The current compliance environment
is complex because it’s hard to predict what’s going to happen in certain areas
— namely regarding automated advice, fee compression and the broker protocol,
according to former Securities and Exchange Commission official John Walsh.
Walsh, now a partner at Eversheds
Sutherland in Washington, said during a session at Charles Schwab’s annual
Impact conference Monday that the current compliance landscape is “complex,”
rather than complicated.
Complicated, he said, means “there
are a lot of moving parts but the outcome is predictable.” Complex, on the
other hand, also means there may be many moving parts, however, “we cannot
predict what’s going to happen, what the outcome will be.”
Walsh, a former architect of the
SEC’s Office of Compliance Inspections and Examinations who served as OCIE’s
acting director as well as its associate director and chief counsel, pointed to
four areas where the compliance realm is complex.
1. Automated advice.
It now “pervades the investment
advisor business to the point that many advisors are relying on these platforms
themselves,” Walsh said. The question for compliance professionals to ask is do
they understand “what’s going on in these algorithms?” A recent example of an
SEC case involving algorithms is the ongoing case involving F-Squared.
“The F-Squared saga isn’t over,”
Walsh said. In this case, the SEC “went after the firms who developed the
algorithms and those firms that used it.”
Walsh offered session attendees an
action item: “You need to take a look at the process that you have in place on
algorithms you produce or use.”
2. Fears of fee compression are
growing. Is it real?
“There’s some debate,” Walsh said.
“You can see it in terms of [mutual] funds and 12b-1 fees, but some advisors
are raising their rates” and “going directly against fee compression,” he said.
“Even if the compression has not yet reached you, the threat hangs over
What does fee compression angst mean
for compliance? “Compliance costs money,” Walsh said. “Most people view
compliance as a cost center. Are we looking at a future where it’s harder to
make a profit? What do you do? Cut costs,” he said, and likely in compliance.
Regulators are also “starting to
show concern,” Walsh said. “SEC examination managers are reporting they are
spending increasing time reviewing resources provided to compliance.”
3. Compliance requirements are in
“Complexity comes from regulators
shifting positions,” Walsh said. He said a “good example” of this shifting is
the “four stages” of compliance around advisors’ receipt of 12b-1 fees.
While the SEC has required advisors
to disclose that they receive them as well as that the receipt of 12b-1 fees
poses a conflict, the SEC required earlier this year that advisors must
disclose the availability of lower-cost shares, as well as that advisors must
provide “itemized accounting of forgone lower-cost shares.”
Walsh stated that “all the attention
to fiduciary duty” has put a spotlight on 12b-1 fees.
4. What will happen to the broker
“The industry is doing this one to
itself,” Walsh said. The Protocol for Broker Recruiting, he explained, “allowed
reps to move between firms with a fair amount of freedom, and firms entered
into it to avoid fighting.”
In 2008, the SEC proposed
“codifying” the protocol as part of Regulation S-P, the privacy rule, and it
“got swept aside” by the financial crisis. The SEC “would have approved it if
it wasn’t for the financial crisis.”
With firms dropping out and with
reports that “recruiting has gotten harder,” what does this mean from a
The broker protocol uncertainty
throws “a new light on Reg S-P, privacy and the movement of client
information,” Walsh said. “I could see regulators getting interested in this.
Make sure your recruiting rules cover Reg S-P. I would consider adding this as
a topic in your annual review.”
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