By Amanda Maine, J.D.
During a special meeting of the SEC’s Asset Management Advisory Committee (AMAC), members unanimously approved a preliminary recommendation of its Operations Panel to expand the use of digital tools to comply with certain Commission regulations relating to the delivery of documents, remote work, and digitized methods of authorization. In the first months of the pandemic, the Commission and FINRA had provided temporary relief from regulations requiring mail delivery, physical presence for supervision and testing, and manual notarization and signature requirements. The AMAC recommended permanent regulatory changes to these rules that will outlast the duration of the pandemic.
Digital delivery. The AMAC recommended that the SEC update its rules and interpretations to permit firms to use an investor’s digital address (such as an email or smart phone telephone number) as the primary address when delivering regulatory documents. It should also amend its rules to replace "written notification" or notification "in writing" with a requirement to "furnish" or "provide" documents.
In the recommendation, the AMAC noted that there is a long-term trend of greater use of digital communications and increased investor preference to receive documents and brokerage information electronically versus paper sent through the mail. The COVID-19 pandemic only increased this movement towards digital, the committee stated. It also said that from a customer identity protection standpoint, mailed paper documents have the disadvantage of having to be disposed of compared to a document stored on a financial institution’s secure website. In addition, the potential for mis-delivery and theft of information is greater with paper delivery as it can be dependent on third parties for printing and delivery.
Remote work. The AMAC also recommended that the SEC work with FINRA to modernize internal inspection requirements to provide firms with the flexibility to conduct remote technology-assisted inspections and to revise its office registration and inspection requirements. The SEC should also coordinate with the North American Securities Administrators Association (NASAA) and FINRA to make remote testing capabilities permanent for securities licenses and make permanent exemptive relief from the in-person voting requirements for mutual fund boards.
Noting that the pandemic triggered an unprecedented shift to "work from home" for financial services employees, the AMAC recommended that the SEC work with FINRA to allow member firms to conduct remote inspections for 2020 and 2021. It also stated that video conferencing tools can be used to conduct inspections and that technical advancements allow firms to supervise employee and customer activities remotely. In addition, AMAC noted that FINRA and NASAA used a successful online testing service pilot and recommended that it remain a permanent option for firms even post-pandemic.
E-authorizations. The AMAC recommended that the SEC adopt rules to digitize methods of authorization, including those relating to manual wet signature requirements and notarizations. According to the recommendation, online video software technology and remote notaries have been well-used during the pandemic and effectively took the place of a physical presence requirement. In addition, electronic authentication can also provide an additional layer of security through the use of two-factor authentication or audit trails, which might make them even more reliable than manual processes, AMAC stated.
Dematerialization. Finally, the AMAC called for the SEC to hold a staff roundtable about dematerialization of paper security certificates. The recommendation notes that the costs to process physical certificates has increased, with many of these costs borne by investors. The SEC should seek input from issuers, transfer agents, broker-dealers, clearing corporations, banks, investors, regulators, exchanges, underwriters, and industry experts at this dematerialization roundtable.
Discussion. SEC Chairman Jay Clayton said that COVID-19 provided a "real-time stress test" for asset managers and other market participants on their ability to operate remotely while complying with regulatory requirements that were designed for an environment with vastly different operational characteristics. He remarked that the Commission last substantively addressed electronic delivery over 20 years ago. "Our regulations should not cling to the mails and paper as the default or preferred paradigm for communications," Clayton advised.
Commissioner Hester Peirce also welcomed the recommendations for laying the foundation for a more flexible, technology-based regulatory structure, rather than doing so in an ad hoc manner through temporary exemptive relief. Peirce also posited that firms should be able to tell new customers clearly and in advance that they are a "digital-only" firm without paper documentation. It would then be up to the potential customer to give their business to the firm, she explained.
AMAC member Mike Durbin of Fidelity Institutional said that Peirce’s idea might result in an asymmetry depending on whether the "digital-only" designation applied to new clients or a current client opening a new account. In that case, it should probably be anchored around clients or households rather than accounts, he said.
Neesha Hathi of Charles Schwab said that her firm probably would not embrace the idea that customers wouldn’t have a choice to stick with paper but added that newer firms may want to go in that direction. For existing customers, firms could notify legacy accounts that they would be switching to digital on a certain date, and customers opposed to the change could let the firm know their opposition. AMAC Chairman Ed Bernard of T. Rowe Price agreed that with proper notice, many legacy accounts could be transitioned to fully-digital.