity and pricing of these funds. These proposals would help protect investors and promote fund resiliency.
In enacting the ’40 Act, Congress understood the importance of a fund’s name to investors and thus included provisions about fund naming conventions.
Congress updated these provisions in 1996, giving the Commission rulemaking authority to address potentially misleading investment company names
So much has changed in the 22 years since the Commission first adopted the Names Rule. Thus, we put forward a proposal to update the Names Rule and enhance the transparency regarding fund names, including with respect to Environmental, Social, and Governance-related (ESG) fund names.
We also put out a separate proposal to establish disclosure requirements for funds and advisers that market themselves as having an ESG focus.
These proposals are about truth in advertising, from the name a fund uses to the information standing behind a funds’ claims.
Separately Managed Accounts
In the 80 years since Healy’s testimony, we’ve also seen enormous growth in separately managed accounts advised by investment advisers. In the last five years alone, the number of separately managed accounts to registered investment advisers has grown 60 percent from 34 million to 53 million. Fifty-one million of these accounts are held by individual investors.
We’ve also seen significant developments in financial technology, including robo-advisers and wealth management apps.
Underlying these developments are advancements in the internet, artificial intelligence, natural language processing, and predictive data analytics—each of which likely would have knocked Healy’s fedora off his head.
By the 2000s, investors found it difficult to see the difference between brokers and advisers, the services they offer, and the disparate standards required of those professionals. After smartphones came around, investors might have started to believe that the difference between brokers and advisers might merely be tapping one part of their screen versus another.
In 2019, the SEC addressed this blurring and these disparities through rulemaking on Regulation Best Interest for broker-dealers and through an interpretation of the fiduciary standard for investment advisers. These set forth, amongst other things, that investment advisers, consistent with their fiduciary duty, need to act in an investor’s best interests and not place their own interests ahead of an investor’s. That duty cannot be addressed through disclosure alone.
In the last year, the staff has published a number of important bulletins regarding these standards of conduct for investment advisers and broker-dealers.
As to artificial intelligence, this technology already is playing a part in call centers, account openings, compliance programs, trading algorithms, sentiment analysis, robo-advisers, and brokerage apps. Such applications can bring benefits in market access, efficiency, and returns.
As commenters to our request for comment on digital engagement practices noted, however, the use of predictive data analytics also can lead to potential conflicts. In particular, conflicts may arise to the extent that advisers or brokers are optimizing for their own interests as well as others.
Thus, I’ve asked staff to make recommendations for the Commission’s consideration for rule proposals regarding how best to address any of these potential conflicts.
Before I close, I’d like to mention three additional trends relevant to investment management.
First, the use of third-party service providers by investment advisers.
Though investment advisers and funds have used third-party service providers for decades—such as for information technology, middle-office functions, or sub-advisers—their use has grown and evolved.
That’s why we proposed rules to ensure that advisers continue to meet their fiduciary obligations to their clients, regardless of whether they use service providers.
Second, the use of qualified custodians.
Qualified custodians play a critical role to help ensure that investment advisers don’t inappropriately use, lose, or abuse investors’ assets.
The Commission first adopted a custody rule for investment advisers in 1962, and we last updated it in 2009. Importantly, though, in response to the 2008 financial crisis and Bernie Madoff’s frauds, Congress granted us new authorities in 2010 to expand the advisers’ custody rule to apply to all assets, not just funds or securities.
Thus, we proposed rules to expand and enhance the role of qualified custodians so that investors receive the time-tested protections that they deserve for all of their assets, consistent with what Congress envisioned.
Third, the evolving challenges regarding cyber security and protecting customer information.
Asset management increasingly relies on complex, interconnected, and ever-evolving information systems. Those who seek to harm these systems have become more sophisticated as well: in their tactics, techniques, and procedures.
Thus, the Commission has proposed to enhance cybersecurity practices and incident reporting of investment advisers and funds.
In addition, we also put forward a proposal that would require covered firms—including investment advisers and investment companies, among others—to notify customers of breaches that might put their personal financial data at risk.
If I had one, I’d tip my fedora to our dedicated Investment Management staff for all they do, including organizing this conference, as well as to all of you for participating.
In advocating for the passage of the ’40 Acts, Healy said: “These organizations could then perform the vital functions of furnishing honest and unbiased investment management to the large group of small investors who require this service.”
Your input on the matters discussed today—and the SEC’s rule proposals—will help us build on that vision.
See Statement of SEC Commissioner Robert E. Healy (“Healy Testimony”) (April 2, 1940), available at https://www.sec.gov/news/speech/1940/040240healy.pdf. See, e.g., Healy Testimony at 13: “In general, everyone seems to be pretty much agreed that the function of investment trusts should be to afford the small investor an opportunity to spread his investment risks by a diversification of security holdings, to furnish competent and continuing investment supervision, and to assist in making capital available for industry.”
Ibid at 6. “The mere recital of the abuses which have occurred since 1933 and 1934, tends to prove that the Securities Act of 1933 and the Securities Exchange Act of 1934, valuable as they are in most fields, are inadequate here. Because of the peculiar character of investment companies and their resemblance to savings banks, mere disclosure is inadequate as a remedy.”
Based on Form ADV filings through March 31, 2023. Represents sum of Registered Investment Adviser gross asset value and Exempt Reporting Adviser gross asset value, less estimated overlap.
Based on Form ADV filings, registered investment advisers report more than 50,000 private funds and exempt reporting advisers report more than 40,000 funds. Form ADV filings may reflect double-counting or other forms of overlap between reported private funds.
Healy Testimony at 2.
Per Form ADV data from 2017 through December 2022.
See Securities and Exchange Commission, “Regulation Best Interest: The Broker-Dealer Standard of Conduct” (Sept. 10, 2019),available athttps://www.sec.gov/rules/final/2019/34-86031.pdf.SeeU.S. Securities and Exchange Commission, “Commission Interpretation Regarding Standard of Conduct for Investment Advisers” (Jul. 12, 2019),available athttps://www.sec.gov/rules/interp/2019/ia-5248.pdf.See alsoU.S. Securities and Exchange Commission, “Regulation Best Interest, Form CRS and Related Interpretations” (March 30, 2022),available athttps://www.sec.gov/regulation-best-interest.
See Securities and Exchange Commission, “SEC Requests Information and Comment on Broker-Dealer and Investment Adviser Digital Engagement Practices, Related Tools and Methods, and Regulatory Considerations and Potential Approaches; Information and Comments on Investment Adviser Use of Technology” (Aug. 27, 2021), available at https://www.sec.gov/news/press-release/2021-167.
Healy Testimony at 14.