The Impacts of the Dodd-Frank Wall Street Reform and Consumer Protection Act on Registered Investment Companies and Advisers

Largely in response to the recent financial crisis, Congress has just approved the "Dodd-Frank Wall Street Reform and Consumer Protection Act" ("Act"). The Act is an historic and wide-ranging piece of legislation that will result in significant changes to the regulatory framework, operations and supervision of the financial services industry.

The Act is largely focused on improving the regulation and supervision of the financial institutions that were viewed as triggering the 2008 financial crisis, namely banking institutions as well as other firms that acted as major players in the derivatives marketplace or were involved in subprime lending and securitization of such loans.1 Nevertheless, the Act's extremely broad reach leaves very few financial services firms untouched.

Notwithstanding that registered investment companies and registered investment advisers (also referred to herein as "funds" and "advisers," respectively) were widely viewed as minor players in the financial crisis,2 there are a number of statutory provisions, rulemaking directives, and required studies that we believe could have an impact on funds (and their boards) and advisers. In this regard, it is important to note that, in addition to implementing various new and amended statutory provisions, the Act defers many of the "details" of this comprehensive regulatory initiative to future regulations and studies by a variety of federal regulatory agencies. These future regulations and studies, the substance and findings of which cannot be predicted, are likely to impact funds and advisers in a variety of ways for years to come.

This update focuses on those specific provisions of the Act that could affect funds and advisers. In particular, we consider these impacts in the following manner.

Regulatory Impacts to Registered Funds and Advisers

While the Act does not include many direct amendments to the Investment Company Act of 1940 ("1940 Act") or the Investment Advisers Act of 1940 ("Advisers Act") (other than the new private fund adviser registration requirements), it does contain a number of regulatory changes that will, or could in the future, impact registered funds and advisers:

Establishment of an Investor Advisory Committee and Investor Advocate – new areas within the SEC separately tasked with addressing consumer-oriented concerns; Eventual removal of credit ratings from securities laws and regulations – most notably, this would require major changes to Rule 2a-7 under the 1940 Act; Increasing and enhancing the enforcement tools and focus of the SEC, including changes to the examination structure and organizational reform; Increased regulation of consumer financial products and services; Private fund adviser registration; and Bringing nonbank financial companies (i.e., nonbank holding companies that are predominantly engaged in financial activities) that are determined to be significant to U.S. financial stability under comprehensive financial regulation and supervision. Studies that Could Impact Registered Funds and Advisers

Among the approximately 67 studies that are mandated by the Act, the following could directly impact funds and advisers:

Study and rulemaking regarding the effectiveness of existing legal and regulatory standards of conduct and obligations of broker-dealers and advisers, improved investor access to information, and disclosure of information regarding the available range of products; Studies on mutual fund advertising, retail investor disclosures, financial literacy, and other topics that are intended to lead to regulatory changes; SEC study and report on short selling; SEC study on enhancing adviser examinations; GAO study and report on accredited investors and self-regulatory organization for private funds; and GAO study on conflicts of interest between investment banking and analyst functions. Impacts to Registered Funds and Advisers as "Buy-Side" Participants in the Financial Marketplace

As was the case with almost all investors, most registered funds experienced substantial losses in value in late 2007 and most of 2008. A number of provisions in the Act are aimed at improving regulation in areas that either are viewed as precipitating the crisis or that experienced problems once the crisis began. These include the following:

Changes to derivatives regulation; Changes to municipal securities regulation; Changes to asset-backed securities regulation; and Securities lending rulemaking. Changes in Governance of Public Companies and Systemic Risk Regulation

Finally, there are a number of provisions in the Act, particularly those in Subtitle E of Title IX, that impact most public companies. These will impact certain funds and advisers in the following ways:

Corporate governance and executive compensation reforms applicable to public companies generally; and Systemic risk regulation applicable to entities that are deemed to be "systemically important." Regulatory Impacts to Registered Funds and Advisers

Raising the Bar – a Heightened SEC Level of Activity

The provisions in several of the subtitles of Title IX of the Act (i.e., Subtitles A, B, C, and F) are intended to implement changes to the functions, authority, and enforcement capability of the SEC. These changes reflect Congressional concerns as to the ability of the SEC to effectively discharge its role of protecting investors and appear to be designed to make the SEC a more aggressive agency.

