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Speech By SEC Commissioner Troy A. Paredes: Remarks Before The 2011 Investment Adviser Compliance Conference

Date 10/03/2011

Thank you for the kind welcome. It is a pleasure to join you this morning at the Investment Adviser Association’s 2011 Investment Adviser Compliance Conference. I want to start by recognizing the important contributions that the Association and its members make to our efforts at the Commission to fashion a regulatory framework that responds effectively to the challenges we face while allowing market participants room to take advantage of emerging opportunities.

The SEC’s mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. When making policy choices with the goal of advancing these interests, we find ourselves having to decide what conduct we are going to permit, what conduct we are going to prohibit, and what conduct we are going to mandate. In other words, as securities regulators, we find ourselves having to draw lines. I can assure you that I am better able to perform my responsibilities as a Commissioner when we receive thoughtful input from you and other interested parties. We need to understand the consequences of our choices to ensure that the regulatory regime we administer and enforce serves the public interest, especially at this very important time.


The individuals you will hear from over the course of today and tomorrow will undoubtedly share with you detailed insights about the specifics of the Investment Advisers Act regime; about particular practices that you should watch out for; about how incentives might be influenced to motivate or thwart, as the case may be, sound compliance; and about best practices that you should consider implementing at your firms. Accordingly, I am going to speak more generally, sharing with you some of my overarching thoughts for fashioning the regulatory regime that governs our securities markets. Because the SEC is in the throes of several Dodd-Frank rulemakings, my remarks will be oriented around that legislation, although it is worth emphasizing that my observations are in no way limited to Dodd-Frank.

But before saying more, I want to pause to remind you that the views I express here today are my own and do not necessarily reflect those of the Securities and Exchange Commission or my fellow Commissioners.

The common theme underpinning my remarks this morning is this: As regulators, we must approach our regulatory responsibilities with humility if we are to succeed in striking appropriate balances among diverse interests and competing considerations. We need to acknowledge our limitations and avoid being overconfident that we can craft well-calibrated regulatory regimes that will in fact do more good than harm. We need to appreciate that while markets may not operate perfectly, it remains possible for regulation, no matter how well-intentioned, to create more problems than it solves.


The Dodd-Frank Wall Street Reform and Consumer Protection Act has realigned the relationship between the government and the private sector. In doing so, the statute charges the SEC with extensive rulemaking. Among the scores of Dodd-Frank-related rulemakings that fall within the Commission’s jurisdiction – not to mention the numerous studies that Dodd-Frank instructs the agency to conduct – are regulatory initiatives concerning derivatives; asset securitization; the “Volcker Rule”; credit rating agencies; hedge funds, private equity funds, and venture capital funds; municipal securities; clearing agencies; and corporate governance and executive compensation.

Over the course of just the past few months, the Commission, in accordance with Dodd-Frank, has proposed or adopted rules to require investment advisers to hedge funds, private equity funds, or other private funds to report information to the SEC to assist the Financial Stability Oversight Council in assessing systemic risk;1 to establish a registration regime for security-based swap execution facilities and to implement 14 “Core Principles” to govern these trading venues;2 to begin removing references to credit ratings from SEC rules and regulations, including the requirement that money market funds hold commercial paper that is rated investment grade;3 to institute standards for the operation and governance of clearing agencies;4 to provide for the registration of municipal advisers;5 to regulate incentive-based compensation arrangements at broker-dealers and investment advisers;6 to further regulate the asset securitization process;7 and to provide for shareholder approval of executive compensation and certain “golden parachute” compensation arrangements.8 I should note that I have not supported all of these rulemakings and that I look forward to continuing to evaluate the comments on the Commission’s outstanding proposals.

