2017 ICI CONFERENCE

ICI Mutual Funds and Investment Management Conference Summary

2017 ICI MUTUAL FUNDS AND INVESTMENT MANAGEMENT CONFERENCE

March 12–15, 2017 | Palm Desert, California

TABLE OF CONTENTS

1 GENERAL COUNSEL’S ADDRESS 2 KEYNOTE REMARKS 3 GENERAL SESSION The Changing Legislative and Regulatory Landscape—What to Expect 5 SESSION 1-A Inside the Boardroom: A Roundtable Discussion 8 SESSION 1-B A Changing Global Environment: The New Political Landscape and the International Outlook 10 SESSION 2-A The Evolution of Investing: Opportunities and Challenges in the ETF Marketplace 12 SESSION 2-B Mutual Fund Civil Litigation: Year in Review 14 SESSION 3-A Classified Assets: Translating the New Liquidity Rules into Firm Policies 16 SESSION 3-B Retirement Redux: Where Does Regulation Go from Here? 17 SESSION 3-C Variable Insurance Products at a Crossroads: Opportunities and Challenges 18 GENERAL SESSION A Conversation with OCIE and Enforcement 20 SESSION 4-A Derivatives Market Reform: Where Are We Going Now That We Are Almost There? 22 SESSION 4-B Tax Reform: What Does It Mean for the Fund Industry and Fund Investors? 24 SESSION 4-C Surviving the Aftershocks: Fund Distribution After the DOL’s Seismic Fiduciary Rulemaking 26 SESSION 5-A Crashing the (Third) Parties: Mitigating Risk Through Service Provider Oversight 27 SESSION 5-B Mind the GAAP: Accounting and Auditing Update 28 SESSION 5-C Are You Ready for Some Fun(d Reporting)? Implementing the SEC’s New Reporting Modernization Rules 29 GENERAL SESSION Building Successful and Ethical Teams 30 GENERAL SESSION Alert Level Red, Yellow, or Green: Where to Focus in the Current Environment

GENERAL COUNSEL’S ADDRESS that may be unnecessarily burdensome and complex. As examples of opportunities for regulatory improve- Speaker: David W. Blass, General Counsel, Invest- ment or clarification from the U.S. Securities and Ex- ment Company Institute (ICI) change Commission (SEC), he noted aspects of the liquidity rule relating to the classification of assets and Mr. Blass addressed the potential opportunities the treatment of exchange-traded funds (ETFs) that that may arise for the industry out of the recent redeem in kind. He also stated that the ICI would be change in the presidential administration, the ICI’s focused on the role of directors and trustees of mutual priorities, and mission-critical regulatory initiatives for funds and ETFs and the potential to avoid duplication the industry. between their functions and those of Chief Compli- Mr. Blass commented on the high degree of ance Officers (CCO) and other staff. alignment between the stated goals of President Mr. Blass then reported on the ICI’s mission- Trump’s administration for regulation and regulatory critical regulatory initiatives. He commented on the change and those of the industry, including empower- ICI’s intention to focus on shortening the settlement ing Americans to make informed and independent cycle from T+3 to T+2; a uniform fiduciary standard financial decisions, administering efficient, effective for advisers and broker-dealers, which could be and tailored regulations, and fostering economic promulgated by the SEC or Financial Industry Regula- growth and vibrant financial markets. Mr. Blass stat- tory Authority (FINRA); a more focused rule on mutual ed that those priorities should lead to greater entre- funds’ use of derivatives that would not apply the pro- preneurship and ownership, growth, efficient capital posed portfolio limits and would employ a more tar- allocation and diversity in financing sources. geted approach to asset segregation requirements; Mr. Blass observed that the significant new regu- and electronic delivery of shareholder reports. Mr. lations affecting the mutual fund industry, including Blass noted the importance of FINRA rationalizing the enhanced data reporting, liquidity risk management fee rates charged to funds by intermediaries for deliv- and optional swing pricing, have required and will ery of shareholder reports, and ultimately borne by continue to require significant resources. He com- fund shareholders. mented on how those burdensome regulatory initia- Mr. Blass then commented on an industry chal- tives come on the heels of money market reform, the lenge on the horizon. He summarized reports that Department of Labor’s (DOL) amended definition of argue there may be antitrust issues associated with “fiduciary” and related rules (collectively, the fiduciary funds in a fund complex holding ownership positions rule) and the Dodd-Frank Wall Street Reform and in companies competing in the same industry. He Consumer Protection Act (Dodd-Frank Act), including stated that the reports suggest that such ownership the Volcker Rule. He illustrated the avalanche of reg- positions may cause management of those compa- ulatory change by noting that the ICI had submitted nies to not compete as strongly with each other on 111 comment letters over the past year. He said the price. Mr. Blass argued that such assertion seems to ICI will be focused on seeking the space and time to significantly overstate the influence that minority own- implement what has been adopted and will focus on ers can have on management and a company’s busi- working with regulators on aspects of those reforms ness practices, assumes that managers across a sin-

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gle complex will have a monolithic view on the in- staff’s work. He stated that the staff will continue to vestment and how a company should operate, and think about the greater use of electronic delivery, the mistakes correlation with causation. With respect to proposed derivatives rule, third-party examinations of the final point, Mr. Blass noted that the assertion that investment advisers, disclosure effectiveness and rising prices in certain industries were caused by regulations applicable to ETFs. During the discussion common ownership ignores the effect of other dynam- that followed, Mr. Grim said that the Staff was open to ic market factors, such as increasing demand. Mr. discussions on the burdens on trustees and directors Blass stated that although the views stated in the re- and the possibility that some of those responsibilities ports appear misguided it is important to combat such might be delegated to CCOs. He said the staff was ideas before they become part of common wisdom or also open to listening to instances of unintended con- begin to inform policy positions. He noted the ideas in sequences associated with the implementation of the the reports appear to be gaining some traction with liquidity rule and enhanced data reporting. He also some European regulators. He also noted that limits said that the staff was also considering whether a on a fund complex’s investments in competitors in a summary approach to disclosure, as illustrated by the single industry would have dire effects on index in- summary prospectus, would be useful and effective in vesting and the ability to provide diversified portfolios other areas, as well as the potential benefits of the for investors. greater incorporation of technology in communica- tions with investors. In that respect, Mr. Grim encour- KEYNOTE REMARKS aged the industry to communicate its perspectives on these matters with the Staff. Mr. Grim referred to the Speaker: David W. Grim, Director, Division of In- implementation of money market reform as a template vestment Management, U.S. Securities and Ex- for industry and the Staff communicating on areas of change Commission regulation that required clarification in the form of re- sponses to FAQs. Mr. Grim also commented on the Mr. Grim commented on the Division of Invest- disclosure branch’s focus on smart beta funds, com- ment Management’s priorities, including continuing to menting in a manner intended to result in relevant look for industry trends that give rise to regulatory disclosures that are accurate and clear and, where concern, and focusing on providing guidance to the possible, simple. industry through IM Guidance alerts and responses to frequently asked questions (FAQs). He referred to the Staff’s recent guidance on robo-advisers, advisor custody and issues associated with implementation of the DOL’s fiduciary rule. Mr. Grim then commented on potential priorities for Mr. Clayton if he is confirmed. He stated that the hiring freeze order applies to the SEC, while certain other orders do not, but that the staff will still look to such orders for principles that should apply to the

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GENERAL SESSION Mr. Paredes predicted that the proposed Finan- cial CHOICE Act1, an effort to roll back parts of the The Changing Legislative and Regulatory Land- Dodd-Frank Act, was likely to pass the House, but scape—What to Expect that its fate in the Senate was unclear. He said that Moderator: Heidi Stam, Former Managing Director the best opportunities for change were non-regulatory, and General Counsel, Vanguard such as through FAQs, rules, exemptive relief, no- Speakers: Barry P. Barbash, Partner, Willkie Farr & action letters, enforcement priorities, and through the Gallagher Office of Compliance Inspection and Examinations Joseph J. Barry, Senior Vice President, Industry Af- (OCIE) favoring “educational” deficiency letters over fairs, State Street enforcement referrals. The panelists were in agree- Troy A. Paredes, Founder, Paredes Strategies ment that the Trump administration is unlikely to des- Dawn Vroegop, Chairperson, MetLife Funds ignate any entity a systemically important financial institution (SIFI); however, Mr. Barry noted that it re- This panel discussed the implications for the reg- mained important to address issues with the Financial ulated fund industry and fund shareholders of chang- Stability Oversight Council (FSOC) to ensure that the es in legislative and regulatory priorities under the SEC remained the primary regulator for the fund in- Trump administration. Mr. Paredes said that he was dustry. optimistic for economic growth, the markets and in- Mr. Barry predicted that Jay Clayton would be vestors, stating his view that policies favoring capital confirmed as Chairman of the SEC by Easter, but that formation implied investor protection as a necessary it may be months beyond that before other Commis- corollary. Mr. Barry said that the Obama administra- sioners were confirmed. Mr. Barbash noted the im- tion had been locked into a post-crisis mentality, and portance of appointing SEC Division Directors in the that it was now time for a new administration to look meantime. Mr. Paredes said that he expects the SEC forward. He said that it would be difficult to change under Mr. Clayton to emphasize capital formation as a the Dodd-Frank Act even if the administration wanted goal, and that he did not consider this to be at odds to, but that the administration could affect the imple- mentation of revenue-related elements of the Dodd- 1 The key principles as stated in the Executive Summary are: Frank Act. Mr. Barbash agreed that any changes to economic growth must be revitalized through competitive, the Dodd-Frank Act would be slow and incremental, transparent, and innovative capital markets; every American, and predicted that the derivatives trading regulations regardless of circumstance, must have the opportunity to would remain in place. Ms. Vroegop said that invest- achieve financial independence; consumers must be pro- tected from fraud and deception as well as the loss of eco- ment company boards would welcome better-tailored nomic ; taxpayer bailouts of financial institutions must regulations, observing that many recent regulations end and no company can remain too big to fail; systemic risk (such as those addressing money market reform, must be managed in a market with profit and loss; simplicity liquidity, and business continuity) imposed duties on must replace complexity, because complexity can be gamed boards that risked diverting attention from oversight of by the well-connected and abused by the Washington pow- investment advisers and conflicts of interest. erful; and both Wall Street and Washington must be held accountable.

