On June 15, 2022, the U.S. Securities and Exchange Commission (Commission) issued a request for comment with respect to whether certain index, model, pricing, and other information providers should be regulated as investment advisers under the Investment Advisers Act of 1940. The Commission suggests fresh consideration is needed in light of changes in technology and market practices in the decades since these topics were last given significant attention — especially given the continuing expansion of index-based investment strategies. Responses to the request for comment are due the later of August 16, 2022, or 30 days after publication of the release in the Federal Register.
The fact that the Commission is raising these questions now is not surprising, as the agency has shown increasing interest in these service providers in recent years.1 Still, it is interesting that this is only a “request for information” and not a proposed rule. While timing for next steps is uncertain — in this regard, the Commission is proposing rules at a record pace but has to be constrained by a regulatory pipeline that can handle only so much volume in a year — the release is a clear statement that the Commission intends to formalize some form of regulation for at least some providers.
That said, we also see meaningful hurdles to new regulation. First, many providers rely on a statutory exclusion from the Advisers Act for publishers of financial information. To proceed, the Commission therefore will need to revisit how that exclusion is understood and will be constrained, to a degree, by case law. Second, while there may be policy goals encouraging the Commission to expand its jurisdiction, the broad scope of who might be regulated is striking. With an ever-expanding number of information-based business models, the Commission faces either difficult line drawing, practical limitations on its ability to supervise and examine a large population of newly regulated firms, or both. Even estimating costs and resources associated with regulation will be a significant challenge. Finally, the Advisers Act and its rules in their current forms are clearly not designed for these businesses. These factors collectively may leave the Commission with only a relatively narrow path forward.
The Advisers Act generally defines an “investment adviser” as any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or any person who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities. The definition generally includes three elements for determining whether a person is an investment adviser: (i) The person provides advice, or issues analyses or reports, concerning securities; (ii) the person is in the business of providing such services; and (iii) the person provides such services for compensation. Each element must be met in order for a person to be deemed an investment adviser.
Importantly, the definition does not require that an investment adviser exercise discretionary investment authority. Providing reports or analysis alone may be sufficient. Given the breadth of the definition, the Commission staff have been asked many times to consider the application of the Advisers Act for business models involving databases or analytical tools.
In response, the staff have offered guidance in the form of “no-action” letters that regulation under the Advisers Act is not required when (i) the information involved is readily available to the public in its raw state, (ii) the categories of information are not highly selective, and (iii) the information is not organized or presented in a manner that suggests the purchase, holding, or sale of any security or securities.2 However, this guidance has been largely unchanged since the 1990s, which means that the business models in those staff letters typically are not directly on point to those of today’s internet-based, algorithmic, and other services and not well suited to the types of joint ventures, partnerships, and layers of providers that represent much of the modern marketplace for these services.
As noted above, Congress also provided for a statutory exclusion from the definition of an investment adviser for a “publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation.” This “publisher’s exclusion” is widely relied upon by information-based businesses including index providers.
The Commission’s Questions
To help inform its considerations, the Commission requested information on the following topics, among others:
- how industry participants apply the different prongs of the investment adviser definition to these businesses
- whether the factors outlined in the no-action letters are still appropriate
- how industry participants apply the publisher’s exclusion
- whether broker-dealers rely on tailored exemptions specific to their regulated status
- whether consumers are confused by the status of these different kinds of businesses
- whether providers view themselves as having fiduciary obligations
- whether customization and personalization of services changes these analyses
- whether broad-based indices should be treated differently from more specialized indices
- the degree to which providers are transparent about inputs and methodologies that underlie their services
- how providers are compensated
- whether additional guidance is needed or desirable
- whether new Commission exemptions are needed or desirable
The Commission also asked for information relevant to what a registration regime might look like for these businesses, including
- whether provisions of the Advisers Act would be operationally complex or burdensome in this context and, accordingly, whether exemptions from specific requirements would be appropriate
- whether registration would cause firms to change their business models, consolidate, or exit the market
- what kinds of information should be required from registered firms and what should be public versus reported to regulators on a confidential basis
- whether Form ADV (the federal registration form for investment advisers) needs to be adapted for use in this context
- when a firm should “look through” to an end user in considering the nature of its clients for purposes of disclosure and substantive requirements under the Advisers Act
- whether a U.S. approach to regulation of index providers should be aligned with or different from that in the European Union
The Commission next discussed how regulatory assets under management thresholds separate investment advisers that register with the Commission from those that do not qualify for federal registration and therefore must register with one or more states. Those thresholds frequently mean that businesses that do not provide discretionary investment advice (i.e., most types of providers discussed here) are eligible only for state registration. The Commission therefore requested information relevant to those thresholds, including
- how industry participants manage these state versus federal registration issues today
- bases that allow firms to register with the Commission notwithstanding these regulatory assets under management (RAUM) limits
- whether there should be special treatment for firms with “national presence”
- whether Commission registration in this context should be mandatory or optional
Finally, the Commission asked questions specific to when the end user is a registered investment company, including
- whether the provider of a bespoke index created for a single fund should be treated as an investment adviser to the fund for purposes of the Investment Company Act of 1940
- if so, whether the provider would need to comply with relevant provisions of the Investment Company Act
- how the compliance program requirements for investment companies might apply to these providers
- whether fund board approval of these providers is or should be required
- whether the structure of the relationship — including whether the provider is hired directly by the fund versus by another provider to the fund — should change the analysis
1See, e.g., William Birdthistle, Director, Division of Investment Management, Remarks at the IAA Investment Adviser Conference (March 3, 2022), available at https://www.sec.gov/news/speech/birdthistle-remarks-iaa-investment-adviser-compliance-conference-030322; Dalia Blass, Director, Division of Investment Management, Keynote Address, ICI Investment Management Conference (March 19, 2018), available at https://www.sec.gov/news/speech/speech-blass-2018-03-19; Commissioner Hester M. Peirce, Statement on S&P Dow Jones Indices LLC (May 17, 2021), available at https://www.sec.gov/news/public-statement/peirce-statement-sp-dow-jones-indices-051721.
2See, e.g., Missouri Innovation Center, Inc., SEC No-Action Letter (Oct. 17, 1995); Media General Financial Services, Inc., SEC No-Action Letter (July 20, 1992); Charles Street Securities, Inc., SEC No-Action Letter (Nov. 28, 1989); Butcher & Singer, SEC No-Action Letter (Jan. 2, 1987).