Investor Advisory Committee, the Investor Advocate, and the Ombudsman – New Internal Functions Within the SEC Designed to Represent the Interests of Investors

Investment Advisory Committee. The Act establishes an Investor Advisory Committee, the members of which are (i) the Investor Advocate (a newly created position within the SEC, as described below); (ii) a representative of State securities commissions; (iii) a representative of the interests of senior citizens; and (iv) between 10 and 20 members appointed by the SEC who represent the interests of individual or institutional investors, including the interests of pension funds and investment companies.

The stated purpose of the Investor Advisory Committee is to advise and consult with the SEC on: (i) regulatory priorities of the SEC; (ii) issues relating to the regulation of securities products, trading strategies, fee structures, and the effectiveness of disclosure; (iii) initiatives to protect investor interests; and (iv) initiatives to promote investor confidence and the integrity of the securities marketplace. The Act directs the Committee to study and submit its findings and recommendations to the SEC, including recommendations for proposed legislative changes.

Separately, the Act clarifies the SEC's authority to engage in temporary investor testing programs and to consult with investors, the public, academics, and consultants for the purpose of developing new programs and rulemaking initiatives.

Investor Advocate. The Act also creates a new position within the SEC, the Investor Advocate, who is appointed by, and reports to, the Chair of the SEC. The Investor Advocate will assist retail investors in resolving significant problems with the SEC or self-regulatory organizations ("SROs"), identify areas in which investors would benefit from changes in SEC regulations or SRO rules, identify problems investors have with financial service providers and investment products, analyze the impact of proposed rules and regulations on investors, and propose appropriate changes to the SEC and Congress.

The Investor Advocate is required to submit reports to Congress regarding the objectives of the Investor Advocate for the following year and the activities of the Investor Advocate during the preceding year. The SEC must establish, by regulation, procedures requiring a formal response to these reports.

Ombudsman. Within 180 days of his or her appointment, the Investor Advocate must appoint an Ombudsman, who will report directly to the Investor Advocate. The Ombudsman must (i) act as a liaison between the SEC and any retail investor in resolving problems the retail investor may have with the SEC or an SRO; (ii) review and make recommendations regarding policies and procedures to encourage persons to present questions to the Investor Advocate regarding compliance with the securities laws; and (iii) establish safeguards to maintain confidentiality between retail investors and the Ombudsman. The Ombudsman must submit a semi-annual report on his or her activities and their effectiveness, which the Investor Advocate is required to include in his or her reports to Congress.

Coordination. It seems curious that Congress determined that, in addition to the resources and personnel the SEC already has, it needs an Investor Advisory Committee, an Investor Advocate, and an Ombudsman, all of whom are charged with the goal of representing the interests of investors.

These provisions in the Act suggest that Congress may not appear to be convinced that the SEC currently has the resources and personnel to most effectively fulfill its mission as "the investor's advocate."3 On the other hand, those working at the SEC already view their role to be advocates for investors. The addition of new functions within the SEC with an overlapping mandate could present an interesting dynamic. For example, the Investor Advisory Committee, an Investor Advocate, and an Ombudsman might develop an agenda and recommend rulemaking objectives that are at odds with the SEC's existing regulations, functions, or vision. Similarly, it is possible these new functions might conflict with the watchdog role of fund independent directors. On the other hand, these new offices and positions within the SEC should be able to find a meaningful role that will allow them to work in a complementary fashion with existing SEC offices and personnel. At the very least, funds and advisers should expect to see a more aggressive and investor-oriented regulatory agenda in the...