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with investor protection. Mr. Barbash said that the money is.” He said that OCIE was originally designed SEC rulemaking agenda would reflect the Trump ad- to be an educational mechanism for the industry, but ministration’s big picture themes, such as less regula- that this role had been diminished under the enforce- tion and an emphasis on capital formation. As an ment-oriented, broken windows philosophy. He said example, he said that money market reform passed he hoped that OCIE would become more cooperative with these themes in mind could have favored capital and educational in the future. formation. Mr. Paredes said that he expected a rigor- The panel concluded with thoughts on a range of ous cost-benefit analysis to inform SEC rulemaking, questions posed by Ms. Stam. Regarding enforce- and also advocated a retrospective cost-benefit anal- ment settlement costs, Ms. Vroegop said that was not ysis of existing rules to assess their effectiveness. Mr. fair that bad acts by individuals resulted in corporate Barbash cautioned against over-reliance on cost- penalties that ultimately harmed investors, including benefit analyses, stating that he believed such over- mutual fund shareholders, but Mr. Barbash noted that, reliance could result in the loss of broader perspective. from the SEC’s perspective, it was hard to get quick Ms. Vroegop said that cost-benefit analysis was par- successes by going after individuals, because the ticularly important in assessing the impact of regula- individuals fight back hard, resulting in degraded en- tion on smaller and mid-sized investment advisers. forcement statistics. Mr. Barry said that there may be She also recommended that the SEC allow boards to some movement in Congress to reduce the regulatory delegate fully day-to-day responsibility for valuation. burden on issuers, including through a rethinking of Turning to international matters, Mr. Barry said some aspects of Sarbanes-Oxley. Mr. Barbash said that it was not clear how committed the Trump admin- that the emphasis on capital formation may result in a istration is to international organizations, but that it focus on business development companies and on would be good to have some global leadership allow- restrictions on what investment companies may pur- ing U.S. banks to operate worldwide on U.S. stand- chase. Finally, the panelists predicted that there may ards and, if international standards instead were es- be (i) a rule addressing ETFs, (ii) a review of how tablished, that U.S. standards should align with those 401(k) accounts are invested, (iii) a movement to- standards. As an example, Mr. Barbash noted that wards “Rothification” of retirement accounts so that all the treatment of soft dollars in the U.S. and accounts are funded with after-tax earnings, and (iv) a was not in sync, which introduced operational com- potential re-evaluation of existing SEC rules, but per- plexities for firms operating globally. haps not a fiduciary standard equally applicable to Looking to the future, Mr. Paredes said that, investment advisers and broker dealers. while it was not clear how Mr. Clayton would view the SEC’s enforcement role, he did not expect a pullback in overall enforcement efforts, although it was possi- ble that the “broken windows” approach would be scaled back, allowing more resources to be applied to more serious matters. Mr. Barbash said that there would be continued enforcement focus on the asset management industry because “that’s where the

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SESSION 1-A recent AXA mutual fund fee litigation noted, apparent- ly with disapproval, that the AXA fund board did not Inside the Boardroom: A Roundtable Discussion include any members who were former regulators. Moderator: Amy B. R. Lancellotta, Managing Director, Ms. Lancellotta said that the SEC should take care Independent Directors Council not to assign to fund boards any responsibilities that Speakers: Marguerite C. Bateman, Partner, Schiff only a technical expert would be capable of discharg- Hardin LLP ing. She observed that the SEC’s proposed deriva- Patricia Louie, Executive Vice President and General tives rule, and the original version of the new liquidity Counsel, AXA Equitable Funds Management Group, rule, threatened to cross this line. LLC How Fund Boards Cope with the Increased Philip H. Newman, Partner, Goodwin Procter LLP Complexity of Their Role. The panel discussed a variety of approaches for keeping fund boards in- Has Fund Board Composition Changed as Board formed regarding the evolution of the adviser’s busi- Responsibilities Have Increased? Ms. Lancellotta ness and the changing competitive landscape. It was opened the session by reviewing developments in noted that periodic presentations to the fund board by investment company over the past quar- the adviser’s senior management regarding these ter century, highlighting (i) the 1992 SEC Staff Report, matters is now typical. “Protecting Investors: A Half Century of Investment Mr. Newman cited ICI/IDC survey data indicating Company Regulation” (which, she noted, proposed a that boards have tended not to increase the number number of regulatory changes relating to fund gov- of meetings they hold, but instead to increase the ernance, most of which were not adopted), (ii) the length of their meetings and to rely more and more on 1999 ICI Best Practices report, (iii) SEC fund govern- board committees to conduct a substantial part of the ance rules adopted in 2001 and 2004 and (iv) the board’s functions. Ms. Louie noted that many boards SEC’s compliance program (rule 38a-1), which in- have formed a number of separate subcommittees creased fund boards’ formal responsibilities with re- focused on investment matters and that these com- spect to compliance matters. mittees can meet concurrently to review the portfolio The panel discussed the tendency of many fund activities of different funds in the fund group. Ms. boards to seek new board members who have very Bateman said that, if a board relies heavily on com- specialized experience relevant to certain topics that mittees, it is important to have an effective means of have come to require more board attention (such as communicating to the full board the substance of each derivatives, liquidity, cybersecurity, distribution prac- committee’s activities, so that all board members are tices and subadviser oversight). Mr. Newman noted appropriately informed of matters dealt with at the the risks that, if boards are composed increasingly of committee level. Practices that help promote board technical experts (1) they may be tempted to act more understanding of the work of committees include (1) as managers than as overseers and (2) other board periodic rotation of members among the different members will defer to the views of board members committees and (2) making every committee’s meet- who are perceived to be experts with respect to par- ing materials available to all board members as a ticular topics. Ms. Louie noted that the judge in the matter of course.

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Mr. Newman noted the importance of a substan- Some boards, he said, view the CCO simply as the tive “onboarding” process to introduce new board administrator of the funds’ compliance program, oth- members to the fund group and the work of the board. ers look to the CCO to be a strategic thinker regarding He said that informational sessions designed for new compliance matters, and some others see the CCO board members can also serve as good “refreshers” as an independent reviewer of compliance functions for existing board members. He also observed that that are conducted primarily by other units within the some boards appoint an experienced board member organization. to serve as a mentor for each incoming new member. Innovations in Board Practices. The panel dis- Mr. Newman said that communication among cussed the utility of fund board site visits to subadvis- board members in advance of scheduled meetings ers and other third-party service providers. Panelists can help identify matters on which the board wishes expressed the view that board site visits to subadvis- to focus its attention during the meeting. Ms. Bate- ers’ offices can be useful, but suggested that boards man noted the value of putting the most significant should view these visits as observational opportuni- issues that will be considered at the meeting first on ties, rather than as occasions for the board to inter- the meeting agenda. Ms. Bateman noted the utility of vene in the adviser’s performance of its role of select- having each committee chair contact each committee ing and overseeing subadvisers. member in advance of committee meetings to elicit With respect to electronic board books, Ms. members’ views and comments regarding matters on Lancellotta observed that there is a tendency for the meeting agenda. board materials to become more voluminous if pro- Mr. Newman said that independent board chairs vided in electronic format. Regarding the general are increasingly involved in helping determine how tendency of board materials to become more exten- much meeting time will be allocated to each item on sive as the board’s oversight responsibilities increase, the meeting agenda. Ms. Bateman cautioned that Mr. Newman noted the value of executive summaries management should not treat the independent chair of important topics, and of the use of dashboard-style as the sole voice of the independent board members, presentations that provide a concise pictorial sum- and should not assume that the chair is necessarily mary of key data. Ms. Louie said that her firm’s board empowered to speak for all the independent board materials are divided into two volumes, one contain- members on all matters. ing more summary materials and the other containing Ms. Louie commented regarding the importance supplemental materials that board members may wish of a good working relationship between management to consult in their discretion. Ms. Bateman noted that and the independent directors’ counsel. many boards rely on “exception reporting” as a means Mr. Newman offered the observation that fund of highlighting matters that might merit closer board boards have limited ability to bring about change at a attention. Mr. Newman cautioned that if a board fund group. Their principal role, he said, is to engage chooses to rely on exception reporting, it should un- in a dialogue with management regarding issues that derstand the standards and processes that are em- are of critical importance to fund shareholders. ployed in identifying the matters that are reported as Mr. Newman commented regarding different exceptions. views as to the role of the CCO of a fund group.

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Recent Litigation. The panel discussed the re- taken to eliminate board functions that are not espe- cent AXA decision, noting that the court in that case cially useful, in order to allow boards to focus on the looked not only at the board’s annual contract renewal matters where they can make the most valuable con- process, but also more broadly at the board’s govern- tribution. ance and oversight practices (including the process Ms. Bateman recommended that boards be re- for selecting new board members, the process for lieved of the obligation to make quarterly compliance setting board compensation and the board’s educa- determinations regarding routine portfolio transactions tional sessions with outside presenters). Mr. Newman between funds and their affiliates. observed that the documentary record of the board’s Ms. Louie suggested that fund boards be relieved contract review process is extremely important evi- of the responsibility for “fair value” determinations of dence in shareholder suits challenging the level of assets for which market quotations are not readily advisory fees. available. Ms. Bateman summarized a recent court decision Mr. Newman proposed that boards be relieved of in the PIMCO excessive fee litigation, Kenny v. Pac. the burden of policing payments to intermediaries as Inv. Mgmt. Co. LLC., noting that the court had held possible payments for “distribution in guise,” suggest- that the attorney-client privilege did not entitle a fund’s ing that the SEC make the recipients of the payments independent trustees to withhold from the plaintiff rather than the fund board accountable for compli- shareholders communications between the independ- ance in this regard. ent trustees and their outside counsel. She cautioned Ms. Louie said that fund boards should be re- against the use of email for the discussion of highly lieved of the obligation to approve fidelity board cov- sensitive matters. She also stated that merely label- erage, and that SEC should address the now largely ing a communication “attorney-client privileged” does obsolete list (issued at the time of adoption of Rule not, by itself, establish that the communication is, in 12b-1) of factors that boards should consider when fact, privileged; the privilege applies only to confiden- approving Rule 12b-1 lans. tial communications between a lawyer and his or her The panel concluded with a discussion as to client in which legal advice is either sought or deliv- whether it would be desirable to eliminate the re- ered. She further noted that sharing a communication quirement that certain fund board approvals occur at between lawyer and client with any third party will a meeting held in person. Panelists disagreed on this typically extinguish the privilege with respect to that question. communication. Desired Regulatory Changes Regarding the Role of Fund Boards. The session concluded with an op- portunity for each panel member to identify regulatory changes regarding the role of fund boards that he or she thinks would be desirable. Ms. Lancellotta noted that the Independent Directors Council (IDC) intends to approach the SEC staff in the relatively near future to initiate a dialogue regarding steps that could be

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SESSION 1-B EU Politics and Brexit. Ms. Creighton highlighted the fragile political condition of the EU at present, and A Changing Global Environment: The New Politi- commented on what she perceives as a dispropor- cal Landscape and the International Outlook tionately -centric emphasis by U.S. firms when Moderator: Gregory P. Dulski, Senior Corporate they consider developments in Europe. While an Counsel, Federated Investors upcoming Dutch vote would not likely be dramatic, Speakers: Lucinda Creighton, Chief Executive Officer, elections later in the year in could have a sig- Vulcan Consulting nificant destabilizing effect. Brexit raises the prospect Sara P. Crovitz, Deputy Chief Counsel, Chief Coun- of a new Scottish independence referendum, and any sel’s Office, Division of Investment Management, U.S. significant delays in implementing changes to Brexit Securities and Exchange Commission could place massive pressure on the UK to negotiate Paul J. Elmlinger, Deputy General Counsel, Franklin a full array of trade agreements in a very short time. Templeton Investments Implications of Brexit for U.S. Managers with London Offices. Mr. Elmlinger described several im- The panel addressed international developments plications for U.S. managers that rely on their London- and regulatory initiatives as they impact global asset based personnel to access European clients and managers, focusing on U.S. managers with significant markets, focusing on key buzzwords (1) equivalence, operations and sales efforts in the (2) delegation, and (3) substance. He said that the (EU) and (UK). practical downsides would not be dramatic if the EU SEC’s Interaction with Non-U.S. Regulators. Ms. determines that the UK regulatory regime is “equiva- Crovitz described ways in which the SEC coordinates lent” to the European regime. He stated that “delega- with non-U.S. regulators. The SEC participates regu- tion” requires a licensed management company in the larly in groups such as the International Organization EU that can delegate portfolio management discretion of Securities Commissions (IOSCO) and the Financial to a UK-based manager, provided there are appropri- Stability Board (FSB). European regulators had con- ate cooperation arrangements in place between the sulted with the SEC in connection with preparing the regulators in the UK and the relevant EU . MiFID regulations and AIFMD passporting rules. In Where there is a delegation of portfolio management addition, the SEC had actively engaged with individu- by an EU-based management company, the “sub- al European in connection with reclaims stance” requirements dictate that the manager have of withholding tax payments on dividends received by adequate substance on the ground in the relevant EU non-EU institutional investors. She described a final member state. He predicted that the substance re- report by the FSB on structural vulnerabilities in the quirements will be a focus of regulators seeking to asset management industry that directed IOSCO to prevent jurisdictional arbitrage, noting that the Euro- operationalize and implement its recommendations on pean Securities and Markets Authority (ESMA) is cur- liquidity and leverage. While this process of address- rently undertaking a study of the application of sub- ing structural vulnerabilities is ongoing, there will be a stance requirements. pause in any efforts to designate non-bank global U.S. Trade Agreement Process. Ms. Crovitz de- “systemically important financial institutions” (G-SIFIs). scribed how the Treasury Department and U.S. trade