The Commission’s regulatory responsibilities under Dodd-Frank follow in the wake of what already has been an active period for the agency. Since the financial crisis, the SEC has advanced a number of non-Dodd-Frank-related initiatives concerning matters such as short selling;9 the election of board members;10public company compensation and governance disclosures;11 money market funds;12 credit rating agencies;13 municipal securities;14 asset-backed securities;15 target date funds;16 broker-dealer risk management controls;17mutual fund fees;18 dark pools;19 the custody of advisory client assets;20investment adviser disclosures;21 and political contributions by certain investment advisers or so-called “pay to play.”22

One could add the May 6 “flash crash” to the mix, when the markets fell precipitously before rebounding rapidly. In the aftermath of May 6, single-stock circuit breakers were instituted23 and market maker “stub quotes” were effectively prohibited.24

Two concept releases that the Commission put forth last year – one regarding equity market structure25 and the other regarding the U.S. shareholder voting system26 – suggest still other items that are receiving attention. The equity market structure concept release solicits input from commenters on high frequency trading, co-location, the price discovery process, order execution, undisplayed liquidity, the quality of our equity markets, as well as other things. The shareholder voting system concept release covers topics such as the distribution and solicitation of proxies, the role of proxy advisers, the methods by which issuers communicate with shareholders, and the relationship between a shareholder’s voting power and economic interest.

There is much that could be said about the particulars of the regulatory agenda, but for now, let me speak more generally, offering the following overall perspective of mine: The extent to which the sweep of financial regulation will displace and distort private sector decision making in our economy concerns me, and I am troubled that ongoing regulatory initiatives – notably, the regulations implementing Dodd-Frank – will go too far, unduly burdening the financial system at the expense of economic growth. My concern is not an abstract one; there are concrete harms when the government overregulates. I am especially troubled that, over time and perhaps even in the short-term, the cumulative effect of regulations that go too far will compromise the competitiveness and efficiency of U.S. financial markets.

The SEC’s far-reaching rulemaking authority under Dodd-Frank allows the agency a great deal of choice and discretion to shape the legislation’s practical contours and thus to determine Dodd-Frank’s ultimate impact. Without question, there is a fundamental role for government, including the SEC, in overseeing our financial markets and our economy more generally; and regulatory reform affords us the chance to fashion a regulatory framework that keeps pace with innovations in the marketplace, that is resilient, and that fits our increasingly interconnected and complex financial system.

Yet even as we share the common goal of mitigating the prospect of a future financial crisis and look to fend off the hardship that such a crisis would spawn, we have to recognize the real-life costs to society if the regulations implementing Dodd-Frank excessively constrain and hamper the U.S. financial system. We need to be mindful that, as the regulatory regime becomes increasingly restrictive, the cost of the capital that companies need to grow and hire may increase; the credit that consumers rely on may become more challenging for them find; the ability of businesses and investors to manage their risks appropriately may become more difficult; the commercialization of new ideas and technologies may be stymied; and the investment opportunities investors can look to to accumulate wealth and earn income may become fewer.

Put differently, as the U.S. regulatory regime becomes more confining and rigid, all of us are impacted – financial institutions and intermediaries, mutual funds and private funds, non-financial companies, entrepreneurs, consumers, employees, and investors – if the financial sector loses the flexibility it needs to provide the full range of products, transactions, capital-raising techniques, and services that drive our economy. New regulatory strictures that end up burdening the economy in these ways come at the expense of private sector innovation, entrepreneurism, and competition – which is to say, at the expense of U.S. economic growth.

This builds to a straightforward but important point – namely, we need to use the regulatory authority Dodd-Frank has conferred upon us cautiously, carefully evaluating the intended benefits of our actions while giving due regard to the potential undesirable effects of our regulatory choices. This point should be self-evident once we acknowledge that we often have to make decisions under tight time pressures; that we always have to make decisions with imperfect information; and that we never can predict the future with certainty. Every regulatory choice we make – whether or not related to Dodd-Frank – has both costs and benefits associated with it. It should come as no surprise, therefore, that it can be difficult to choose where to draw the regulatory lines that determine how far the government will reach into the private sector and how heavy the government’s hand will be.

