SEC May Put Cap on Derivatives Exposure

The Securities and Exchange Commission is concerned that some mutual funds and actively managed and leveraged ETFs, in particular, may be investing too heavily in swaps and derivatives. If the staff determines that the investments are inconsistent with the leverage, concentration and diversification provisions of the Investment Company Act, it will cease granting exemptions going forward. Funds that already received exemptions would not be impacted, the SEC said.

The Commission recently issued an investor warning on leveraged ETFs, and advisors have responded by clearly explaining the risks involved with investing in leveraged ETFs beyond one day.

"Although the use of derivatives by funds is not a new phenomenon," said Andrew Donohue, director of the Division of Investment Management at the SEC, "we want to be sure our regulatory protections keep up with the increasing complexity of these instruments and how they are used by fund managers."

The SEC will also investigate whether funds with derivatives holdings maintain and implement adequate risk management, pricing and liquidity, and if their boards are providing appropriate oversight. Further, the SEC will examine whether prospectuses adequately address the particular risks created by derivatives. If necessary, the SEC will impose additional reporting requirements on such funds.

Fido to Advertise on iPad

Well ahead of Apple's iPad launch last Friday, advertisers were jostling for their places on the new tablet. Time magazine signed up Fidelity Investments, Unilever, Toyota Motor and three other leading companies, The Wall Street Journal reports. Each Time contract is worth $200,000 apiece. By comparison, The Journal has signed up six advertisers, including Coca-Cola and Federal Express, for a four-month advertising package for $400,000.

Advertisers are reportedly drawn to the interactivity, video, flash, social networking, navigation, touch technology, downloads and even games that can be embedded on the iPad. Conde Nast's Wired magazine, for instance, is offering different levels of this type of functionality to advertisers. For video, the magazine is asking advertisers to commit to eight ads in a single issue. The Journal did not indicate the pricing structure.

Rep-as-Adviser SMAs Up 29% Since 2007

The number of managed accounts in rep-as-adviser programs increased 29% from 2007 through year-end 2009, but because advisers are required to contact clients every time a change is made to these non-discretionary portfolios, managed accounts are inefficient, Cerulli says.

Thus, while SMAs are expected to continue to grow in the double digits in 2010, capacity and scalability will slow long-term growth, the research firm says. And not all programs will benefit equally. Take the market downturn. In that period, home-office programs, despite their penchant for diversification, took the hardest hit, while rep-driven programs thrived.

Technology Advances UMAs for High-Net-Worth

Along with turnkey asset management programs, which allow advisers to outsource functions such as manager research, portfolio construction and performance reporting in order to gain operational and cost efficiencies, unified managed accounts are gaining popularity.

Celent Research says UMAs are the fastest-growing segment in the managed account industry and are the future of managed accounts. Celent projects UMA assets will reach $327 billion by 2013, representing a compound annual growth rate of 35%.

Through these programs, there is automatic diversification so advisers don't have to worry about asset-reallocation, and both the adviser and the client are able to monitor the account in real time. Other benefits: the UMAs offer a wider choice of asset managers. Efficiencies help keep costs down for client and adviser. And advisers like the transparency the UMAs offer "because they can gain complete visibility on all their client's financial assets," according to Celent.

Not all overlay technologies have proven themselves equal, though. Technologies have improved, which have allowed UMAs to be used with more mass-affluent clients, but they still have room to improve even more.

Tom Steinberger, a senior vice president at Fiserv, said that as more wealth managers and banks move to an open architecture platform they need someone to "manage the managers."

"That's the next evolution of our business," he said during a recent discussion at the American Bankers Association conference in Phoenix. "Our technology allows for multiple managers and someone to oversee and take responsibility for what they are doing."

This is especially important for high-net-worth clients who tend to have many advisers who do not talk to one another. "We'll continue to see this technology evolve further," Steinberger said.

Fidelity Helps RIAs, B/Ds With Cost-Basis Reporting

New requirements from the Internal Revenue Service on cost basis reporting could present both challenges and opportunities for advisers and broker/dealers, according to a whitepaper from Fidelity Institutional Wealth Services.

Although the new requirements don't take effect until Jan. 1, Fidelity is encouraging advisers and broker/dealers to begin the process of incorporating the new rules into their current tax reporting workflow.

Outlined in the Emergency Economic Stabilization Act of 2008, the new regulations, which will be phased in over three years, will require B/Ds to report adjusted cost basis for "specific securities" on the annual IRS Form 1099-B. B/Ds will have to stipulate whether the holding periods of the disposed securities were short- or long-term. The regulations also establish requirements on how RIAs, B/Ds and their end clients handle cost basis for transfer of assets, short sales, wash sales and corporate actions.

These new requirements could mean additional costs to RIAs and B/Ds, as well as additional education for staff and clients.

"Firms certainly have to assess their internal systems," said Robert Adams, an EVP at Fidelity Institutional. "For instance, organizations that have not supported wash sell will have to now incorporate that. I do believe that there are changes that need to be made to front-end systems."

Adams said that Fidelity has been tracking costs basis for its customers through its tax lot accounting system for more than a decade. The whitepaper said that investors and tax preparers could face frustrations reporting gains and losses on both covered and non-covered securities when investors utilize more than one adviser or broker, or have assets at more than one financial institution.

Fidelity's clients are encouraged to promote their services "by emphasizing how easy it is to work with your firm" because they already have the technology in place to prepare a consolidated gain/loss report.

The industry is still awaiting clarifications from the IRS on some of its new requirements, Adams said. This includes rules pertaining to options reporting and alternative investments.

Fiduciary Standard Seen Solidifying Client Relations

Even though Senate Banking Committee Chairman Christopher Dodd (D- Conn.) introduced his financial regulatory reform without a key provision on the fiduciary standard, some industry observers who support a more stringent standard are cautiously optimistic that tighter reforms will be implemented.

It was Treasury Secretary Timothy Geithner's speech at the conservative think tank American Enterprise Institute that raised the hopes of some in the industry. He said that the Obama Administration will only pass a financial reform bill that provides strong protection for consumers and reigns in the risk taking that has run rampant on Wall Street in recent years.

David G. Coffaro, chief fiduciary officer at Wells Fargo, said in an interview that whether or not a fiduciary standard is legislated for broker/dealers, financial advisers can use the fact that they are fiduciaries to speak to investors about how holding their practice up to such a higher standard benefits investors.

The struggle for a stricter fiduciary standard is not going to end with Dodd's bill. Sen. Tim Johnson, (D-S.D.), has proposed that a study be conducted by the Securities and Exchange Commission "to determine appropriate obligations of brokers, dealers, investment [advisors] and their associated persons relating to the provision of personalized investment advice about securities to retail customers."

After the one-year study, the SEC will decide the rules around adviser and broker/dealer oversight.

In the long run, Knut Rostad, chairman of the Committee for the Fiduciary Standard, doesn't think the Dodd bill prevent a higher fiduciary standard.

(c) Copyright 2010 Money Management Executive and SourceMedia, Inc. All rights reserved.

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.