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representatives generally take the lead on negotiating ments for trading and payments for research, Mr. trade agreements with other countries. She noted Elmlinger observed that specific payments for re- that the SEC works in parallel to develop memoranda search might not fall under the Section 28(e) safe of understanding with non-U.S. regulators in order to harbor for soft dollars, raising the possibility that the coordinate the implementation and enforcement of adviser could fall within the technical definition of a rulemaking and policy initiatives. broker or dealer and, therefore, be subject to a dual Managing Uncertainty and the Future of Globali- registration requirement. Ms. Crovitz stated that re- zation. Turning to broader themes, Mr. Elmlinger quiring dual registration would impose “huge cost” commented that the current political uncertainty pre- and that the SEC staff would require a “principles- sents both challenge and opportunity for U.S. regula- based way to give relief” to advisers that would poten- tors, which could lead either to greater protectionism tially fall within the broker-dealer definition solely be- and withdrawal by the U.S. or to continued interna- cause they disaggregate trades in response to EU tional engagement. He noted that the ultimate selec- anti-inducement regulations. tions to fill several important U.S. policy positions in Challenges Facing the Industry Globally. The the Trump administration could have a significant panelists closed by discussing their views of the big- impact on the positions taken. Citing the recent logis- gest challenges facing the global fund industry. Mr. tical difficulties of coordinating derivatives clearing Elmlinger cited to fee and cost pressures as a para- rules across , he predicted that the U.S. mount challenge, and also singled out the inherent would remain involved enough in the FSB to avoid incongruities of expanding prudential regulation to the any G-SIFI designations for U.S. companies. Ms. asset management industry. Much like the saying Crovitz observed that the Financial CHOICE Act could about the Holy Roman Empire, he concluded, pruden- impede U.S. financial regulators’ ability to participate tial regulation is neither prudential nor regulation. in international working groups. Turning to the UK/EU, Mr. Dulski said he expects a significant period of time to be required following Brexit in order to dig through the mounds of regulation that will have to be imple- mented by the UK, and Ms. Creighton commented that the UK’s Great Repeal Bill, which will have the effect of repealing or adopting all EU law in the UK, might alternatively be referred to as the “great trans- position act” given that it effectively transposes large swaths of EU regulation wholesale into UK law. Soft Dollars and Equivalency. During a question period, the panel discussed the complications for global firms arising out of the treatment of soft dollars (or soft commissions) as potential “inducements” un- der EU regulation. Noting that these EU rules would potentially require asset managers to unbundle pay-

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SESSION 2-A “non-transparent” active ETF structures – the blind trust model and the proxy or hedge basket model. The Evolution of Investing: Opportunities and Noting that neither structure had been approved by Challenges in the ETF Marketplace the SEC, Ms. Fumai highlighted some of the features Moderator: Jane G. Heinrichs, Associate General of each model. The blind trust model involves in-kind Counsel, Securities Regulation, Investment Company creation and redemption transactions made through a Institute blind trust that shields the ETF portfolio, with author- Speakers: Gregory A. Friedman, Head of ETF Ser- ized participants (APs) and market makers receiving vices, Fidelity Investments an enhanced “INAV” (or indicative NAV) throughout Allison Fumai, Partner, Dechert LLP the trading day to enable them to hedge their expo- Jasmin Sethi, Vice President, BlackRock, Inc. sures and to engage in arbitrage activities. In con- trast, the proxy basket or hedge basket model would The panel focused on current issues in the ETF utilize an optimized creation/redemption basket that space. would closely mirror the exposures of the ETF portfo- ETF Product Trends. The panel began with a lio without disclosing details of the portfolio. This discussion of four significant trends and their impact model would utilize INAV to transmit indicative pricing on ETFs: (i) active-versus-passive investing, (ii) smart information to APs and market makers during the beta, (iii) robo-advisers, and (iv) non-transparent trading day. Certain of these structures have been in ETFs. The panelists first noted that the active versus front of the SEC for over 10 years without approval, passive debate has been raging for years, and added largely because the SEC staff remains unconvinced that passive has been doing well relative to active in that APs and market makers will have enough infor- recent years in terms of new flows, but that the trend mation for the ETF arbitrage mechanism to function is primed for a reversal. It was noted that many firms effectively. Ms. Fumai also described the exchange- are banking on active management as a differentiator traded mutual fund (ETMF) structure, noting that the in the ETF space. With respect to smart beta or “fac- market price of the ETMF shares is pegged to the tor” products, the panel noted that there has been a end-of-day NAV. She added that a number of ETMFs proliferation of such products, especially since the had been launched, but it is too early to determine definition of “smart beta” is open to interpretation. whether the products will be successful. The panelists pointed out that the SEC staff has been Opportunities and Challenges for ETFs. The scrutinizing smart beta offerings recently by focusing panel discussed the U.S. ETF market and some of on whether a smart beta ETF’s index methodology is the challenges and opportunities that sponsors will truly rules-based, noting that the staff has been re- face. Mr. Friedman noted that “dipping your toe into questing index “rule books” and requiring additional the market” has not proven effective, even for large disclosure of index methodologies. The panel dis- asset managers. Instead, he suggested that new cussed robo-advisers and asset allocation model port- entrants need to have a clear approach and a differ- folios, noting that ETFs fit very well in those programs entiating narrative. Will the ETFs be clones of exist- due to their low cost, relative tax efficiency and wide ing mutual fund products? Are you merely offering range of exposures. The panel described two basic the same product at a lower price because the ETF

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structure is preferable to investors? Will ETFs func- cussed the exception from the rule for in-kind ETFs, tion as building blocks in the sponsor’s broader prod- including what it means to be an in-kind ETF and uct lineup or will the ETFs be complimentary to the what a “de minimis” amount of cash might be, as the existing product set? The panelists agreed that effec- SEC did not articulate a clear standard in the adopting tive distribution is the key to ETF success, and noted release. The panel discussed research that the ICI that building successful distribution requires sales had performed regarding the number of ETFs that force training, alignment of compensation and incen- might meet the in-kind definition. There was consen- tives with other products and patience. The panel sus that additional SEC guidance would be helpful to also talked about the need for ETF sponsors to build the industry in making a determination as to what a real ETF team with expertise in a variety of critical constitutes a “de minimis” amount of cash. areas, including navigating the legal and regulatory Fund Reporting Rules. The panel discussed the landscape, effective engagement with APs and mar- impact of the recently adopted fund reporting rules on ket makers through an experienced, dedicated capital ETFs. Areas discussed included the designation of markets team, and a product team that understands funds as “in-kind” ETFs, disclosure of creation and the existing ETF market and opportunities for differen- redemption activity by APs, as well as information on tiating the offering. The panel discussed the unique securities held as collateral in connection with such legal and regulatory issues ETFs face, including the activity, and information about transaction fees col- exemptive order process and the potential need for lected by ETFs. The panel also noted that the SEC Rule 19b-4 relief to list an ETF’s shares. In addition, staff appears to be particularly concerned about what the panel discussed recently adopted exchange rules happens when an important AP ceases to facilitate requiring ETFs to continuously meet the exchange’s creations and redemptions. initial listing standards. Areas of Regulatory Focus. The panel discussed Distribution. The panel discussed the potential the likely areas of regulatory focus in the coming year, for ETFs to be included on 401(k) platforms. It was including (i) compliance with exemptive order condi- agreed that while 401(k) platforms do not currently tions and exchange listing rules, (ii) disclosure of have the technology to allow participants to trade strategies in registration statements and on websites, ETFs, the technology would likely be developed in the (iii) the mechanics of the creation and redemption future. The panel also discussed creation and re- process and the effectiveness of the arbitrage mech- demption basket issues and their potential to hamper anism and (iv) secondary market trading and related newer ETF market entrants as early ETF sponsors market structure issues. The panelists predicted that have more flexibility to construct efficient in-kind bas- there would be increased focus on the roles of APs kets that contribute to tax efficiency and superior in- and market makers in the secondary market, espe- dex tracking. cially with respect to trading in fixed-income ETFs and Liquidity Rule. The panel touched on the recently underlying fixed-income securities. adopted liquidity rule which goes into effect in 2018, noting that ETFs had to consider the impact of liquidi- ty determinations on the arbitrage mechanism and on basket construction practices. The panel also dis-

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SESSION 2-B ing a manager’s profitability. In other words, plaintiffs have begun to allege that the manager is earning Mutual Fund Civil Litigation: Year in Review more money than is consistent with the manager’s Moderator: Julia S. Ulstrup, Moderator, Vice Presi- fiduciary duty. dent and General Counsel, ICI Mutual Insurance Ms. Ulstrup explained that, over the past year, Company, RRG there have been several positive developments for Speakers: Jeremy P. Blumenfeld, Partner, Morgan advisers with regard to Section 36(b) litigation. The Lewis & Bockius LLP advisers prevailed in each of the two trials during the Roberta R. Kameda, General Counsel, Dodge & Cox last 12 months, and, in various other cases, there Sean M. Murphy, Partner Milbank, Tweed, Hadley & were summary judgment decisions in favor of the McCloy LLP advisers based on one or more of the Gartenberg factors. Mr. Murphy noted that, in a manager of man- The panel focused on three key areas of fund- agers case, plaintiffs may be facing an uphill battle, as related litigation (i) fee litigation under Section 36(b) of “there are now two decisions that, at their core, reject the 1940 Act, (ii) attorney-client privilege and the fidu- the plaintiffs’ main theory.” Of course, he noted, a ciary exception and (iii) “proprietary funds” litigation judge could, in the future, decide differently. But at under ERISA. this time, there have been nine trials, and no plaintiff Fee Litigation under Section 36(b) of the 1940 has ever won a case brought under Section 36(b). Act. Mr. Murphy provided an overview of lawsuits And indeed, Mr. Murphy noted, there have been no following Jones v. Harris Associates, noting that there filings since the AXA decision in August 2016—the have been 27 cases filed over the last five years, in- longest stretch of time without a filing in the last five cluding three cases filed since March 2016 (and 17 years—a fact that may indicate that plaintiffs are more cases that are still pending). In these cases, plaintiffs hesitant to file Section 36(b) cases, and that 2017 and have advanced two principal theories: (i) in the “man- beyond may bring a significant slowdown in the filing ager of managers” lawsuits, plaintiffs have alleged of these cases. Furthermore, recent decisions in fa- that the adviser delegated substantially all of its man- vor of the advisers may lower plaintiffs’ settlement agement and administrative responsibilities to sub- expectations. advisers, yet retained a substantial portion of the fees, In spite of this impressive string of victories, Ms. and (ii) in the “reverse manager of managers” lawsuits, Kameda advised that it is important for managers to plaintiffs have alleged that a manager’s fee in respect stay ahead of these issues. For example, Ms. Kame- of the manager’s proprietary fund is excessive be- da’s team routinely consults with litigation counsel to cause that fee is substantially higher than the fee that hear about lessons learned from recent decisions, the manager charges as a sub-adviser to other fund new theories being tested by plaintiffs and which complexes. Mr. Murphy also explained that the plain- plaintiff evidence seemed to resonate with a judge or tiffs’ approach to “manager of managers” cases has jury. Another practice Ms. Kameda suggested is re- changed recently insofar as plaintiffs have become viewing and cataloguing for the board of directors any more accepting of a manager’s cost allocation meth- improvements in IT, research and trading, operations, odology and have begun to focus instead on challeng- shareholder communications, headcount, expense

