The SEC may extend the rules for advisors to providers of indexes and other investment services

When an index provider chooses a basket of stocks that becomes the benchmark used by investment advisers to evaluate the effectiveness of a client portfolio, is this an act of advice? How about a portfolio model maker whose investment choices become real shares for clients for actually registered investment advisers?

“The role of these information providers today raises important questions under securities law about when they provide investment advice, not just information,” said Gary Gensler, chairman of the US Securities and Exchange Commission.

Al Drago / Bloomberg

The Securities and Exchange Commission is considering potentially significantly expanding the scope of its advisory regulations to include various market participants who do not directly advise retail investors, but whose decisions can significantly affect the structure of the client’s portfolio – and in ultimately its success or failure.

The Commission requested comments on the role of index providers, portfolio model providers and pricing services – what it broadly calls information providers – and whether they should be subject to any part of the regulatory framework. of the Investment Advisers Act of 1940, the basic statute for the regulation of advisers.

“In recent decades, the use of information providers has increased, changing the asset management industry,” said SEC President Gary Gensler in a statement. “The role of these information providers today raises important questions under securities laws about when they provide investment advice, not just information.

The call for comment, Gensler explained, was intended to help the SEC “determine when – and under what facts and circumstances – these providers give investment advice.”

This raises a number of questions, including whether index providers and others should be required to register with the SEC, as investment advisers do, and whether they should be subject to such codes of conduct, most notably a fiduciary standard.

The move expands the SEC’s already ambitious agenda and catches some of the commission’s long-standing observers unprepared.

“This request seems to come from the left, much to my surprise, as I have seen and heard very little about the problems in this area or the commission’s implementation work,” said Dwayne Thompson, president of Potomac Strategies.

The request for comment notes that retail customers working with an advisor who uses the services of a portfolio model manufacturer may be confused about conflicts of interest, the source of the fees they pay, who performs which service and who is involved. from a fiduciary obligation.

“This uncertainty may increase when, for example, the client-oriented consultant seeks to waive or limit its trust obligation or any other obligation when applying a model provided by a third-party portfolio provider,” the statement said. in the committee’s call for comment.

Excessive dependence? The Commission expressed concern about market risk or investor harm that could result from advisers’ growing confidence in information providers, including “the potential for pre-launch transactions in which providers and their staff have prior knowledge of changes in information that they also generate potential conflicts of interest when suppliers or their staff hold investments that they value or that are part of their indices or models. ”

The SEC also suggested that the information provider could be interpreted as acting as an investment adviser to a fund or other investment firm that could trigger the regulatory requirements set out in the Investment Companies Act 1940.

Commission officials supporting the request for comment noted that information providers, as the SEC broadly defines the term, have begun to play an extraordinary role in marketing activities and investment advice. Commissioner Caroline Crenshaw pointed to the “dramatic increase” in index funds, which represent trillions of dollars tied to each of the approximately 3 million indices used today.

Thompson suggested that the commission could try to “anticipate the growing problem with service providers in the consulting industry”, although he was skeptical about the extent of the problem. He also warned that the commission could take on more than it could handle. The dramatic expansion of the registrant population that occurred in the 1980s with the regulation of financial planners, Thompson noted, could stretch the agency so thin that it could not meet its frequency targets.

He also raises the question of where the commission will draw the line if it chooses to extend the registration and regulatory requirements to some of the information providers it assesses.

“This may be a slippery slope for companies that offer data analysis for a variety of securities products, but not for a finished ‘product’ in the form of portfolios or indices,” Thompson said. “Shouldn’t asset managers, as trustees, evaluate the data and be responsible for their own due diligence in deciding what to use in formulating prudent portfolios and own indices?”

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