On Friday, Thomas Vartanian, Chair of Dechert LLP's Financial Institutions practice, submitted a comment letter "respond[ing] to the SEC's request for comments on behalf of certain clients by comprehensively criticizing the methodology, operating predicates and lack of factual or legal support for the Office of Financial Research's Report on Asset Management and Financial Stability (Report)." Vartanian says, "On behalf of certain clients of our Firm, we appreciate the opportunity the Securities and Exchange Commission ("Commission" or the "SEC") has provided for public comment on the report issued by the U.S. Office of Financial Research ("OFR") entitled "Asset Management and Financial Stability" ("Report"). We sincerely appreciate the efforts of the SEC to invite public participation in this process, which has so many important ramifications. The leadership demonstrated by the SEC will be essential to increasing the understanding of asset management in the regulatory community and analyzing any potential regulatory policies in a rigorous, objective and transparent manner."
He writes, "We submit for the SEC's consideration that the Report is fundamentally flawed in many respects and analytically unreliable. In this comment letter, we focus on the flaws in the Report regarding its assessment of risks that may be applicable to U.S. registered, floating net asset value ("NAV"), open-end investment companies ("Funds") and their investment advisers."
The Dechert comment explains, "The analysis in this comment may be summarized as follows: 1. Neither the Financial Stability Oversight Council ("FSOC") nor the OFR have laid the proper legal foundation to use the Report for its intended purpose to help the FSOC better understand asset management, any threats that may arise from it, any need for additional regulation, and whether any such regulation should involve the designation authority under Section 113 of the Dodd-Frank Act ("DFA") or an alternative response. 2. Reliance on the Report will taint the administrative record and provides a basis for companies to challenge designation and other regulatory actions that attempt to rely on the Report, including any recommendation for regulatory action such as any final FSOC proposed recommendations to the SEC regarding the regulation of money market funds ("MMFs")."
It continues, "3. The Report has significant and substantive factual, analytical, and methodological defects that render it completely unreliable and insufficient to form the basis of any policy determinations. 4. It paints the widely diverse asset management industry with the same brush, and draws conclusions about risks as if the industry were a monolith, failing to differentiate adequately between different investment vehicles, structures, strategies, and entities, which is essential to measuring, modeling and drawing any meaningful conclusions regarding individual vulnerabilities and systemic risks. 5. It ignores that: a. Investors purchase shares of a Fund with the understanding that the potential for poor investment performance, including the loss of principal, is a natural and well-understood risk; b. Investors do not rely on the financial strength of the investment adviser of a Fund; and c. Volatility and fluctuation of a Fund's NAV are normal market features, and not inappropriate risks that require extraordinary regulation and supervision."
Vartanian adds, "6. The Report's concerns regarding asset management risks are based on unsupported arguments, speculation or theories that investors will conclude that Funds are engaged in undisclosed "reaching for yield" or "herding" behavior, which will trigger rapid redemptions by the shareholders who learn of such behavior. 7. It fails to provide any substantiation or sufficient data to support its speculation that Funds are subject to significant redemption risk, or that "runs" on Funds would cause or amplify systemic risk. 8. By only acknowledging limited aspects of the SEC's comprehensive and well-tested legal and regulatory regime governing Funds, contractual limitations and basic economic realities and then proceeding with speculative discussions of risks as if none of these factors would have any impact, the Report, does not adequately take into account the myriad inherent structural safeguards that significantly mitigate the risks about which it speculates."
He tells the SEC, "9. It fails to consider the stability and resiliency Funds demonstrated during the very economic crisis that led to the creation of the OFR and the FSOC, which shows that they are viewed by investors as long-term investment vehicles and strongly suggests that the risk mitigating factors described in the preceding point are effective. 10. The Report views the asset management industry unrealistically and improperly through a prudential regulatory lens that is calibrated to the proprietary risk-taking activities of banks or insurance companies, rather than the activities and purposes of the asset management industry, and ignores the fundamental difference between the role played by asset managers acting as agents for investors, as opposed to principals."
Dechert writes, "11. The Report suffers from a range of administrative defects and attempts to identify and measure risks before establishing basic definitions and metrics that the public can evaluate and use. 12. The SEC should act to ensure that its extensive understanding and regulatory perspective in regard to the asset management industry is utilized to (a) correct the fundamental defects in the Report and (b) help the FSOC better understand asset management, any threats that may arise from it, any need for additional regulation, and the appropriate form of any such regulation."
Finally, the comment says, "The Report's stated purpose is to respond to the request of the FSOC for the OFR to provide data and analysis that would inform the FSOC's analysis of whether and how to consider asset management firms for enhanced prudential standards and supervision under Section 113 of the DFA. The Report does not achieve its stated purpose. In fact, it seriously misstates the risks it discusses, or simply fails to provide adequate empirical support or analysis to substantiate those which it purports to identify. Reliance on the Report by the FSOC will taint the administrative record and provide a basis for challenging any designation actions by the FSOC that rely upon it."