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ratios, and anything else that benefits the fund. Build- Ms. Kameda advised that, while it is difficult to ing a narrative, she advised, can be helpful to the provide concrete advice on how to address concerns manager should the need for it arise. Indeed, Mr. arising from the invocation of the fiduciary exception Murphy advised that, while a manager cannot avoid in Section 36(b) cases, it is important to remember being sued, the best thing a manager can do is to that something that is expected to be privileged— review its 15(c) materials to ensure that its processes even if it is labeled “privileged”—is not always privi- are robust and the information given to the board is leged. Specifically, Ms. Kameda suggested raising comprehensive. In fact, Mr. Murphy noted that in two awareness about attorney-client privilege and the of the recent cases in which managers were granted “fiduciary exception” both with internal legal staff and summary judgment, the court granted summary with company executives and trustees. Reminding judgment, in part, based on good board materials and them to think before putting anything in writing and processes. encouraging independent directors to consult orally Attorney-Client Privilege and the Fiduciary Ex- with counsel are critical steps. ception. Ms. Ulstrup noted that plaintiff shareholders Attorney-client privilege and the fiduciary excep- recently have attempted to invoke the “fiduciary ex- tion is an area, Mr. Blumenfeld noted, that should ception” to compel production of privileged communi- continue to be watched very carefully. cations between independent trustees and their coun- Proprietary Funds Litigation Under ERISA. Ms. sel. While these privileged documents generally Ulstrup noted that, during the last several years, there would not be expected to be discoverable, plaintiffs have been class actions brought against plan spon- have argued that the independent trustees owe sors and/or members of a plan’s investment commit- shareholders a fiduciary duty and consult counsel in tee on behalf of plan participants, alleging that the furtherance of that fiduciary duty, and thus the docu- plan participants would have been better served if the ments should be discoverable. Mr. Blumenfeld, dis- investment options for the plan had consisted of non- cussing the “chilling effect” that these “fiduciary ex- proprietary funds that were less expensive, and/or ception” cases have on communications between yielded better performance, than the proprietary funds independent trustees and their counsel, discussed a that were in fact offered. Mr. Blumenfeld noted that recent Section 36(b) case, Kenny, in which a judge, the focus of these allegations has been that the plan relying exclusively on the fiduciary exception, com- sponsor offered proprietary funds to benefit the fund pelled the production of privileged communications manager and its affiliates rather than funds that would between the independent trustees and their counsel. have benefited the plan participants. Ms. Kameda Among all of the recent positive developments in the advised that this, too, is an area that should be Section 36(b) space, Mr. Blumenfeld characterized watched closely, and that firms should consult with the Kenny case as a “stand-out that went the other ERISA counsel to learn about the specifics of recent way.” Mr. Blumenfeld added, however, that in a more cases. Ms. Kameda added that it is advisable for recent case—a case that was decided during the last firms to maintain robust documentation supporting several weeks—a judge without elaboration or men- their investment option selections and may also wish tion of the “fiduciary exception,” denied a similar mo- to revisit their form of severance agreement to deter- tion on the basis that the documents were privileged. mine whether the agreement’s release language

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should be altered to restrict former employees from process would likely benefit from more input, and that bringing lawsuits alleging breaches of fiduciary duty. it would likely be desirable to receive input from risk, compliance, and trading personnel. SESSION 3-A The panel noted that a number of third-party ser- vice providers are developing programs and products Classified Assets: Translating the New Liquidity to assist fund groups in complying with the Liquidity Rules into Firm Policies Rule. One panelist noted that his fund group expects Moderator: Dorothy M. Donohue, Deputy General to send sample portfolios to a number of those third- Counsel, Securities Regulation, Investment Company party providers to test their products. Panelists Institute agreed that use of third-party service providers would Speakers: Paul G. Cellupica, Managing Director and not limit a fund’s obligations to ensure that the pro- General Counsel, Securities Law, TIAA cess is being conducted appropriately. Jerry Cubbin, Senior Vice President, Director of Fixed Panelists noted that the role of sub-advisers in Income and Alternatives Risk, OppenheimerFunds the liquidity determination process is one of the most Nancy M. Morris, Managing Director and Chief Com- challenging aspects of the Rule. Panelists noted that pliance Officer, Wellington Management Company a fund’s portfolio manager may be in the best position LLP to provide useful color as to a security’s liquidity, but a portfolio manager at a fund’s sub-adviser will not nec- The panel began by discussing a number of essarily have much insight as to expected levels of broad points regarding the Liquidity Rule. In general, redemptions, or as to the institutional ownership of the panelists felt that the Rule’s adopting release did not fund. Panelists said that, at a minimum, the process provide especially helpful guidance as to compliance would require frequent and detailed communication with the Rule, and suggested that the SEC staff might between a fund’s adviser and sub-adviser. They also usefully publish an FAQ. They expressed the view noted the logistical difficulties of potentially maintain- that the Rule’s provisions allowing funds to determine ing and monitoring different liquidity determinations liquidity generally on the basis of asset class is a for the same security for different sub-advisory clients. helpful development, although it will not necessarily Panelists noted that the liquidity classification of a be easy to apply. security can vary across different funds in the same Panelists discussed the likely location within their complex, that liquidity is not a function of the security firms of principal responsibility for day-to-day compli- alone, but also of context. Panelists agreed that it is ance. Views diverged, with one panelist saying that important not that a security’s liquidity classification the compliance function would likely be located prin- be the same across funds, but that the process used cipally among operations personnel, and another say- to evaluate liquidity be the same. Panelists discussed ing that it would likely be centered in a subcommittee the possibility of automating a portion of the process, of the firm’s risk management committee. The panel- possibly using technology to highlight candidates for ists agreed that it would likely be preferable that a possible changes in liquidity status, with a closer committee or group of persons be charged with rule evaluation to be conducted manually. A panelist said compliance, rather than a single individual, since the that, in his opinion, the hard question is how substan-

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tial a change in circumstances needs to be in order to liquid” classification bucket appears to have been trigger a detailed re-look at a security’s liquidity. Pan- developed by the SEC largely with senior loans in elists discussed fund boards’ responsibilities generally, mind, in light of the extended settlement periods for focusing on timing in particular. They noted that, as- many loans. A panelist noted that it is fortunate that suming boards will need some number of meetings to the SEC included the availability of lines of credit develop and become comfortable with board reporting among the factors a fund may consider in periodically protocols and formats, they might, in fact, want to determining liquidity risk, since lines of credit have begin that review and comment process in early 2018. helped to make senior loans appropriate for use in The panel noted that a “highly liquid investment” open-end funds. A panelist discussed whether a sen- includes any investment that the fund reasonably ex- ior loan might be characterized as a “moderately liq- pects to be convertible into cash in three business uid investment.” He noted the difficulty in developing days or less without significantly diluting the remain- assurance of seven-day settlement ex ante, noting ing shareholders’ interests. Panelists noted that the that it would likely be possible to do that in certain determination as to what amount of a security may be cases, but that it might be difficult in many cases. traded without resulting in a “significant change” in Panelists noted that public disclosures regarding market value would require both quantitative and liquidity are likely to bring more “market discipline” to qualitative inputs. They said that a fund group would funds with high illiquidity. They noted that investors likely want to rely for the quantitative analysis on trad- and consultants will likely look more carefully at fund ing data available to it, but that, for the qualitative liquidity, and it is possible that less liquid funds will not analysis, it would likely want to rely on the long expe- grow as large as they have in the past. rience of its trading desk personnel. They agreed that Panelists noted that it is unlikely that many funds it will be difficult to develop hard and fast rules as to will exceed their highly liquid investment minimums, what constitutes a significant change, and that the since most funds will probably be run with a level of ultimate determination will depend to a significant liquidity substantially higher than the minimums. They extent on trader input. noted the difficulty of considering long- and short-term In this regard, panelists noted the special chal- cash flow projections where the fund manager does lenges posed by fixed-income securities. They said not have transparency through to underlying holders that, by contrast to many securities, for which of omnibus accounts. They noted that, in such cases, there is substantial trading data, trading information is funds may simply “assume the worst” and set a cush- not available for many fixed-income securities, and ion. A panelist said that policies and procedures that some amount of modeling will likely be required. seeking or requiring early large trade warnings may They noted that market depth is a real issue for many become more common. Panelists noted that funds fixed-income securities, and that liquidity determina- that have been in existence longer will have an ad- tions for those securities will likely require a significant vantage in setting their highly liquid investment mini- amount of qualitative input from traders and portfolio mums, since they can rely on historical data to some management personnel. extent. One panelist noted that determination of a The panel discussed liquidity considerations re- highly liquid investment minimum is not required of a lating to senior loans. Panelists noted that the “less fund that does not primarily hold assets that are highly

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liquid investments; the panelist said that the word in Mr. Bortz discussed the impact of the fiduciary rule to the industry is that the SEC staff will construe that date on fund distribution models, noting that the sta- status “very narrowly.” tus of “Class T” shares was uncertain given that they were designed to solve specific issues raised by a SESSION 3-B rule that is likely to change. The panelists observed that litigation risk is a significant concern under the Retirement Redux: Where Does Regulation Go current iteration of fiduciary rule, and that some FAQs from Here? published to date by the DOL seem more helpful to Moderator: Elena Barone Chism, Associate General plaintiffs’ firms than to those trying to follow the Rule. Counsel, Investment Company Institute The panelists discussed aspects of the Rule they Speakers: Jason Bortz, Senior Counsel, Capital would most like to see addressed through revisions, Group including clearer guidance regarding whether certain Robert A. Holcomb, Vice President, Legislative and activities are “advice” or “education,” more limited Regulatory Affairs, Empower Retirement disclosure requirements, and greater choice as to the Margaret H. Raymond, Vice President, Managing structure of compensation paid for advice (e.g., asset- Counsel, T. Rowe Price Associates, Inc. based fees, commissions). Ms. Raymond provided an overview of recent de- Ms. Chism outlined the three topics to be covered velopments relating to state-run retirement plans. by this panel: (i) the DOL fiduciary rule, (ii) state-run She noted that several states have already created retirement plans for private-sector workers and (iii) tax plans aimed at workers without access to workplace reform and other possible retirement legislation. plans, and a number of other states are considering Mr. Holcomb provided an update on the status of legislation to create new state-run programs. Mr. the fiduciary rule. He noted that the November elec- Bortz noted that the idea underlying these plans is tion results created significant uncertainty as to when that workers without workplace plans represent an or if the rule would take effect. Mr. Holcomb indicated underserved population, and that states are stepping that the DOL had proposed to delay the applicability in to address a market failure. He noted that the date from April 10, 2017 to June 9, 2017, and that this sponsoring state generally subsidizes the administra- delay is widely expected to take place. He noted that tive costs of supporting these plans, effectively provid- the deadline for comments on the re-examination of ing state-sponsored competition to private markets. the rule and its exemptions pursuant to the February Mr. Holcomb observed that these are well-intentioned 3 Presidential memorandum is April 16, 2017, at statutes, but it is not clear they will succeed or wheth- which time the industry should have a better sense of er investors would be better off if private markets (ra- next steps. The panelists speculated regarding the ther than states) filled this void. most likely outcome for the fiduciary rule and agreed Mr. Holcomb discussed elements of possible tax that revisions are more likely than outright rescission. reforms and other retirement legislation that could be Mr. Bortz noted that it would be challenging for a new introduced in the coming months. He noted that tax Secretary of Labor to rescind the fiduciary rule without reform appears to be the Trump administration’s facing litigation from various public interest groups. number two priority after health care. The panelists

