"Implementing The National Securities Markets Improvement Act" Remarks By Isaac C. Hunt, Jr., Commissioner, U.S. Securities and Exchange Commission National Regulatory Services Annual Compliance Conference for Investment Advisers and Broker-Dealers Puerto Rico April 10, 1997 Good morning. It's my pleasure to be with you today. My how the securities laws have changed in the past several months. For some of you, October 11th -- the day President Clinton signed into law the National Securities Markets Improvement Act of 1996 -- will be celebrated as a national holiday. For others, October 11th will be observed as a day of mourning. Today, I thought I would discuss some of the more significant issues that the SEC is struggling with as we promulgate rules to implement the provisions of the new law that will affect investment advisers and broker-dealers. Reviewing your conference schedule, a certain universal truth begins to emerge: _ I see that Mark Griffin of the North American Securities Administrators Association chaired a panel yesterday. _ Latter this morning, you will have a panel on "Issues for Small Advisers" with Duane Thompson of the Institute of Certified Financial Planners. _ And, tomorrow, Bob Zutz of Kirtpatrick & Lockhart will head up another panel entitled "Advisers Managing Over $25 Million." You may ask yourself what is the universal truth here? It seems clear to me that no matter how the SEC implements the National Securities Markets Improvement Act -- "we can't please all the people all the time." Our goal, at the SEC, is to faithfully implement the Congressional intent of the new legislation. Even within these parameters, we face many difficult issues. Investment Advisers With respect to the investment adviser rule proposals alone, the SEC has received over 100 comment letters. Each of these letters represents a different point of view. Many of them reflect the concerns and wishes of your panel participants over the next couple of days. Let's take a look of some of the more significant issues presented by the Adviser Act amendments. At first blush, the new provisions seem straightforward. The SEC will have primary responsibility for larger investment advisers -- that is, those advisers with more than $25 million under management or that advise mutual funds. Smaller advisers, such as most financial planners, will be prohibited from registering with the SEC and primarily will be regulated by the states. Of course, legal matters are never as straight forward as they seem. For SEC-registered advisers, the new legislation provides that a state may still license, register, or otherwise qualify any "investment adviser representative" who has a "place of business" located within that state. In the Commission's proposing release to implement the adviser provisions, we acknowledged that the term "investment adviser rep" is used in many state adviser laws, but concluded that Congress could not have intended the term to be interpreted by reference to state law. Looking to state law would have permitted investment adviser rep definitions to vary among the states and one of the purposes of the new legislation was to promote uniformity of regulation. The Commission proposed to define these adviser reps as those whose business substantially consists of providing advice to clients who are natural persons. The objective here was to permit states to regulate those reps that service "retail clients." Most commenters strongly support this approach. Other commenters, however, argue that the Commission does not have the authority even to define the term. This latter group believes that Congress clearly intended for state law to prevail in this area. They believe that these adviser reps are within the primary jurisdiction of the states, and therefore it is important for the states to define who these reps are in order to carry our their oversight responsibility. A significant number of commenters thought we should broaden our approach. They argued that adviser reps should include those persons who provide advice to any client -- not just retail clients. This group suggests that although the thrust of the testimony to Congress was to protect individual or retail clients, Congress' regulatory concern was not limited to individuals. Some thought, for example, that small businesses should be included. There is also a substantial number of commenters who would narrow the SEC's proposal. Some stated that persons who provide advice to high net worth or sophisticated individuals should be excluded from the adviser rep definition. There also are different suggestions on how "high net worth individuals" should be defined. There were suggestions that we should refer to Reg D accredited investors, others want us to look to clients eligible to enter into performance fee arrangements under Rule 205-3 of the Advisers Act, while one letter suggested that we should use the "qualified purchaser" standard in newly enacted Section 3(c)(7). Trust me -- I could go on all morning. * * * Let's assume for a moment that the SEC can faithfully implement Congress' intent by adopting or not adopting a definition of "investment adviser rep." Each state will have qualification authority only concerning those reps who have "a place of business" located with their state. Currently, a state may assert jurisdiction over adviser reps having clients in the state, thus potentially subjecting the reps to registration in many states. The Commission's proposed definition sought to balance the concerns of the states and the industry, while being consistent with the statutory language of the new legislation. Under the proposal, a place of business is any "place or office" from which the rep "regularly" provides advisory services. Most commenters acknowledged the need for a federal definition, but opposed the use of the term "regularly." Many states want an adviser rep to be deemed to have a place of business in any state in which the rep is physically present and providing advice. They are concerned that under the proposed definition they would not be able to enforce state registration requirements, and presumed the SEC would not look at state licensing compliance as part of the Commission's inspection program. Investment advisers want an adviser rep to be deemed to have a "place of business" only in those states in which the rep has a business office. Several commenters thought that it would be helpful if the SEC clarified what "regularly" means. Some expressed concern that adviser reps could avoid registration by defining the term themselves. One group suggested that place of business should be defined broadly to include any place where a rep "solicits or meets" with clients -- even if the contact is sporadic. On the other hand, one large investment adviser argued that place of business should be limited to locations where the rep spends at least 25% of his or her time. Our proposed rules also tried to deal with itinerant investment adviser reps. If a rep does not regularly provide advisory services at any place or office, the Commission's proposal would define place of business to be the residence of each client. This provision was designed to prevent itinerant reps from claiming they have no place of business. We thought that as a practical matter an adviser rep would designate at least one place or office in a state in which he or she regularly communicates to clients. This seemed like a good approach at the time. With only one exception, however, every commenter who addressed this issue opposed the Commission's proposal. The vast majority stated that the standard was too broad and would create a "doing business" standard. Several commenters argued that it was not necessary for the SEC to address the issue of itinerant reps because reps will have at least one office in the U.S. They also thought it highly unlikely that a rep would claim that he or she had no place of business. Now let's assume for the moment that the SEC can faithfully carry out Congressional intent and define or not define "place of business." * * * The next provision in the legislation provides that the states have the continued authority to investigate and bring enforcement actions with respect to "fraud and deceit" against any investment adviser -- big or small -- or persons associated with any investment adviser. Unfortunately, there is not an explanation of the scope of the states' authority in the legislation's legislative history. The Commission, in the proposing release to implement the advisory provisions, commented that a state should not be able to indirectly regulate the activities of SEC-registered advisers by enforcing requirements that are defined as "dishonest" or "unethical" business practices -- unless the activities rise to the level of being "fraudulent." In comment letters, many states have raised objections to this interpretation, arguing that it would limit their enforcement authority. Certain members of Congress also have raised objections to this aspect of the Commission's release. As you can imagine, the mutual fund industry generally wants the states' enforcement authority to be interpreted as narrowly as possible. * * * Well, we can say with certainty that each state has the authority to license or otherwise qualify investment adviser reps -- of SEC-registered advisers -- who have a place of business within that state. We also can say with certainty that the states may bring enforcement actions for fraud and deceit against SEC-registered advisers and their associated persons. Working out the details is going to be the tough part. Given your profound interest in how these details are resolved, I'm sure you will read the SEC's adopting release for the investment adviser rules with great interest. * * * Broker-dealers Let me now shift topics to another recent proposed rule- making: the Commission's current proposal to amend the Exchange Act's broker-dealer books and records requirements. Now, I don't know whether my segueway from the Commission's proposed investment adviser rules to our proposed books and records amendments is like going from the proverbial frying pan to the proverbial fire but, I do know one thing -- it has been really warm lately at the Commission. Section 103 of the National Securities Markets Improvement Act prohibits any state from imposing broker-dealer books and records requirements that are different from, or in addition to, the Commission's requirements. The Section also directs the Commission to consult periodically with state securities authorities concerning the adequacy of the Commission's books and records requirements. In accordance with Congress's directive, the Commission recently offered proposed amendments to its Exchange Act books and records requirements. The proposed amendments are designed to clarify and modify the Exchange Act's recordkeeping requirements. The proposals addressed several areas, such as purchase and sale documents, customer records and customer complaints, and associated person records. In addition, the proposals would specify those books and records that broker- dealers must make available in their local offices. The Commission's staff worked closely with NASAA in crafting the proposals. The staff also had discussions with members of the broker-dealer industry and with representatives of the Securities Industry Association. The staff and the Commission tried to tailor the proposals so as to minimize additional burdens on the broker-dealer industry, consistent with providing the states with those additional records that would be useful in state enforcement initiatives. Despite our efforts, it was clear from the onset that the proposals would be controversial even if the Commission could be fully responsive to the legitimate needs and desires of both the states and the industry -- which, of course, really is close to impossible. I expected that larger broker-dealers might raise objections to certain of the additional reporting requirements, while some smaller broker-dealers might question the entire proposal. I also knew that the Commission would be subject to intense scrutiny regarding those proposed requirements which, arguably, are similar to existing Exchange Act requirements. Going forward, the Commission will have to make very difficult choices as to whether it should mandate new requirements relating to records already maintained by firms and those relating to records already maintained by firms in different formats. The Commission received 150 comment letters concerning the books and records proposals. The divergence of opinions expressed in those comments is quite remarkable. The comments show a wide chasm separating the views of state regulators from the views of broker-dealer firms. Unfortunately, there does not seem to be much middle ground, although a few commenters offered alternative approaches to those we raised in the proposing release. To those commenters who offered other approaches -- you have my thanks. Because of the divergence of opinion, it is hard for me to predict what the staff's final proposals will look like, and whether the Commission will agree with each and every one of them. As with the investment adviser proposals, I know that you will read the SEC's adopting release for the books and records rules with great interest. Thank you and good luck. # # #