Cost-Benefit Analysis

All of this is to say, then, that the Commission must engage in rigorous cost-benefit analysis when fashioning the securities law regime. 27 A demanding cost-benefit analysis that permits us to make informed tradeoffs across a range of potential outcomes is the best way of achieving the common good, of ensuring that the benefits of regulation outweigh the costs. This should include assessing the cumulative impact of the entire package of regulatory demands – including the regulatory requirements and restrictions that are new, as well as those that are longstanding – to anticipate the overall effect of the regulatory regime when viewed in its entirety.

To be clear, cost-benefit analysis is not an argument for or against regulation. Rather, by obligating us to justify our actions, it is an argument for regulatory decision making that fully accounts for both the good and the bad – that nets the costs against the benefits – to ensure that we have smart regulation. The discipline that cost-benefit analysis brings to decision making should impress upon regulators the complexity of the challenges and opportunities we face and help manifest for us the potential unintended consequences of a regulatory initiative.

This brings to mind Section 913 of Dodd-Frank. My remarks this morning further amplify the stance I took with respect to the study the SEC staff recently conducted pursuant to this section of Dodd-Frank.28 As you know, Section 913 directs that a study be conducted into the legal obligations of broker-dealers and investment advisers when providing personalized investment advice to retail investors in expectation that the study could inform the Commission in determining whether any new regulation would be appropriate. The staff study, which was delivered to Congress in January of this year, ultimately recommended “establishing a uniform fiduciary standard for investment advisers and broker-dealers when providing investment advice about securities to retail customers that is consistent with the standard that currently applies to investment advisers.” The staff also recommended several “suggestions for considering harmonization of the broker-dealer and investment adviser regulatory regimes, with a view toward enhancing their effectiveness in the retail marketplace.”

I did not support releasing the 913 study to Congress as drafted.29 A statement that Commissioner Casey and I issued indicating our views explained, among other things, that the study did not adequately articulate or substantiate the problems that the recommended regulation would address or adequately recognize that the study’s recommendations could adversely impact retail investors. There is a considerable risk, for example, that the regulatory impositions the 913 study recommends could leave investors with fewer broker-dealers and investment advisers to choose from; with access to fewer products and services; and with having to pay more for the services and advice they do receive. Our statement went on to outline the kind of additional research and analysis – including collecting important data – that is needed before judgments should be made regarding the prospect of revamping the regulatory regime for broker-dealers or investment advisers.

For me, my view of the 913 study generalizes into a more far-reaching statement about regulatory decision making at the SEC on the whole – namely, data and rigorous economic analysis must be much more central to decision making at the SEC than has been the case. Not only does empirical analysis allow the Commission to leverage its expertise, but data and economics often reveal insights – many of which are counterintuitive – that we might not have appreciated otherwise and that allow us to challenge, in fruitful ways, our presuppositions and inclinations. With good data and sound economics, we are able to make better, more informed choices in discharging our regulatory duties.

With the thoughts that I have shared so far as a backdrop, let me conclude by offering five additional considerations and suggestions for putting rigorous cost-benefit analysis into practice.

First, in administering and enforcing the federal securities laws, we need to be mindful of, and appropriately account for, the compliance burden that the regulatory regime can impose on market participants, including, among others, investment advisers. It is costly for firms to comply with the regulatory obligations they confront both in terms of out-of-pocket expenditures, as well as the opportunity cost of the time and effort of personnel that could have been directed toward other productive endeavors. Indeed, the compliance burden on investment advisers has increased of late due to, for example, the need to comply with the new “pay to play” rule restricting political contributions by certain advisers;30 the recent amendments to Part 2 of Form ADV concerning the preparation and delivery of a “brochure” and “brochure supplements” to advisory clients;31 and the recent amendments to the custody rule.32

Proposals that have been advanced pursuant to Dodd-Frank – including proposed disclosures that investment advisers to private funds would have to make on new Form PF33 and proposed amendments that would expand the disclosures required under Part 1 of Form ADV34 – would add additional regulatory burdens. Dodd-Frank brings about a fundamental change in the compliance burden for investment advisers that had been exempt from registration but that will now have to register under the Advisers Act because Dodd-Frank repealed the private adviser exemption.