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speculated regarding the structure of future tax re- Fiduciary Rule Impact. Ms. Krawczyk opined that forms, including possible movement toward Roth the adoption of the fiduciary rule had been the biggest treatment of contributions (with only some limited por- event affecting the variable insurance product industry tion of the maximum contribution permitted to be in 2016. She noted that the DOL had proposed to made on a pre-tax basis) and possible reduced limits delay the fiduciary rule’s April 10, 2017 compliance for contributions and/or deductions. The panelists date for 60 days and that it was difficult to predict speculated regarding the potential impact of these when or whether the fiduciary rule would ultimately sorts of changes on retirement savings, including re- take effect. Ms. Krawczyk reported that, on March 10, duced savings rates and the risk that balances will be 2017, the DOL had published a field assistance bulle- insufficient to last through retirement. tin indicating that, in the event the delay is imple- mented after April 10 or no final action has been tak- SESSION 3-C en on the delay after April 10, it would not seek to enforce the fiduciary rule during the gap period. She Variable Insurance Products at a Crossroads: Op- noted, however, that the effect of that position with portunities and Challenges respect to individual retirement accounts (IRAs) was Moderator: Sarah A. Bessin, Associate General unclear, as the DOL does not have enforcement au- Counsel, Securities Regulation, Investment Company thority with respect to IRAs. Mr. Mazza stated his Institute understanding that most insurance companies were Speakers: Susan S. Krawczyk, Partner, Eversheds currently planning on delaying the mailing of the spe- Sutherland (US) LLP cial notice required for reliance on the fiduciary rule’s Michael J. Mazza, Assistant General Counsel, North- “Best Interest Contract” exemption during the transi- western Mutual tion period until there was more certainty regarding Tamiko Toland, Agility Retirement Income Intelligence the implementation of the fiduciary rule. Ms. Krawczyk discussed some of the special The panel discussed the structure of variable in- challenges the fiduciary rule posed in the variable surance products, the impact of the fiduciary rule on annuity context. She stated that the SEC’s recent no- those products, and recent industry trends and key action letter to Capital Research and Management areas of regulatory focus relating to those products. Company contemplated that brokers relying on the Variable Insurance Product Structure. Mr. Mazza letter to externalize sales charges for “clean shares” reviewed the structure of a typical variable insurance would be acting as agents of the investor, rather than product, noting that insurance company separate ac- the issuer, but noted that, under state insurance regu- counts are investment companies, typically unit in- lations, representatives selling variable annuities are vestment trusts, the assets of which are insulated required to be agents of the selling insurance compa- against claims of the insurance company’s creditors. ny. Ms. Krawczyk also noted that because the hold- He explained that Prudential Ins. Co. v. SEC (3rd Cir. ers of variable annuities typically make ongoing in- 1964) had held that an insurance company is the vestments, the fiduciary rule’s provisions grandfather- sponsor and depositor of its separate accounts, but is ing sales made prior to April 10, 2017 were unlikely to not itself an investment company. be very helpful. Ms. Krawczyk reported that, since

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the adoption of the fiduciary rule, many intermediaries some state insurance departments have developed had sought to withdraw as broker of record for varia- regulations governing supervision, suitability and dis- ble annuities. She noted that this could have implica- closure obligations in connection with replacements. tions for the provision of ongoing services to, and the Ms. Krawczyk noted that variable annuities were maintenance of records for, variable annuity custom- mentioned in the 2017 regulatory priorities of both ers. FINRA and the SEC. Industry Trends. Mr. Mazza described the range of underlying funds serving as investment options for GENERAL SESSION variable annuity contracts, noting that the average variable annuity contract offered 75-100 underlying A Conversation with OCIE and Enforcement fund investment options. He noted that recent money Moderator: Christopher Michailoff, Director, market reforms had prompted many separate ac- Deutsche Bank, LP counts to substitute money market funds Speakers: Stephanie Avakian, Acting Director, Divi- for institutional prime money market funds. Mr. Maz- sion of Enforcement, U.S. Securities and Exchange za noted that there was increasing interest in advisor Commission annuities, for which the representative receives ongo- Peter Driscoll, Acting Director, Office of Compliance ing advisory fees, but no sales compensation. Inspections and Examinations, U.S. Securities and Ms. Krawczyk stated that L share annuities had Exchange Commission declined in popularity in 2016 due to FINRA enforce- Lorraine B. Echavarria, Partner, Wilmer Cutler Picker- ment actions generally taking the position that the ing Hale and Dorr LLP pricing of L shares, which typically bear higher asset- based mortality and expense risk charges than B The panel provided the opportunity for attendees share annuities and are generally most appropriate to hear first-hand about some of the priorities of the for investors expecting to liquidate the annuity in a SEC’s Office of Compliance Inspections and Exami- relatively short time, are inconsistent with long-term nations (OCIE) and Division of Enforcement (En- benefit riders. forcement). In response to a question from the audience, Mr. Enforcement Priorities. Ms. Avakian indicated Mazza stated that the fiduciary rule had sensitized that Enforcement is looking to bring impactful cases insurance companies to the differences between qual- that improve efforts to protect investors by leveraging ified and non-qualified accounts, and he expected to the technology and data available to the staff, noting see greater differentiation in the products offered to the staff’s focus on protecting retail investors from qualified and non-qualified accounts going forward. online “cyber” attacks and scams. Areas of Regulatory Focus. Ms. Krawczyk sum- OCIE Priorities. Mr. Driscoll discussed OCIE’s marized the SEC’s 2016 investor bulletin with respect goal to take a risk-based, data-driven approach to to insurance contract buyout offers and replacements, conducting narrow, deep dive reviews of key risk are- noting that the bulletin provides helpful insight into as. He detailed OCIE’s exam priorities, including a relevant risk considerations. She also observed that focus on retail investors, seniors and retirement as- replacements are subject to FINRA rules, and that sets and market risk related to technology and ex-

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change controls. He then described how OCIE de- that she typically advises clients not to waive privilege termines exam priorities, taking input from the exami- early in the process because a waiver to the SEC will nation staff and the regional offices, as well as the probably also result in a waiver for third parties, in- SEC’s risk and surveillance teams, before engaging cluding future plaintiffs. She then detailed other ways with other SEC branches and the Commissioners. He an exam subject can demonstrate cooperation, in- then described the top five areas where OCIE makes cluding providing non-privileged documents and mak- findings – custody, codes of ethics, compliance and ing witnesses available. She added that, if she does books and records rules and SEC registration. advise a client to waive privilege, such waivers tend to Reasons for Enforcement Referrals. The panel be limited. noted that the principal reasons for Enforcement re- Enforcement Activity. Next, the panel discussed ferrals are (i) fraud, (ii) likelihood of serious harm to OCIE referrals to Enforcement, with Ms. Avakian not- investors, (iii) recidivist activity, (iv) magnitude of po- ing that most, but not all, of the 10% of OCIE exams tential or actual harm, (v) length of violations, (vi) con- that result in referrals lead to investigations by En- cern for dissipation of investor assets and (vii) non- forcement, while 70% of exams result in deficiency cooperation. The panel also discussed how referrals letters and 20% result in no comments. She noted might occur, including as a result of conversations that former Chair White’s “broken windows” enforce- between OCIE and Enforcement during exams. In ment approach, which targets stand-alone, technical response to an audience question, the panelists indi- violations, has not yet been changed but may be cated that it is important to get the facts right during deprioritized by the next SEC Chair. It was noted that an SEC exam to avoid a potential referral, so exam registrants who take immediate corrective action in subjects should speak out to make sure the record is response to issues raised internally or by the SEC complete and accurate before the conclusion of an staff will be better off. exam. Often, the exit interview will provide an appro- Self-Reporting. The panel then discussed self- priate opportunity for an exam subject to make any reporting of actual or potential violations by registrants. additional facts known to OCIE. The SEC staff advises registrants to reach out to Privilege. With respect to claims of privilege for OCIE or the relevant SEC division to notify them mock exams conducted prior to an OCIE exam, OCIE about violations. It was noted that registrants typically does not take a negative view of the assertion of privi- receive credit for self-reporting issues and for taking lege, but did suggest that maintaining a privilege log steps at remediation. Ms. Echavarria stated that con- will help clarify the issue should OCIE later seek privi- siderations with respect to self-reporting include the leged materials. Ms. Avakian indicated that Enforce- seriousness of the conduct, the potential for the con- ment does see tension where there is an informal duct to become a significant story when reported, the assertion of privilege based on a reliance on counsel seniority of the individual involved in the conduct, the claim. While Ms. Echavarria then noted that an exam amount of money involved and whether the registrant or enforcement subject does not need to waive privi- has conducted an internal investigation. Another fac- lege to be cooperative with the staff, she said that if a tor to consider is whether the SEC’s whistleblower firm does waive privilege, it typically receives cooper- rules will apply, because if a registrant fails to self- ation credit from the staff. Ms. Echavarria mentioned

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report a matter that is later reported by a whistleblow- SESSION 4-A er, the consequences may be more severe. OCIE and Enforcement Practices. The panel first Derivatives Market Reform: Where Are We Going noted that while OCIE typically cites registrants for Now That We Are Almost There? violations of the law, it will also cite failures to comply Moderator: Jennifer S. Choi, Associate General with informal SEC staff guidance. In contrast, it was Counsel, Securities Regulation, Investment Company noted that Enforcement referrals must be based on Institute violations of law. Next, the panel discussed staff in- Speakers: Leigh R. Fraser, Partner, Ropes & Gray terview approaches. OCIE often seeks to interview LLP attorneys and firm CCOs to obtain a complete picture Jason M. Goggins, Managing Director, Daly Consult- of the registrant’s activities, while Enforcement rarely ing Group puts attorneys on the record. Enforcement views Tracey Jordal, Executive Vice President, Senior interviewing CCOs as necessary and appropriate in Counsel, PIMCO LLC most instances. The panel noted that both OCIE and Enforcement are seeking to interview fund directors This panel discussed the status of derivatives with increasing frequency. market reform, the effects of derivatives market re- Data Collection and Analysis. The panel ex- form on markets and market participants and potential plained that both OCIE and Enforcement increasingly future changes to derivatives regulation. rely upon data to shape and perform examinations Reporting Requirements. Ms. Choi stated that, and investigations. It was suggested that compliance under the new reporting requirements in the United professionals attempt to analyze firm data to antici- States implemented in connection with the Dodd- pate what areas the SEC staff may focus on. Mr. Frank Act, generally the swap dealer who is party to Driscoll described an analytical tool the staff has de- the swap must report swap transactions either to a veloped to review trade blotters and run approximate- swap data repository or directly to the SEC or CFTC. ly 50 different reports, and he suggested that regis- She noted that, pursuant to the European Market In- trants take a similar approach to analyzing firm trade frastructure Regulation (EMIR), each party to a swap data. transaction that is an entity established in the EU Additional OCIE and Enforcement Topics. Finally, must report certain trade information to an EU trade the panel discussed likely future issues, including a repository. focus on robo-advisers and other forms of algorithmic Clearing Requirements. Ms. Choi stated that, advice. There was also discussion of the recent 10th while the SEC has not yet proposed clearing require- Circuit’s decision regarding the SEC’s administrative ments for security-based swaps, the CFTC has im- law judge function. In addition, the panelists dis- plemented clearing requirements for interest rate cussed recent criticism of penalties imposed on public swaps in certain currencies and credit default swaps companies that punish public shareholders rather on certain indices. She noted that clearing require- than the individuals involved in misconduct. ments for interest rate swaps in certain other curren- cies are being phased in over time. She stated that there is a similar clearing requirement in the EU on a

