SEC eyeing collective investment trusts

Collective investment trust platforms have been around for decades, but the Securities and Exchange Commission is beginning to have questions about whether investors in the funds are sufficiently protected. The trust accounts, which allocate pooled assets to individual investment managers, are exempt from the Investment Company Act of 1940, removing the banks that sponsor them from the reach of the SEC. But Andrew “Buddy” Donohue, director of the agency's Division of Investment Management, said today that the commission is looking for ways to claim jurisdiction. “The collective funds are out there marketing [themselves] to advisers, saying ‘give us your clients, you manage and we'll provide the back-office,'” Mr. Donohue said at the Practising Law Institute's investment management program in New York. He added that the SEC “can't get into the bank, but I can get into the advisers. It's important for me to see if the banks are using their exemption properly … or merely renting a space [to advisers] inside a trust company.” Mr. Donohue said examining the trusts is a priority this year because the platforms are offering a growing array of investment choices and becoming increasingly popular as retirement plan investments. Assets in the vehicles grew from $780 billion in 1989 to over $1 trillion at the end of the second quarter of 2009, he said without attributing the source of the data. Asked by Barry Barbash, a former director of the commission's investment management division, whether he doubted the ability of bank regulators to enforce protections for individual investors, Mr. Donohue declined to comment. “I do like our regime,” he said of the SEC's emphasis on disclosure and other prophylactic practices. Mr. Donohue spent the bulk of his address outlining his concern about the way funds and other investment vehicles have increased their risk profiles through the use of derivatives. The agency recently put a moratorium on approving applications for exchange-traded funds that would invest heavily in derivatives, a move that Mr. Donohue does not take lightly. “We're aware that some people are waiting for exemptive relief while competitors” who already operate such funds are moving ahead, he said. Mr. Donohue said that at a minimum, the SEC hopes to offer short-term guidance in coming months on the use of derivatives, but said its full review could result in new rules, interpretive guidance, concept releases or a mix of those. On the subject of reforming money market rules to avoid another jolt to the financial system like the one caused by the Primary Reserve Fund's breaking of the buck in September 2008, Mr. Donohue said there are no “silver bullets.” Neither the Treasury Department nor the Federal Reserve system will again be able to take drastic measures to prop the funds up, he said. Turning to another issue of real interest to advisers and brokers, Mr. Donohue said the SEC will almost certainly this year propose modifications that will affect 12(b)-1 fees charged by sellers of mutual funds. The fees were initially approved to help funds offset the marketing costs of attracting new investors. Over the years, however, the fees have evolved into “a substitute for a sales charge,” said Mr. Donohue, noting that the SEC is partially responsible because it offered various forms of exemptive relief on such fees to funds. SEC Chairman Mary Schapiro has highlighted her concern about 12b-1 fees, and Mr. Donohue said his division believes it has a way of addressing the most serious abuses, in part through heightened disclosure requirements. The dual purpose of any new or modified rules will be to “improve the ability of people to know what they are paying for,” he said, and to ensure that they are not “continuing to pay a sales load for something they bought ten years ago.” “If I were a betting man,” Mr. Donohue said, “I would bet you'd see something on this in 2010.”