As required by Section 416 of the Dodd-Frank Act, the Government Accountability Office (the “GAO”) released a report (the “Report”) on the feasibility of forming a self-regulatory organization (“SRO”) to provide primary oversight of private fund advisers. In preparing the report, the GAO reviewed, among other things, (1) the SEC staff’s Dodd-Frank mandated study on its investment adviser examination program (discussed in the January 25, 2011 Financial Services Alert) and (2) past regulatory and legislative proposals to create an SRO for investment advisers. The GAO also interviewed members of the staffs of the SEC, existing SROs and other regulators, and various market participants and observers.
According to the Report, the general consensus among regulators, industry representatives, investment advisers and others was that forming a private fund adviser SRO while possible, would face several challenges. First, Congress would need to enact legislation to allow for the formation of such an SRO. Second, the SRO would face formation challenges and costs, including raising necessary start-up capital and reaching agreement on the fees to be imposed by the SRO and the SRO’s governance structure, as well as attracting, hiring and retaining qualified personnel. Given the principles-based approach of the Investment Advisers Act of 1940 (the “Advisers Act”) and related SEC rules, an SRO for private fund advisers would also face challenges in adopting the kind of rules-based approach to member regulation typically taken by SROs as a means of addressing the conflicts inherent in self regulation. According to the SEC staff and industry representatives, it would be difficult for a private fund adviser SRO’s rules to capture how the fiduciary duty principles that are the focus of Advisers Act regulation would apply in all possible circumstances.
The Report also found that, although a private fund adviser SRO could assist with the capacity challenges that the SEC currently struggles with in its oversight of investment advisers, a private fund adviser SRO’s jurisdiction would necessarily be limited to a fraction of all registered investment advisers since the majority of all registered investment advisers advise clients other than private funds. In this way, the formation of a private fund adviser SRO might do little to alleviate the SEC’s burdens as the SEC would still retain oversight of the majority of registered investment advisers as well as of the private fund adviser SRO itself. The Report cited the risk of fragmentation of investment adviser oversight and regulation in the event that a private fund adviser SRO were to create interpretations or rules inconsistent with SEC positions on the same matters. Regulators and industry representatives both expressed concern that limiting a private fund adviser SRO’s authority to private funds could make it difficult for the SRO to understand other aspects of an adviser’s activities that may affect its private funds.
The Report concludes by noting that other options for addressing the SEC’s adviser oversight capacity constraints – forming an SRO to examine all advisers and charging user fees to fund SEC examinations – also involve trade-offs.