Tag: Risk

Opening Remarks at the 75th Anniversary of the Investment Company Act and Investment Advisers Act

Mary Jo White is Chair of the U.S. Securities and Exchange Commission. The following post is based on Chair White’s remarks on the 75th Anniversary of the Investment Company Act and Investment Advisers Act. The full text, including footnotes, is available here. The views expressed in this post are those of Chair White and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Good morning. Thank you for coming today [September 29, 2015], and welcome to the SEC, both those here in person and through our webcast. Before I say anything else, I would like to acknowledge staff from the Division of Investment Management for their hard work in putting this anniversary program together. In particular, kudos go to Director Dave Grim, Jennifer McHugh, Bridget Farrell and Jamie Walter. I also would like to thank my fellow Commissioners who are introducing the panels, and all of the stellar panelists who will be sharing with us their insights throughout the day.

Today, we celebrate 75 years of the Investment Company Act and the Investment Advisers Act—two pieces of legislation that came to shape the financial markets as we know them. And this event is more than an anniversary celebration—it is a day to reflect on this extraordinary regulatory system that has facilitated the management and growth of assets for millions of Americans and other investors from around the world. In these opening remarks, my assignment is to first take us on a brief historical tour and then come back full circle to today where we see just how powerful and alive these Acts are in the modern markets.

The Importance of Being Earnest About Liquidity Risk Management

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s recent public statement at an open meeting of the SEC; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The fund industry has witnessed substantial changes in recent years, including the rise of novel investment strategies, a growing use of derivatives, and an increased focus on assets that, traditionally, have been less liquid. Unfortunately, it appears that not all funds’ liquidity risk management practices have kept pace with these developments.

Today [September 22, 2015], the Commission considers proposing a set of rules and amendments that will help ensure that open-end investment companies—which include mutual funds and exchange traded funds—manage their liquidity risks in a prudent and responsible manner. The proposed changes will also help attenuate the dilution risks that confront long-term shareholders, and will give investors needed tools to monitor how well funds are managing their liquidity risk. These proposals are important, because they will adapt our decades-old liquidity regime to the fund industry’s new and vastly altered landscape. The proposals we consider today are especially timely, for at least two reasons. First, a study published just last night suggests that U.S. bond funds need to sharpen their methodologies for analyzing the liquidity of their portfolios, because their current methods might be inadequate. And second, a resurgence of volatility in the bond markets in recent months has, in concert with shifting market dynamics, thrust liquidity concerns in that space to the forefront.

These proposals are intended to foster a rigorous and analytically sound approach to liquidity risk management, while also helping investors to better gauge the ability of funds to fulfill redemption obligations.


Open-End Fund Liquidity Risk Management and Swing Pricing

Mary Jo White is Chair of the U.S. Securities and Exchange Commission. The following post is based on Chair White’s remarks at a recent open meeting of the SEC, available here. The views expressed in this post are those of Chair White and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The Commission will consider a recommendation of the staff to propose a new rule and amendments designed to strengthen the management of liquidity risks by registered open-end investment companies, including mutual funds and exchange-traded funds (or ETFs).

Regulation of the asset management industry is one of the Commission’s most important responsibilities in furthering our mission to protect investors, maintain orderly markets, and promote capital formation. The Commission oversees registered investment companies with combined assets of approximately $18.8 trillion and registered investment advisers with approximately $67 trillion in regulatory assets under their management. At the end of 2014, 53.2 million households, or 43.3 percent of all U.S. households, owned mutual funds. Fittingly, next Tuesday, we will reflect on our history of regulating funds and advisers at an event to celebrate the 75th anniversary of the Investment Company Act and the Investment Advisers Act.


Why University Endowments are Large and Risky

Thomas Gilbert is an Assistant Professor of Finance & Business Economics at the University of Washington. This post is based on an article authored by Professor Gilbert and Christopher Hrdlicka, Assistant Professor of Finance & Business Economics at the University of Washington.

Universities as perpetual ivory towers, though often meant as a pejorative, describes well universities’ special place in society as centers of learning with a mission distinct from that of businesses. Universities create new knowledge via research while preserving and spreading that knowledge through teaching. The social good aspect of universities makes donations critical to funding their mission. But rather than investing these donations internally to build the metaphorical towers higher and shine the light of learning more widely, universities have built large endowments invested heavily in risky financial assets.

In our paper, Why Are University Endowments Large and Risky?, forthcoming at The Review of Financial Studies, we model how universities’ objectives, investment opportunities (internal and external) and public policy, specifically the Uniform Prudent Management of Institutional Funds Act (UPMIFA), interact to create this behavior. Our findings suggest a reevaluation of UPMIFA’s ability to achieve its goal of maintaining donor intent in light of the costs it imposes on universities.


Corporate Risk-Taking and Public Duty

Steven L. Schwarcz is the Stanley A. Star Professor of Law & Business at Duke University School of Law. This post is based on a draft article by Professor Schwarcz, available here.

Although corporate risk-taking is economically necessary and even desirable, it can also be harmful. There is widespread agreement that excessive corporate risk-taking was one of the primary causes of the systemic collapse that caused the 2008-09 financial crisis. To avoid another devastating collapse, most financial regulation since the crisis is directed at reducing excessive corporate risk-taking by systemically important firms. Often that regulation focuses on aligning managerial and investor interests, on the assumption that investors generally would oppose excessively risky business ventures.