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narrower band of swaps that will affect funds or other form (clearing requirements, for example) may have entities established in the EU and U.S. accounts trad- evolved in the market naturally due to risk manage- ing with EU-based counterparties. ment benefits. Ms. Fraser stated that she has not Trading Requirements. Ms. Fraser explained seen a material change in the overall use of deriva- that a subset of the swap transactions required to be tives by funds. She noted that funds that do not ex- cleared must trade either on an exchange or on a pect to use derivatives extensively may be deterred swap execution facility (SEF). She stated that by the additional steps that must be taken in connec- benchmark interest rate swaps and credit default in- tion with derivatives trading but, in general, funds that dex swaps are currently required to be executed on a use derivatives as a core part of their strategy have SEF and additional categories of swaps may be sub- simply complied with the additional requirements. ject to this requirement over time. She noted that the Potential Future Changes to Derivatives Reform. SEC has not yet proposed any trading requirements The panelists agreed that a wholesale repeal of Title for security-based swaps and that, in the EU, trading VII of the Dodd-Frank Act, which provides the frame- requirements are expected under MiFID II, although work for the regulation of the swaps markets, is not details regarding those requirements are not yet practical or likely. Mr. Goggins discussed the poten- known. tial impact of the Financial CHOICE Act and CFTC Ms. Fraser described the mandatory minimum Reauthorization Bill on Title VII. The panelists then margin requirements for uncleared swaps in the Unit- discussed certain issues with the current require- ed States. She noted the March 1 compliance date ments, which may be the subject of further reform. for variation margin requirements and commented Ms. Jordal discussed the need for potential re- that many funds in the industry were still in the pro- form relating to the capital requirements for banks cess of finalizing their documents. She described under Basel III. She noted that the capital require- initial margin requirements that will become effective ments have increased the cost of accepting clearing in 2020 and noted that these requirements apply only accounts and some futures commission merchants to funds with material swap exposure (i.e., $8 billion in have exited the business as a result. Mr. Goggins notional amount, with deliverable currency forwards stated that he did not expect Congress to address the counting toward the threshold). Ms. Fraser described concerns related to stricter capital requirements, de- mandatory minimum margin requirements in the EU, spite the fact that the Financial Stability Oversight highlighting the fact that the U.S. requirements apply Council has been tasked with evaluating how rules only to dealers, but any entity established in the EU is implemented pursuant to the Dodd-Frank Act are im- subject to the EU rules. pacting markets. The Effects of Derivatives Market Reform. The Ms. Fraser noted issues with the minimum trans- panelists discussed the changes they have seen in fer amount for variation margin. She explained that the derivatives market as a result of the reform. Ms. the U.S. variation margin rules provide that margin Jordal commented that derivatives market reform has does not need to be posted until the amount to be resulted in a more stable financial system. She noted transferred exceeds $500,000 of combined initial and that there are more barriers to derivatives trading now, variation margin. She stated that, while this is helpful but that some of the changes resulting from the re- relief, the cap is applied at the legal entity level, which

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results in issues for funds with multiple managers and market regulation, most of the existing regulation is for investment advisers to separately managed ac- likely here to stay. counts because managers typically do not know what exposures other managers have put on. SESSION 4-B Ms. Jordal noted the conflict of interest relating to the fact that SEFs can, in effect, determine which Tax Reform: What Does it Mean for the Fund In- swaps must be traded on a SEF. She stated her view dustry and Fund Investors? that the CFTC should be responsible for determining Moderator: Karen Lau Gibian, Moderator, Associate which swaps need to be traded on a SEF in order to General Counsel, Tax Law, Investment Company avoid this conflict. Mr. Goggins stated that SEFs Institute were addressed in the 2015 white paper issued by Speakers: Marc J. Gerson, Partner, Miller & Cheva- CFTC Acting Chairman Giancarlo. He noted that the lier white paper reflected Mr. Giancarlo’s view that market Joshua D. Odintz, Partner, Baker & McKenzie LLP participants should be able to choose how to trade Gwen Shaneyfelt, Senior Vice President, Global Tax- without having the process dictated by the govern- ation, Franklin Templeton Investments ment. Ms. Fraser stressed the need for a unified cross- This panel focused on the prospects for tax re- border framework for swaps regulation, as funds trad- form and the potential impact on the mutual fund in- ing in multiple regions are currently required to com- dustry and fund investors. ply with multiple sets of requirements that are not Opportunity for Tax Reform. The panel began aligned. She noted that the G20 leaders agreed that with an overview of the post-election composition of derivatives regulation is important to a well- Congress and the presidential administration and the functioning market and agreed on a general overall prospects for enacting tax reform. Mr. Odintz noted regulatory framework, but that significant cross-border that, while Republicans hold 52 seats in the Senate, issues remain. As an example of the misalignment, they do not have the 60-vote “supermajority” needed she noted the fact that the cutoff time for posting vari- to defeat a filibuster. In addition, he said that despite ation margin is T+1 under the EU rules and T+0 in the the Republican majority in the House of Representa- . Ms. Jordal agreed that if a cross- tives, Speaker Ryan will need to simultaneously man- border framework is not implemented, a fund’s ability age both a divided Republican caucus and his some- to trade globally may be hampered. Mr. Goggins times-turbulent relationship with President Trump. Mr. added that conflicting jurisdictional requirements Gerson then observed that no one has yet been nom- could result in regional trading with higher risk con- inated for the position of Assistant Secretary for Tax centration, which would be contrary to the intent of the Policy, and that the person that fills this role will likely Dodd-Frank Act. be a key player in passing tax reform. In concluding the panel, the panelists reiterated The discussion also focused on the process for that, while there are multiple bills moving through passing comprehensive tax reform. Mr. Gerson noted Congress that could potentially impact derivatives that whether there is sufficient time to complete com- prehensive tax reform in 2017 very much depends on

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the timing of the effort to “repeal and replace” the Af- ipates releasing an outline that will address tax rates, fordable Care Act (ACA). He said that the House international tax reforms and plans to grow jobs. No Ways and Means and Senate Finance Committees other details have been provided, and the outline is are involved in both the ACA and tax reform, and not expected to discuss how to pay for the proposal. much time and political capital may well be spent Mr. Odintz went on to summarize some of the completing health care legislation, leaving less time key provisions of the House “Blueprint,” which was and energy for tax reform. released by House Republicans in June 2016 and is The panel noted that Senate Democrats have currently viewed as the base document for tax reform. been silent regarding their views, making the likeli- With respect to individuals, he said that the House hood of comprehensive tax reform uncertain. It was Blueprint would, among other things, reduce the top also noted that, in the absence of obtaining 60 votes individual tax rate to 33%, provide for a 50% exclu- to defeat a potential filibuster, a tax reform bill can be sion for capital gains and dividends, and eliminate passed using the budget reconciliation process, which, itemized deductions other than for charitable contribu- because the process is not subject to a filibuster, re- tions and mortgage interest. For businesses, the quires only a 51-vote majority. The panel noted that House Blueprint proposes to reduce the top corporate this would eliminate the need to negotiate with Senate tax rate to 20%, allow for full expensing, and eliminate Democrats, but support of the entire Republican cau- the deduction of business interest expense. Several cus would need to be maintained. Using the reconcil- changes would be made in the international arena as iation process would mean that the bill could not be well, including deemed repatriation of foreign earnings amended, providing less opportunity for compromise (with an 8.75% tax rate on cash and cash equivalents to address taxpayer concerns. It was also noted that, and a 3.5% rate on non-cash investments), repealing because legislation passed through this process could the controlled foreign corporation (CFC) rules, and not increase the deficit outside the ten-year budget adding a new border adjustment mechanism (border window, provisions of the legislation that would so adjustment tax) to exempt exports and tax imports. increase the deficit would expire after ten years (ab- Ms. Shaneyfelt then turned to the impact of tax sent subsequent legislative action), creating uncer- reform on the investment management industry. She tainty for taxpayers. Mr. Gerson said that, in the cur- said that the impact of the border adjustment tax on rent environment, there is significant bipartisan funds, for example, was unclear. She said that U.S. agreement on some items, but the parties are likely funds that have custodians or advisers abroad pre- too far apart on other items to complete bipartisan sumably cannot deduct fees paid to such service pro- comprehensive tax reform. viders, and it is unclear how dividends and interest Current Tax Reform Proposals & Effect on the from non-U.S. companies would be taxed. In addition, Fund Industry. Mr. Odintz provided an overview of the repeal of the CFC rules would implicate funds’ President Trump’s tax plan, which includes a cut in investments in non-U.S., wholly-owned subsidiaries. tax rates for all brackets and would permit businesses Ms. Shaneyfelt said that, while the proposed low- to expense (i.e., deduct) new business investments. er tax rates generally would be favorable for invest- That plan also would impose a 10% tax rate on repat- ment managers, the ultimate effect of tax reform de- riated earnings. He said that the administration antic- pends on a variety of factors particular to each firm.

