Industry regulators' latest priority: Making sure advisors are living up to their obligations under new rules requiring most securities transactions to be settled in a day.
The regulatory consultant ACA Group has heard from clients that the Securities and Exchange Commission has sent out letters asking for evidence of compliance with its
T+1 is aimed at promoting market efficiency and reliability and falls most heavily on the broker-dealers, custodians and exchanges that do much of the back-end work in trading. But it also comes with a bevy of new requirements for registered investment advisors.
Among other things, the rule calls for advisors to keep detailed records for a process in securities trading known as allocation, confirmation and affirmation. These procedures serve as a series of checks and balances meant to make sure buyers and sellers agree on all the details of a proposed trade and that the transaction is then completed as initially ordered.
The new T+1 rule requires advisors to keep detailed records, often including time and date stamps, for each confirmation, affirmation or allocation they receive from the broker-dealers they work with on securities trades. The SEC, according to ACA Group, is also interested in learning what general preparations RIAs have made for compliance with the new settlement requirements.
The role of RIAs
Carlo Di Florio, the global advisory leader at ACA Group, said advisors, who often place buy and sell orders on the behalf of their clients, play a crucial role in making sure trades are completed on time.
"The broker-dealers have a whole lot they've got to do, because they're the ones who kind of own T+1 trading, clearance and settlement and getting that all right," Di Florio said. "But what the SEC is concerned about is that if the advisors don't have their house in order with regard to allocation, confirmation and affirmation — and the ability to do all those quickly and, ideally, in an automated way — they could become a weak link in the chain."
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Karen Barr, the president and CEO of Investment Adviser Association, said she has also heard from members that the SEC has sent out exam letters seeking evidence of compliance with T+1. The IAA represents more than 600 fiduciary investment advisors and related entities.
Among the many things the SEC is looking for is documentation of the steps firms are taking to comply with the rule change.
"This was a heavy lift for investment advisors," Barr said. "They don't have the same extended requirements as other participants in the T+1 chain. But they had to engage in a lot of work to get ready for a smooth transition with T+1. And particularly operationally and in terms of documentation, everyone had to get their ducks in a row."
The SEC's risk alert
The SEC hasn't announced that it's examining firms for compliance with the T+1 rules, and a spokesperson for the agency said it doesn't publicly confirm it's conducting exams on any given topic. But the industry watchdog did telegraph the priority it's placing on the new rule with the release on March 27 of a
Advocates of T+1 generally contend that the less time a trade has to be completed, the less time there is for something to go wrong. The rule change is generally meant to reduce risk that the parties to a transaction won't be able to live up to their end of the bargain — either by not being able to produce a security that's to be sold or the money needed to buy it — after a trade order has already been entered.
T+1 was also meant to eliminate bottlenecks that can slow trading and to generally make the market more efficient.
"For everyday investors who sell their stock on a Monday, shortening the settlement cycle will allow them to get their money on Tuesday," SEC Chairman Gary Gensler said in a statement days before the rule took effect. "Shortening the settlement cycle also will help the markets because time is money and time is risk. It will make our market plumbing more resilient, timely and orderly."
What's on the exam
ACA Group said the letters the SEC seek a lengthy list of compliance evidence. Among other things, regulators are looking for proof that advisors have revised their allocation, confirmation and affirmation policies in keeping with the T+1 rule, firms' contracts with broker-dealers, and any communications on the new rule with clients, broker-dealers and custodians.
Regulators may also ask for a list of any third-party vendors that advisors have turned to for help complying with the T+1 rule. Di Florio said many small RIAs still do at least parts of the allocation, confirmation and affirmation process manually. The SEC would eventually like to see it all become automated through technology.
"And that's probably one of the areas they'll call out in their exams," he said.
Off-channel communications tops list of regulatory hot topics
With the T+1 rule still new, it did not top an
The SEC and the Commodity Futures Trading Commission have together imposed nearly $3 billion in fines on firms accused of breaching prohibitions on these sorts of "off channel" communications. The penalties started with some of
With the size of the fines and with no corner of the industry being left untouched, it's little surprise that proper uses of messaging services should be top of mind for advisors, Di Florio said. Off-channel communications and related surveillance were cited by 60% of the respondents to the ACA and IAA survey, which polled nearly 600 firms.
That put off-channel communications ahead of concerns about advertising and marketing, cited by 57% of the respondents to this year's survey but previously the No. 1 hot topic
AI makes an appearance
The real surprise to Di Florio, though, was to see 46% of the survey respondents list artificial intelligence and predictive analytics as the hottest regulatory topic. That put it ahead of cybersecurity (cited by 37% of the respondents), private funds (16%) and conflicts of interest (10%).
Di Florio said the concern about AI isn't just a result of the result of ChatGPT and similar systems having become the center of virtually every discussion of technological innovation in the past year and a half. It's also coming in response to regulatory action.
In March, for instance,
Amid all the scrutiny, Di Florio said he's found most firms are proceeding very cautiously with AI, if they're using it at all. He noted that only 2% of the survey respondents reported turning to AI to support investment decisions, and 64% said they have no plans to use the technology in any sort of client-facing way.
"What's great about the survey is that we've captured a moment in time when AI has just blown onto the scene," Di Florio said. "This year, it pops up as hot topic No. 3. But then we see less activity. By the time we do the survey next year, it'll be really interesting to see whether those numbers change significantly."
Barr said she thinks many advisors are trying out possible uses for AI, but perhaps not in ways that are immediately apparent to clients.
"Firms are thinking about it and talking about it and experimenting with it and piloting it on the back end," she said. "They're testing it out internally with operations and processes long before they think about client-facing applications."