My article, Misalignment: Corporate Risk-Taking and Public Duty, argues that assumption is flawed. What constitutes “excessive” risk-taking depends on the observer; risk-taking is excessive from a given observer’s standpoint if, on balance, it is expected to harm that observer. As a result, the law inadvertently allows systemically important firms to engage in risk-taking ventures that are expected to benefit the firm and its investors but, because much of the systemic harm from the firm’s failure would be externalized onto other market participants as well as onto ordinary citizens impacted by an economic collapse, harm the public.


Unfinished Reform in the Global Financial System

Lewis B. Kaden is John Harvey Gregory Lecturer on World Organizations, Harvard Law School, and Senior Fellow of the Mossavar-Rahmani Center on Business and Government, Harvard Kennedy School of Government. This post is based on Mr. Kaden’s paper, which was adapted from remarks delivered at Cambridge University on February 27, 2015 and at the Kennedy School of Government, Harvard University on April 9, 2015. The full paper is available for download here.

This paper offers a perspective on the challenges that the global financial system will face in the course of the next decade. While there has been significant progress since the financial crisis of 2007-2009 and the slow and uneven pressure of recovery and reform, a great deal of important work lies ahead. Part I briefly reviews, for the purpose of general background, the context and causes of the financial crisis. Part II identifies the key lessons to be learned from the crisis, and Part III outlines the major reforms adopted to date in the United States, Europe and the G-20. Finally, Part IV highlights what I regard as the principal ongoing issues affecting the financial system and suggests some approaches for dealing with them.


A Framework for Understanding Financial Institutions

Robert Merton is Professor of Finance at the MIT Sloan School of Management. This post is based on an article authored by Professor Merton and Richard Thakor, also of the Finance Group at the MIT Sloan School of Management.

Many financial intermediaries provide “credit-sensitive” financial services—the effective delivery of these services depends on the credit-worthiness of the provider. This potential sensitivity of the perceived value of the intermediary’s services to the intermediary’s credit risk has important ramifications. In the paper, Customers and Investors: A Framework for Understanding Financial Institutions, which was recently made publicly available on SSRN, we examine how this affects the design of contracts between intermediaries and their customers, and how it illuminates ubiquitous features in a wide variety of contracts, institutions, and regulatory practices.


Proposed Regulations May Affect Fee Waivers

David I. Shapiro is a is a tax partner resident at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank publication authored by Mr. Shapiro, Michelle GoldBrian Kniesly, and Christopher Roman.

The Department of the Treasury and the IRS have issued proposed regulations regarding “disguised payments for services” under Section 707(a)(2)(A) of the Internal Revenue Code. The proposed regulations appear to be primarily focused on management fee waivers (and similar arrangements), but could also affect certain aspects of the tax treatment of carried interest.

Management fee waivers are a planning technique seen mostly in the private equity fund industry, where a fund manager waives a share of its management fee in exchange for a share of future profits (that is separate from any carried interest otherwise payable), often in amounts that are intended to replicate the foregone management fees. Management fee waivers are generally intended to achieve certain benefits, including deferring the receipt of taxable income by the fund sponsor, allowing the fund sponsor to meet its capital commitment to a fund on a non-cash basis, and providing for potentially more favorable tax rates applicable to individuals (i.e., if the underlying share of profits is comprised of long-term capital gain). Management fee waivers have been utilized in different forms, over many years, including arrangements which effectively amount to a package of a higher carried interest and a lower management fee, as well as arrangements which are structured as annual elective waivers. Different arrangements vary in the manner and priority in which waived amounts are paid out of future partnership profit.


Outsourcing: How Cyber Resilient Are You?

Dan Ryan is Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Bruce Oliver, Roozbeh Alavi, Garit Gemeinhardt, Amandeep Lamba, and Joe Walker.

Cyber attacks on financial institutions continue to increase, both in number and impact. While the industry’s defenses against cyber criminals have been improving, recent high-profile breaches indicate that many cyber risk areas remain under addressed.

Regulators are particularly concerned that the industry’s third-party service providers are a weak link that cyber attackers can exploit. [1] Financial institutions have become increasingly reliant on the information technology (IT) services these providers offer, either directly through the outsourcing of IT or indirectly through outsourced business processes that heavily rely on IT (e.g., loan servicing, collections, and payments). [2] Regardless, banks remain ultimately responsible—they own their service providers’ cyber risks.


Chamber of Commerce Airs Grievances Related To Internal Controls Inspections

Jason M. Halper is a partner in the Securities Litigation & Regulatory Enforcement Practice Group at Orrick, Herrington & Sutcliffe LLP. This post is based on an Orrick publication by Mr. Halper and William J. Foley Jr.

In recent months, issues related to internal control systems and reporting have taken on an increased profile and significance. For example, as previously noted by the authors here and here, the SEC has sought to prioritize compliance with internal controls by initiating a growing number of investigations into companies based on allegations of inadequate internal controls.

By way of background, “internal controls” refers to the procedures and practices that companies use to manage risk, conduct business efficiently, and ensure compliance with the law and company policy. Public companies are required to maintain sufficient internal controls by the securities laws. In particular, Section 404 of the Sarbanes-Oxley Act (as amended by the Dodd-Frank Act) requires, among other things, that: (i) company management assess and report on the effectiveness of the company’s internal control over its financial reporting, and (ii) the company’s independent auditors verify management’s disclosures. Sarbanes-Oxley also created the Public Company Accounting Oversight Board (“PCAOB”) to oversee public company audits, including the audits of internal control reporting. The PCAOB, in turn, conducts regular inspections to ensure compliance with laws, rules and professional standards.


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