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For example, if a U.S. investment manager hires an SESSION 4-C offshore service center to provide services in the U.S., the investment manager would not receive a deduc- Surviving the Aftershocks: Fund Distribution After tion for the related expense. On the other hand, a the DOL’s Seismic Fiduciary Rulemaking U.S. investment manager that advises an offshore Moderator: Linda M. French, Counsel, Securities fund would not be taxed on the management fees Regulation, Investment Company Institute received and would still be able to deduct its expens- Speakers: Judith R. Hogan, Senior Vice President es. More generally, the panel noted that the House and Associate General Counsel, MFS Investment Blueprint does not specifically address financial ser- Management vices, and, thus, the effect on funds and investment Eric S. Purple, Partner, Stradley Ronon Stevens & managers is not clear. Young, LLP Taxation of Derivatives & Regulated Investment James G. Whetzel, Vice President and General Company (RIC) Modernization II. Ms. Gibian dis- Counsel, USAA cussed proposed changes regarding the taxation of Rana Jewel Wright, Assistant General Counsel, Bank derivatives. Proposals over the last two years have of America Merrill Lynch all provided that derivatives be marked to market and that any resulting gain or loss be ordinary. She said The panel discussed the background of the that a discussion draft released in May 2016 on which DOL’s fiduciary rule, the fund industry’s reactions to the ICI commented also proposed a new investment the fiduciary rule, relevant SEC staff guidance with hedging unit regime, which is intended to simplify the respect to new share class offerings and the future of straddle rules. The panel noted that derivatives tax the competitive landscape under the rule. reform is expected to be folded into broader tax re- Fiduciary Rule Background. The panel first re- form. viewed various elements of the fiduciary rule, includ- Ms. Gibian then stated that the ICI is considering ing the “Best Interest Contract” exemption (the BIC whether it makes sense to pursue a “RIC Mod II” to exemption), which is designed to permit certain types achieve RIC-specific legislative changes. For exam- of compensation that would otherwise be prohibited if ple, such a proposal could include (i) permitting RICs advisers and financial institutions meet specific re- to use net operating loss carryforwards, (ii) making quirements. Mr. Purple noted that the definition of income from commodities qualifying income and (iii) “recommendation” under the fiduciary rule was broad fixing certain excise tax provisions. and that many intermediaries would be considered The panel concluded with predictions on the pas- “fiduciaries” under the rule and, thus, prohibited from sage of tax reform. The panelists all believe that receiving compensation for covered recommenda- some form of legislation will be passed this year, but tions absent an exemption (such as the BIC exemp- the content of such legislation is unclear. tion). Industry Reactions to Fiduciary Rule. Ms. Hogan stated that there have been a multitude of reactions to the fiduciary rule since it was finalized and that finan- cial intermediaries have been making numerous and

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evolving requests for changes in the share class ker-dealer when, as agent on behalf of its customers, and/or sales charge structures of the funds offered on the broker-dealer charges its customers commissions their platforms. Mr. Whetzel noted that his firm has for effecting transactions in “clean shares” of a fund taken a “wait and see” approach in light of the recent- (i.e., a share class without any front-end loads, de- ly-proposed 60-day delay in the applicability date of ferred sales charges or other asset-based fees for the rule, but that his firm is ready to comply with the sales or distribution). The panel noted that the no- fiduciary rule requirements if and when they take ef- action letter took no position with respect to whether a fect. Ms. Wright noted that her firm has proceeded broker-dealer’s receipt of revenue sharing payments under the assumption that the fiduciary rule will take would prevent it from relying on the letter and that effect in its current form and that her firm has an- more guidance in this area could be helpful. nounced its intention to terminate the sale of any Future of Competitive Landscape. The panel funds offered on its platform that do not have an ap- concluded with a discussion of the panelists’ views on propriate share class structure in place. the future of the fund industry competitive landscape The panel also discussed the recent launch of under the fiduciary rule. Ms. Hogan said that she Class T shares by numerous fund complexes. Mr. believed the industry would undergo a share class Purple said that he believed that the growth of Class rationalization, with relatively small, poorly-selling T shares was the collective result of industry efforts to share classes being eliminated. Ms. Wright con- create a single share class that could be responsive curred and noted that her firm had also begun a ra- to the varying business demands of numerous finan- tionalization effort with respect to fund offerings on its cial intermediaries. platform. Mr. Whetzel stated that he believed that the SEC Staff Guidance on New Share Classes and fiduciary rule would lead to greater simplicity and “Clean Shares.” Mr. Purple stated that, in December transparency in the retail product environment. of 2016, the SEC’s Division of Investment Manage- ment issued a Guidance Update titled “Mutual Fund Fee Structures” that focused on disclosure issues and procedural requirements arising from funds offering intermediary-specific variations of their sales loads and funds offering a new share class. He explained that, according to the guidance and subject to several conditions, the SEC staff would not object if sales load variation disclosure applicable to multiple inter- mediaries were included in an appendix to a fund’s prospectus. The panel then discussed the January 11, 2017 SEC staff no-action letter to Capital Research and Management Company. Mr. Purple said that, in the letter, the SEC staff confirmed that the restrictions of Section 22(d) of the 1940 Act do not apply to a bro-

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SESSION 5-A dors that perform services that are critical to an or- ganization’s business and vendors that have access Crashing the (Third) Parties: Mitigating Risk to the organization’s intellectual property and/or other Through Service Provider Oversight proprietary information. Moderator: Matthew Thornton, Assistant General Vendor Diligence Process. The panel also exam- Counsel, Securities Regulation, Investment Company ined what the vendor diligence process entails, un- Institute derscoring the importance of considering whether a Speaker: Canise Arredondo, Senior Vice President, vendor shares the firm’s goals and values, examining Risk Management and Chief Compliance Officer, The how a vendor invests in sustaining the capabilities Capital Group Companies, Inc. that the firm has hired (or will hire) it to perform, and Joseph A. Carrier, Chief Risk Officer, Legg Mason, understanding whether and to what extent the vendor Inc. sub-contracts services to “fourth-party providers.” Rhonda K.R. Cook, Director, Third Party Risk Man- Ongoing monitoring of a vendor, the panel noted, agement, SEI should include tasks such as adherence to service level agreements, performance quality, market infor- This panel examined the importance of vendor mation and news regarding the vendor and quality of monitoring and risk management in the context of the vendor relationship. Periodic reviews, which both business continuity and operational effectiveness should be done as frequently as the vendor’s risk of a fund complex. profile would suggest, may include tasks such as Importance of Monitoring Vendors. Mr. Thornton know-your-customer and anti- explained that, while eliminating all vendor-related risk screening and evaluation of financial stability. De- may not be practicable, thoughtful and diligent vendor pending on the results of the periodic monitoring, the risk management can reduce a fund complex’s level panel noted that a firm may wish to ask the vendor for of risk in several areas. Mr. Carrier, highlighting the more information in order to determine whether the importance of vendors, noted that, if a service fails, vendor continues to be a good match for the firm. fund shareholders may hold the fund complex, and Collaboration with Peers. The panel then dis- not the vendor, accountable. In other words, Mr. Car- cussed issues associated with peer collaboration re- rier stated, while firms can outsource the activity, they garding vendors and their performance of services. cannot ultimately outsource the responsibility. Ms. Arredondo said that, if many firms in the industry Oversight of a Vendor and Proportionality to Risk. use one vendor for a particular service, collaboration The panel discussed how vendors’ risk profiles and among these firms can be a good way to stay ap- their criticality to operations vary widely and advised prised of the risks and other issues that the vendor that a firm’s oversight over a particular vendor should faces. Ms. Cook also noted that, where many firms be proportional to the risk that the vendor presents. use the same provider, it is important to understand For example, Ms. Cook said that firms may want to whether, in the event of a service disruption, the ven- closely examine and monitor vendors that have ac- dor would simultaneously recover services for all of its cess to protected information, vendors that have ac- clients or whether there would be a pecking order and, cess to systems that can move cash or funds, ven-

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in the latter case, where in that order your organiza- unrealized gains/losses (since the payments relate to tion would fall. open contracts that could change in value) or realized gains/losses (since the payments are settlement SESSION 5-B payments rather than margin). Mr. Giordano con- firmed that the SEC staff would not object to either Mind the GAAP: Accounting and Auditing Update approach, although he believed treating such pay- Moderator: Gregory M. Smith, Senior Director, Fund ments as unrealized gains/losses made the most Accounting and Compliance, Investment Company sense. Institute FASB Updates. Ms. Dorsey described a pro- Speakers: Michael Barkman, Partner, Ernst & Young posal under consideration by the Financial Accounting LLP, Chair, AICPA Investment Companies Expert Standards Board that would define “materiality” for Panel purposes of financial statement disclosure in accord- Stephanie Dorsey, Senior Vice President, Fidelity ance with the standard articulated by the U.S. Su- Investments preme Court for federal securities law purposes (sig- Matthew Giordano, Chief Accountant, Disclosure Re- nificantly altering the “total mix” of information made view and Accounting Office, Division of Investment available). Management, U.S. Securities and Exchange Com- Ms. Dorsey also explained a recent change to the mission accounting treatment for premium amortization on purchased callable debt (under ASC 310). She said This panel discussed recent accounting devel- that, previously, such amounts would be measured on opments related to mutual funds from the SEC staff, the basis of yield to maturity but that, under the new the AICPA Investment Companies Expert Panel, the practice, they would be measured on the basis of Financial Accounting Standards Board and the Public yield to first call. She clarified that this treatment ap- Company Accounting Oversight Board. plied only to debt with stated calls (and not, for exam- Accounting for Cleared Swaps. Mr. Barkman ple, to asset-backed securities). discussed a paper the AICPA Investment Companies Auditor Reporting Model. Mr. Barkman described Expert Panel recently submitted to the SEC regarding a proposal by the Public Company Accounting Over- the accounting treatment for cleared swaps. He said sight Board that would require a description of critical that two swaps clearinghouses – the CME and the audit matters in audit opinion letters. He explained LCH – recently revised their rulebooks to provide that that audit letters for registered investment companies mark-to-market payments with respect to cleared were not covered by this requirement, because it was swaps are treated as settlement payments, rather understood that, under typical circumstances, the only than as variation margin payments. He noted that this critical audit matter for such entities would be valua- change makes the treatment of such payments for tion. He noted, however, that audit opinions for busi- cleared swaps under clearinghouse rules similar to ness development companies would have to include the treatment for mark-to-market payments for futures. this information under the proposal. Mr. Barkman explained that the paper described two SEC Staff Comments on Financial Statements. possible accounting approaches for such payments – Mr. Giordano explained that the SEC staff was aiming

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to standardize comments on financial statements for third month of each fiscal quarter will be made public- mutual funds. He noted that, in the short term, this ly available on a 60-day lag. Mr. Chanda then dis- effort had led to an increase in the typical number of cussed new Form N-CEN, noting that it replaces comments on fund financial statements but that he Form N-SAR as an annual report due 75 days after a expected, over the long term, it would decrease the fund’s fiscal year end. He stated that Form N-CEN number of comments. He also said that the SEC staff requires certain census-type information, including was taking a risk-based approach to review of finan- information about reliance upon certain rules under cial statements, looking at whether fund investments the 1940 Act and exemptive orders. He noted that conformed to the fund’s policies and disclosure. He Form N-CEN will require detail on securities lending also noted that he expected the SEC staff would issue arrangements, lines of credit and interfund lending, as an FAQ with respect to the recent amendments to well as share reprocessing information (which is not Regulation S-X. currently available in SEC filings). Mr. Chanda also commented on amendments to Regulation S-X that SESSION 5-C will require enhanced reporting on derivatives. Mr. Krawitz then discussed how the SEC’s Divi- Are You Ready for Some Fun(d Reporting)? Im- sion of Economic and Risk Analysis (DERA) will use plementing the SEC’s New Reporting Moderniza- the data collected from these filings, noting that en- tion Rules hanced data collection will assist DERA in identifying Moderator: Kenneth C. Fang, Assistant General risk trends and outliers. Mr. Krawitz stated it is likely Counsel, Securities Regulation, Investment Company that the SEC staff will look for “event-focused” trends, Institute and that the SEC’s Office of Compliance Inspections Speaker: Rajib Chanda, Partner, Simpson Thatcher and Examinations (OCIE) will use these analytics in & Bartlett LLP determining which registrants are examined. Mr. Jacob D. Krawitz, Branch Chief, Investment Company Krawitz noted that the Staff expects that Form N- Regulation Office, Division of Investment Manage- PORT will be a “game changer” in terms of identifying ment, U.S. Securities and Exchange Commission and assessing trends from a risk perspective. He Stephen P. Van Meter, Chief Compliance Officer, commented on the SEC’s analytical capabilities, and Federated Investors, Inc. noted that the Staff uses a natural language tool to review data in addition to its review of numbers. Mr. Chanda discussed the enhanced reporting Mr. Van Meter then discussed the new reporting requirements adopted by the SEC in October 2016. requirements from an issuer’s perspective, and de- Mr. Chanda discussed new Form N-PORT, noting scribed the resources that will be needed for a large that it requires detailed portfolio holdings information fund complex to handle these new filings. He noted on derivatives, repurchase and reverse repurchase that fund complexes will be looking to their service agreements, securities lending activities, portfolio- providers – custodians, transfer agents and adminis- and position-level risk analytics, total return and flow trators – for assistance. He discussed the pros and information. He noted that Form N-PORT will be filed cons of engaging external service providers for cer- 30 days after each month end, and the filing for the tain reporting metrics versus building those capabili-

