SEC hints at expanding scope of 'investment adviser' to include index providers

By Anne Sherry, J.D.

The SEC is exploring whether certain “information providers” meet the definition of an investment adviser and thus are subject to the registration requirements and other regulations of the ’40 Acts. Specifically, the Commission issued a request for comment on the nature of activities performed by index providers, model portfolio providers, and pricing services. Chair Gary Gensler said that index funds have evolved to a degree that an index provider can influence users of the index to buy or sell securities, which raises questions about how the SEC can best protect the public (Request for Comment on Certain Information Providers Acting as Investment Advisers, Release No. IA-6050, June 15, 2022).

The request for comment cites the growth in both size and scope of index providers, model portfolio providers, and pricing services. According to the SEC, the evolution of these “information providers” has transformed the asset management industry. The information providers may have the status of investment advisers under the Investment Advisers Act, implicating questions of Advisers Act registration and related questions about whether an information provider is acting as an investment adviser of an investment company under the Investment Company Act.

The SEC highlights the ways in which the three types of information provider may act as investment advisers:

• Index providers typically determine the market the index measures, designs the index, creates the methodology, and determines the index’s level under that methodology—activities that leave room for significant discretion. The request for comment observes that while indexes tend to be associated with passive investing, index providers make active design decisions, particularly in the case of specialized indexes. “Whether or not an index is specialized, the index provider’s inclusion or exclusion of a particular security in an index drives advisers with clients tracking that index to purchase or sell securities in response.”
• Model portfolio providers or model originators design allocation models, update or rebalance allocations over time, and provide customization. The SEC notes a growing demand for specialized models focusing on particular industries or strategy, like sustainability or ESG. Model portfolio providers also might tailor their analysis to the characteristics and goals of a general client type or create a customized analysis when creating a model portfolio through the use of direct indexing.
• Pricing services exercise significant discretion, according to the SEC: determining a valuation methodology to use, developing model templates, determining inputs, adjusting valuations; and addressing pricing challenges raised by users. Different pricing services, or even the same pricing service, may determine different pricing levels for the same security.

Under the Advisers Act, an investment adviser is someone who meets three criteria: (1) the person provides advice, or issues analyses or reports, concerning securities; (2) the person is in the business of providing such services; and (3) the person provides such services for compensation. The advice does not have to relate to specific securities, the SEC notes, and does not have to be the primary business activity of the adviser.

The SEC also posits that the activities conducted by information providers may implicate related concerns under the Investment Company Act, which contains requirements and restrictions in investment advisers to a fund. Index providers could meet the definition of an adviser to a fund under the Investment Company Act if the index is tailored to the specific needs of a fund.

Gensler said that the request will help the SEC determine which information providers fall under the investment adviser definition. Registered funds that track indexes have over $10 trillion of assets under management and range from broad-based indexes to specialized funds designed for particular users. The corresponding influence means “an index provider’s decision to include a particular security in an index often influences users of the index to purchase or sell securities,” raising questions about whether the index provider is providing investment advice, Gensler said. Model portfolio providers and pricing services have also grown and evolved, raising questions about the SEC’s oversight and investor protection.

The request seeks comment on whether information providers are acting as investment advisers and how existing rules should apply to providers that do not currently fit neatly into the existing regulatory structure. Gensler said that given the changes in the asset management field since the bulk of SEC staff statements were issued in the 1980s and 1990s, “it is appropriate to seek comment on information providers to consider if regulatory action is appropriate. Some elements of the definition may not be interpreted consistently by market participants. Thus, I believe the market may benefit from further guidance with respect to their applicability to some information providers.”

The comment period will remain open for 60 days after the request was published on sec.gov or 30 days after it is published in the Federal Register, whichever is longer.

This is Release No. IA-6050.