In its recent Request for Comment on Certain Information Providers Acting as Investment Advisers (the Request for Comment), the U.S. Securities and Exchange Commission (SEC)1 asks whether innovative investment indices, model portfolios, and pricing services are forms of regulated “investment advice.” If so, providers of those services—i.e., “information providers”—may need to register as investment advisers under the Investment Advisers Act of 1940 (Advisers Act).
When viewed in tandem with a proposed rule regarding the use of service providers by investment advisers,2 the Request for Comment suggests that the SEC is poised to assert Advisers Act jurisdiction more deeply into the financial technology (fintech) industry. As a result of these regulatory developments, fintech companies may need to rethink whether they are subject to registration and/or regulation under the Advisers Act.
Together, the two releases signal that becoming an investment adviser could be a much more significant undertaking than it has been in the past, and in particular that investment adviser regulation is moving closer to broker-dealer regulation.
Potential Regulation of Information Providers
The Request for Comment specifically seeks feedback from industry participants on whether certain information providers should be regulated as investment advisers under the Advisers Act. The Request for Comment describes three main categories of information providers:
- Index providers, who “compile, create methodology for, sponsor, administer, and/or license market indexes.”
- Model portfolio providers, who “design allocation models, providing various degrees of customization and offer such information on a discretionary or non-discretionary basis.”
- Pricing services, who provide “prices, valuations, and additional data about a particular investment.”
Traditionally, information providers have, for the most part, fallen outside Advisers Act regulation. In the Request for Comment, however, the SEC suggests that increased sophistication and customization of information products should require providers to be subject to additional oversight. This could limit the ability of information providers to rely on exclusions they have typically used to stay out of regulation, including the Advisers Act “publisher’s exclusion” and a series of SEC staff no-action letters excepting the developers of certain types of investment “calculators.”
Implications for Reliance on the Publisher’s Exclusion
Information providers have often relied on the “publisher’s exclusion” of Section 202(a)(11)(D) of the Advisers Act, which excludes any “publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation.” In Lowe v. SEC,3 the U.S. Supreme Court stated that publishers are excluded as long as the publication “(i) provides only impersonal advice; (ii) is ‘bona fide,’ meaning that it provides genuine and disinterested commentary; and (iii) is of general and regular circulation rather than issued from time to time in response to episodic market activity.”
A significant reason behind the publisher’s exclusion is that covered publishers do not provide tailored advice. As a result, their advice does not implicate the fiduciary relationship an investment adviser has with its clients, which the Advisers Act is designed to regulate.4
In this context, standard index providers such as S&P, NASDAQ, and Dow Jones; news services and data providers like Bloomberg and Morningstar; and the publishers of investment-focused newsletters, blogs, or other services have not typically registered as investment advisers.
The Request for Comment notes that many new business models have arisen since the Lowe decision. This is particularly true in the fintech arena, which has provided (among many others) innovations like the following:
- innovative indices or model portfolios built in collaboration with clients and/or using proprietary data and algorithms,
- services that use alternative forms of data such as market sentiment from social media to build securities indices or pricing predictors, and
- modeling services that use technologies such as artificial intelligence to improve their models on an ongoing, dynamic basis.
Users of these products may themselves be regulated investment advisers or broker-dealers, and they may be individual investors.
In many ways, some information provider services may have moved far beyond the traditional activity of “publishers.” As a result, the SEC is considering whether it is appropriate to subject information providers to additional oversight.
Additional Implications for Guidance on “Calculators”
Outside Lowe, some information providers rely on a long line of SEC staff guidance on whether and when software and other technologies (often referred to as “calculators”) used to analyze investments and the markets involve investment advice. Under this guidance (the “calculator no-action letters”), these technology providers must analyze a variety of factors to determine when they are providing advice:
- whether the information used in the software is readily available to the public in its raw state,
- whether the categories of information presented are highly selective,
- whether the information is or is not organized or presented in a manner that suggests the purchase, holding, or sale of any security or securities,
- the sophistication of users,
- the degree to which users themselves perform the calculations,
- the degree to which the product is pre-packaged and not personalized for each customer, and
- whether the calculations or models are based on traditional or standard calculations.5
Developments in technology can make it difficult for providers of software and similar services that operate as information providers to rely on the calculator no-action letters. For example, platforms may use innovative methodologies to categorize securities held by investors as “overvalued” or “undervalued,” which may implicitly suggest that the user should sell or buy the security. Other platforms may center their entire value proposition around sophisticated, proprietary software, and algorithms that are significantly more advanced than those discussed in the calculator no-action letters.
In many cases, there is almost no way for average investors to understand exactly what the technology does or how it produces its results, much less replicate those results on their own. The complexity, sophistication, and innovation of some products may call reliance on the calculator no-action letters into question.
In addition, to the extent these information providers can currently rely on the no-action letters,
it is possible that regulatory changes based on the issues raised in the Request for Comment will overturn the guidance and bring those companies into the SEC’s jurisdiction. As a result, companies in this space should closely monitor any regulatory changes affecting their status.
Takeaways
The SEC’s interest in index providers is not new. In a 2018 speech, for example, then-Director of the Division of Investment Management Dalia Blass suggested revisiting the status of certain index providers that are currently exempt from regulation as investment advisers. The Request for Comment suggests that the SEC may be ready to develop and implement these proposed changes.
Given the increased focus on information providers, companies providing sophisticated services in this space should consider whether they can in fact reasonably fall within the publisher’s exclusion or the relief described in the calculator no-action letters.
Even if information providers do currently fit within one of these exemptions, the SEC may expand its reach or supersede existing relief with new rulemaking. As a result, information providers should monitor regulatory changes in this area.
For additional information, please contact Amy Caiazza, Neel Maitra, or Mara Alioto, or any member of the fintech and financial services practice.
[1] Request for Comment on Certain Information Providers Acting as Investment Advisers, SEC Release Nos. IA-6050; IC-34618 (File No. S7-18-22), available at https://www.sec.gov/rules/other/2022/ia-6050.pdf (the “Request for Comment”).
[2] Outsourcing by Investment Advisers, SEC Release Nos. IA-6176 (File No. S7-25-22), available at https://www.sec.gov/rules/proposed/2022/ia-6176.pdf. (The rule proposal would prohibit investment advisers from outsourcing “covered functions” without conducting due diligence and monitoring of the service providers. “Covered functions” are defined as “(1) those necessary for the adviser to provide its investment advisory services in compliance with the Federal securities laws; and (2) those that, if not performed or performed negligently, would be reasonably likely to cause a material negative impact on the adviser’s clients or on the adviser’s ability to provide investment advisory service.” The rule proposal notes that “covered functions” would include, among others, services related to providing investment guidelines, creating and providing models related to investment advice, creating and providing custom indexes, providing investment risk software or services, providing portfolio management or trading services or software, providing portfolio accounting services, and providing subadvisory services.)
[3] Lowe v. SEC, 472 U.S. 181 (1985).
[5] See, e.g., EJV Partners, L.P., SEC Staff No-Action Letter (Mar. 25, 1996).