Whatever the compliance burden may be, its impact can be disproportionate for smaller firms. Accordingly, to guard against the risk that the regulatory regime itself will discourage the entry and growth of smaller advisory firms – which, after all, are themselves small businesses – we need to consider opportunities for scaling regulatory demands so that smaller advisers are not unduly overburdened. Put differently, we should reject a one-size-fits-all regulatory approach when possible in favor of calibrating the securities law regime more finely to ensure that compliance costs do not hamper smaller enterprises to an unwarranted degree.

Second, it is important to solicit – as the SEC has, especially when it comes to the implementation of Dodd-Frank – the full range of ideas and perspectives that interested parties have to offer. We are better equipped as regulators to make informed decisions when we receive input from those on the ground who would be impacted by the regulatory change. With this input, we can evaluate more critically the practical consequences and tradeoffs of choosing one regulatory course over another. Similarly, the detailed input we receive allows us to refine our regulations, tailoring the regulatory regime to fit the different cost-benefit analyses that attach to different facts and circumstances, such as the disproportionate strain that the cost of compliance can impose on smaller advisory firms.

Indeed, comment on the operational and administrative impact of our rules is particularly welcome. I stand to benefit when commenters are willing to share their views, in some detail, about how a rule proposal would likely impact an adviser’s day-to-day operations and administrative challenges, including the precise steps an adviser may have to take to ensure compliance and what it will cost. Without this input from investment advisers, it can be difficult to fashion regulatory requirements that guard against disrupting the business in unintended ways.

Third, the U.S. regulatory regime must be predictable. Legal uncertainty frustrates business investment and capital formation. This is so whether the uncertainty is because a doctrine or rule is applied inconsistently or because a doctrine or rule is expected to change but in an unknown way. An unpredictable regulatory regime also complicates a firm’s compliance efforts. It becomes more difficult to comply without incurring unreasonable costs when one is forced to fashion a compliance system that accounts for disparate interpretations of regulatory obligations or when one does not know what the rules of the road are or cannot be confident that the rules will not shift beneath one’s feet.

Fourth, once a new rule is adopted, market participants, such as investment advisers, typically need time to evaluate their options in light of the new regulation; structure their operations and activities accordingly; and develop and implement appropriate policies, procedures, systems, and controls to ensure that the new regulatory requirements are met. All of this takes time and expense. Accordingly, as an agency, we need to be realistic about how quickly after being adopted a new rule should become effective.

As an illustration, the Commission amended Part 2B of Form ADV in mid 2010. Later in the year, in response to concerns expressed by registered advisers that the initial compliance date did not allow enough time to develop and implement processes needed to prepare the brochure supplements and ensure their accuracy, the SEC staff recommended, and the Commission approved, an extension of the compliance date for delivering brochure supplements.35

Fifth, the Commission’s cost-benefit analysis should not stop once an initial decision, such as the decision to adopt a new rule, is made. The compliance burden, for example, and how behavior will change cannot truly be known until a new regulatory requirement is actually operative – which is to say, until after a rule becomes effective. The SEC, therefore, needs to revisit our decisions by selecting key rules and regulations for reevaluation from time-to-time. Only by studying the real-life effects of a rule or regulation in practice can we ensure that the regulatory regime that has been put in place is serving its intended purpose at an acceptable cost.


There is much more to be said about many more topics. But for now, let me end by thanking you for the opportunity to share with you some of my thoughts regarding the responsibilities we shoulder at the SEC.

Enjoy the rest of the program.


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10 See see (Commission order granting stay of final rules pending resolution of judicial challenge).

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27 See also Troy A. Paredes, Commissioner, U.S. Securities & Exchange Commission, Remarks at “The SEC Speaks in 2009” (Feb. 6, 2009), available at (discussing the role of cost-benefit analysis in regulatory decision making).

28 See

29 See Statement Regarding Study on Investment Advisers and Broker-Dealers by Commissioners Kathleen L. Casey & Troy A. Paredes (Jan. 21, 2011), available at

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