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ties in-house. In this regard, he noted that the use of GENERAL SESSION external providers would likely help with the scalability of the filings, but noted that in-house capabilities Building Successful and Ethical Teams would likely yield other benefits, as the data, once Speaker: Nancy B. Rapoport, Special Counsel to the collected, could be analyzed and used for internal President of UNLV, Garman Turner Gordon Professor risk-metric assessments. In the end, he noted, it is a of Law, William S. Boyd School of Law, Affiliate Pro- question of resources for most fund complexes. Mr. fessor of Business Law and Ethics, Lee Business Van Meter then commented on the challenges posed School by Form N-PORT for those complexes that use multi- ple sub-advisers, noting that reports for sub-advised Ms. Rapoport discussed the role of teamwork in funds will require extensive coordination. building an ethical culture, what gets in the way of Messrs. Chanda and Van Meter then commented teamwork, cognitive errors and their effects on collab- on board considerations with regard to the data that is oration and ethical conduct and the effect of incen- being compiled and reported to the SEC. The panel tives on ethical behavior. discussed an adviser’s responsibility to notify a board Teams vs. Groups. Ms. Rapoport contrasted the when the adviser realizes that a fund is an outlier. effectiveness of groups and teams, observing that Messrs. Chanda and Van Meter noted that boards often workplaces are organized into groups rather may be asked to consider increases in fees paid to than teams. She cited benefits of an organized team service providers due to the increased workload relat- structure, where it is clear to each team member what ing to the enhanced reporting requirements. Mr. Van he or she is expected to contribute toward the com- Meter discussed the role of an adviser’s disclosure mon goal, in contrast to a group structure, where review committee, citing the increase in volume of group members might achieve a common goal but reports that such committees will have to review once with each individual working on his or her own project the new reporting requirements go into effect. without understanding fully his or her role in the con- The panel then discussed the general timeline for text of the rest of the group. She explained that, compliance with the new reporting requirements. Mr. when a team is too large, it is often difficult for each Krawitz noted that the staff will issue FAQs, and that team member to understand each member’s role and the ICI is gathering questions from industry partici- what he or she is expected to bring to the team. pants for the staff’s consideration. Mr. Krawitz urged Obstacles to Effective Teamwork. Ms. Rapoport attendees to submit questions to the ICI. then focused on the importance of trust among team In conclusion, the panel noted that there is con- members and the question of what gets in the way of sensus that the information sought to be gathered by effective teamwork. She described five key concerns the new reporting requirements is crucial to the SEC’s (i) the absence of trust (e.g., being unwilling to speak mission, and that registrants will work through imple- up when one disagrees with the direction of the team mentation issues. because of a lack of trust that others will listen to or respond well to the person who voiced the concern), (ii) fear of conflict, (iii) lack of commitment, (iv) avoid- ance of accountability and (v) inattention to details.

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To form effective teams, she stated that it is important GENREAL SESSION for a team to consist of members working on these five potential problems and to have a leader who un- Alert Level Red, Yellow, or Green: Where to Focus derstands how to form a team, who provides effective in the Current Environment feedback and who is willing to warn or dismiss some- Moderator: Tamara K. Salmon, Associate General one from the team when he or she is not being a good Counsel, Securities Regulation, Investment Company teammate. Institute Keys to Ethical Teams. Ms. Rapoport cited as Speaker: Kathleen T. Barr, Independent Trustee, keys for forming strong and ethical teams the follow- William Blair Funds ing five factors (i) diversity of approach, viewpoint, Joseph A. Carrier, Chief Risk Officer, Legg Mason, experience and skills, (ii) using a hub-and-spoke Inc. model to avoid having too many people working on Andrew J. (“Buddy”) Donohue, Former Director, Divi- the same problem, (iii) clear direction from the top sion of Investment Management, Former Chief of about the team’s purpose and expectations of each Staff, U.S. Securities and Exchange Commission team member, (iv) constant monitoring to ensure the Thomas J. Fuccillo, Managing Director and Chief team is functioning well without intrusive micro- Regulatory Counsel, Head of Funds and Retail Legal, management and (v) tone from the top. Allianz Global Investors U.S. Holdings LLC Ms. Rapoport explained that cognitive disso- Philip L. Kirstein, Senior Officer and Independent nance (e.g., talking yourself into believing that some- Compliance Officer, Alliance Bernstein thing was acceptable even though it was not) and Nancy M. Morris, Managing Director and Chief Com- social pressures, including peer pressure from one or pliance Officer, Wellington Management Company a small number of people on a team, can lead to un- LLP ethical team behavior, but awareness of those con- Robert P. Scales, Former CCO and General Counsel, cerns can help mitigate risk. She also explained that Columbia Acorn Funds, Principal, Robert P. Scales, it may be possible to encourage team members to LLC engage in more ethical behavior through the use of incentives, but it is important to be thoughtful and In the final session of the conference, panelists aware of what incentives are already in place in an were asked to express their level of concern with re- effort to avoid unintentionally inciting negative behav- spect to certain topics pertinent to the fund industry. ior. She cited the power of praise and symbolic sto- Continued SEC Action with Respect to Distribu- ries told as part of an organization’s cultural lore to tion in Guise. The panel generally agreed that there influence behavior. She also noted that removing an was moderate concern with respect to the SEC staff’s entitlement generally hurts significantly more than the continued actions in this area. Ms. Morris indicated, benefit realized by bestowing a new entitlement. however, that she harbored little concern because industry participants have addressed the SEC staff’s concerns by, for example, revising their policies and procedures. The panel also discussed whether more

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SEC investigations could be forthcoming and agreed Regulatory Uncertainty in Current Political Envi- that there was some concern in this regard. ronment. Panelist reactions on this topic ranged from SEC Rules on Liquidity Risk Management and a moderate to high level of concern. Mr. Fuccillo not- Data Reporting. The panel’s reaction was mixed on ed that, while there is considerable political discussion this topic. Mr. Fuccillo indicated that, while the indus- regarding , given various hurdles associ- try knows what the rules require, significant work will ated with actually effecting regulatory changes, it is be required to comply with the rule. Mr. Donohue uncertain when, if ever, such deregulation may occur. added that the required liquidity data was important Mr. Donohue suggested that the Director of the Divi- for the SEC to be an effective regulator but acknowl- sion of Investment Management could focus on set- edged that the rules are enormously complex. Mr. ting an agenda that focuses on lessening burdens on Carrier countered that the data will have limited utility. fund boards and reducing the length of disclosure Mr. Donohue also noted that the SEC staff may pro- documents, initiatives that the SEC staff has been vide publicly, in a manner similar to Form PF data, working on for some time but has yet to implement. aggregated data reports that may be beneficial. Vendor Reliance and Oversight. Panelist reac- SEC Data Security. The panel’s reaction was tions on this topic ranged from a moderate to a high mixed on this topic. Mr. Donohue stated that the is- level of concern. Ms. Barr highlighted her belief that sue has reached highest levels at the SEC. Messrs. boards need to better understand the services provid- Fuccillo and Kirstein noted their belief that the oppor- ed and suggested board visits to service providers to tunity to access industry-wide data in a single data- broaden their understanding. Mr. Donohue suggest- base will make the SEC’s database too attractive to ed that firms need to better understand the risks of hackers and others looking to attack the United States vendor failures and have plans for dealing with such via its capital markets. Ms. Morris suggested that the risks. Mr. Carrier noted that glitches will happen and SEC should provide some transparency into its sys- that the standard for oversight should be reasonable tems and processes to provide some comfort. care. Department of Labor Fiduciary Rule. Ms. Morris Impact of Proposed Tax Reforms. The panel’s noted her belief that, even if the fiduciary rule were to reaction regarding proposed U.S. tax reforms was be significantly revised or repealed, it may continue to mixed. Most of the panelists felt that the industry have a significant impact because so much work has could handle any regulation that is likely to be prom- already gone into compliance and that business mod- ulgated. Mr. Fuccillo noted that, with a Republican- els have already adjusted. Mr. Donohue countered controlled Congress and a Republican President, it that he believed that there was bias built into the rule was hard for him to imagine any final tax regulations against commission-based compensation and that the that would be significantly detrimental to the industry. rule was accelerating changes that would have al- Ms. Barr, however, noted that certain rumored chang- ready occurred absent the rule. es may lead to negative consequences, such as re- Movement to T+2 Settlement Cycle. The panel ducing retirement savings if the exemption for income generally expressed a low level of concern with re- and capital gains within qualified retirement accounts spect to the SEC’s proposed rule that would shorten were to be eliminated. the standard securities transaction settlement cycle.

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Ransomware. The panel expressed a high level of concern regarding the proliferation of “ransomware,” which involves the encryption of data by hackers who prevent owner access until payment of ransom. Mr. Scales noted the potentially heightened effect of the- se attacks on smaller firms that may have more lim- ited backup systems. Use of Robotics and Artificial Intelligence in Fund Operations. The panel reaction was mixed on this topic. Mr. Carrier noted that, while there may be ear- ly-stage questions around implementation, the use of artificial intelligence in fund operations should prove beneficial to the industry over the long term. The concerns noted by the panelists included oversight of this technology and the potential that it may give rise to unforeseen complexities.

2017 ICI MUTUAL FUNDS AND INVESTMENT MANAGEMENT CONFERENCE | Page 32

The following lawyers attended the conference or contributed to the preparation of this report:

Edward Baer John M. Loder Counsel—San Francisco Partner—Boston +1 415 315 6328 +1 617 951 7405 [email protected] [email protected]

Dalia Blass Brian D. McCabe Counsel—Washington, D.C. Partner—Boston +1 202 508 4664 +1 617 951 7801 [email protected] [email protected]

Sarah Clinton Brynn Rail Partner—Boston Counsel—New York +1 617 951 7375 +1 212 596 9194 [email protected] [email protected]

Timothy F. Cormier George B. Raine Counsel—Boston Partner—Boston +1 617 951 7747 +1 617 951 7556 [email protected] [email protected]

Tim Diggins Rita Rubin Partner—Boston Counsel—Chicago +1 617 951 7389 +1 312 845 1241 [email protected] [email protected]

Leigh R. Fraser Adam M. Schlichtmann Partner—Boston Partner—Boston +1 617 951 7485 +1 617 951 7114 [email protected] [email protected]

Pamela Glazier Jeremy C. Smith Partner—Boston Partner—New York +1 617 951 7420 +1 212 596 9858 [email protected] [email protected]

Thomas R. Hiller James E. Thomas Partner—Boston Partner—Boston +1 617 951 7439 +1 617 951 7367 [email protected] [email protected] OUR OFFICES WORLDWIDE

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