Reading into the SEC Adviser Disclosure Reform Package

Reforms by the SEC to modernize financial adviser disclosures remain in the early stages, but the eventual impact could be substantial for firms offering separate account services to institutional clients.

Scott Weisman is a managing director within PwC’s financial services regulatory practice, where he specializes in the asset management and regulatory space, and a former Securities and Exchange Commission (SEC) staffer in the division of enforcement. Leveraging an 11-year career with the commission, his daily role with PwC involves providing advice and assisting asset managers using alternatives and institutional separate accounts to remain in compliance.

Weisman tells PLANADVISER yesterday’s vote by the SEC to propose Sunshine Act disclosure reforms is an important step in the regulator’s ongoing effort to get a more holistic and proactively informative view of financial markets and emerging systemic risks. He suggests the effort is a continuing legacy of both the mortgage-backed security crisis and the Bernard Madoff scheme.

The rulemaking language is fairly technical due to the specific changes it would make to a host of forms advisers and fund companies deliver to the SEC, Weisman notes, but one clear goal is for advisers to provide additional information for the commission and investors in general to better understand the risk profile of individual advisers and the industry as a whole. 

“The biggest data gap that the new proposed rule would fill for advisers involves the use of separate accounts, especially by large institutional clients,” Weisman notes. In short, the proposed amendments to the investment adviser registration and reporting form, known as Form ADV, would address issues that staff has identified since the commission made significant changes to the form in 2011.

For example, the proposals would require aggregate information related to assets held and use of borrowings and derivatives in separately managed accounts, Weisman says. By the SEC’s measure, approximately 73% of registered investment advisers manage a wide variety of client assets in separately managed accounts, which generally provide advisory clients with individualized investment advice and direct ownership of the securities and other assets in the account. 

Beyond these points, the changes also would “permit by rule certain ‘umbrella registration’ filing arrangements that are currently outlined in staff guidance,” according to comments from SEC Chair Mary Jo White. The rulemaking would additionally provide wider disclosure of information to the SEC about an adviser’s business operations, including branch office operations and the use of social media.

“The goal is to help complete the data picture the SEC has looking into the area of large managers of pooled vehicles, who also manage separate accounts side by side that employ similar strategies to the pooled vehicles,” Weisman explains. “This will give greater transparency into aggregate portfolio holdings, derivatives usage, and other key items that they’re currently missing. In some ways this is also a response to an increased trend towards institutional clients wanting separate accounts or funds-of-one arrangements, as opposed to being part of a pooled vehicle.”

Weisman notes some advisers may see parallels between this effort and FINRA’s attempts to launch its controversial “CARDS System,” which was recently put on hold so FINRA could review data security concerns and questions about the privacy of proprietary investment methodologies. 

“It will be interesting to see what industry feedback is to this rulemaking, and whether problems will be raised,” he says. “It’s possible that similar objections could be raised—certainly the SEC’s ability to safeguard confidential data until it is ripe for publication will be a concern that many in the industry will raise in comment letters. One thing to note is that the information that will be called for in these forms won’t go to the same level of individual client specificity as the FINRA CARDS system would have presented.”

Weisman feels the other important note for advisers coming out of yesterday’s vote are proposed reforms to the Investment Advisers Act Rule 204-2, commonly known as the Books and Records Rule, which would require advisers to maintain records of the calculation of performance information that is distributed to any person. Currently, advisers are required to maintain performance information that is distributed to 10 or more persons, Weisman adds, but the new rule arrangement would apply to one-on-one performance evaluations customized for a specific client portfolio.

“The proposed amendments also would require advisers to maintain communications related to performance or rate of return of accounts and securities recommendations,” Weisman adds. “My sense is that the new rules, if implemented, would cover any performance data presented to a single perspective client in the one-on-one format—it would require stronger backup and documentation of the argumentation that is used to make your case.”

Weisman acknowledges that retirement specialist advisers could be worried about the idea of having to keep all the records of these client conversations and performance reviews—it’s a big part of the value-add in the retirement space delivered to plan sponsor clients. So there’s curiosity about how this will be set up, to say the least. 

“We should note that advisers are already required to keep requisite support for their performance claims,” Weisman says. “Under the new rule, if they chose to customize performance for a one-on-one presentation, this would likely create an enhanced practice of just ensuring the adviser is maintaining and checking this backup for customized performance presentations. Most firms are going to have the data that’s called for in the forms. The challenge operationally will be to aggregate the data and make it uniform in the manner the SEC is calling for—and of course there will be costs associated with that.”

Weisman’s final comment at this early stage is just that—this rulemaking effort remains in the very early stages.

“In terms of the broader SEC initiatives around liquidity, risk management and derivatives, as well as stress testing and transition planning, all of these proposals are politically charged and that stretches out the comment period,” he says. “We’re already entering a presidential election cycle, so the outcome of the elections is important to all of this. We know that SEC Commissioners Gallagher and Aguilar are both stepping down after this term, so a lot depends on the future commission composition and the staff turnover as we enter into the election cycle.”