Dangers of the Unbounded Administrative State

Commissioner Mark T. Uyeda. Image Credit: US SEC

Remarks to the Council of Institutional Investors

March 5, 2024/US SEC

By Commissioner Mark T. Uyeda

Thank you for the invitation to address the Council of Institutional Investors, whose members are responsible for combined assets under management of nearly $5 trillion.[1] They include pension plans obligated to act prudently when investing the savings of millions of workers and their families to provide retirement benefits. Council members include state and local government pension plans, which are important to secure the retirement promise made to individuals who have provided a lifetime of public service. It is a promise that I am quite familiar with. As a former California state securities regulator, I am a member of the California Public Employees’ Retirement System (CalPERS). I am also the son of a retired community college instructor, whose retirement has been made possible by the California State Teachers Retirement System (CalSTRS).

When one compares the investment holdings of CalPERS or CalSTRS to the holdings of the Federal Thrift Savings Plan (TSP) or a target date fund in a 401(k) plan, one will notice a significant difference: defined benefit plans often have an allocation to private funds while the others do not. There may be reasons for investing in private funds, such the potential for higher risk-adjusted returns, increased diversification, and the ability to better match anticipated cash outflows from the plan. However, for the average worker who invests through a 401(k) plan or an individual retirement account, it is nearly impossible to obtain exposures to a diversified portfolio comparable to CalPERS and CalSTRS even if he or she does not expect to retire for 30 years or more. As returns in the public markets become more closely correlated, regulators should be thinking about whether investors might be better served with more opportunities to diversify – such as exposures similar to those held by pension funds.

Private Fund Adviser Rules

Recently, the Commission has finalized several rules impacting private funds and their advisers, which will impact pension plans and other institutional investors.[2] One significant rulemaking was an integrated package of reforms for private fund advisers (the “Private Funds Rules”), that included quarterly fund statements, mandatory fund audits, procedures for adviser-led secondaries, restrictions on certain activities, and prohibitions on certain preferential treatment.[3] The Council supported the rules’ provisions on fee and expense disclosure as well as performance disclosure.[4] More recently, the Council joined an amicus brief in support of the final rules, expressing the view that they would address harms resulting from the imbalance of power between advisers and institutional investors and the information asymmetry around the conflicts that can result.[5]

While I understand that the Council might be pleased with the results of the rulemaking, some caution about the Commission’s statutory authority to promulgate such rules may be in order. The Commission relies on an expansive view of Section 211(h)(2) of the Investment Advisers Act of 1940 (“Advisers Act”). This provision was added by paragraph (g) of Section 913 of the Dodd-Frank Act under the heading of “authority to establish a fiduciary duty for brokers and dealers.”

Section 913(g) contained parallel provisions amending both the Securities Exchange Act of 1934 (“Exchange Act”) and the Advisers Act to authorize the Commission to impose a fiduciary standard of care for brokers, dealers, and investment advisers. Section 913(g) also included parallel provisions, codified in Section 15(l) of the Exchange Act and Section 211(h) of the Advisers Act, directing the Commission to “examine and, where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and the protection of investors.”[6]

By ignoring the context provided by Section 913, the Commission’s broad reading represents a significant jurisdictional extension. Section 913 does not mention private funds, but focuses on brokers, dealers, and investment advisers. It does not make sense that Congress would use Section 913, which was part of Title IX of the Dodd-Frank Act, to regulate private fund advisers when Congress specifically addressed them in Title IV of the Dodd-Frank Act. Should we believe that Congress omitted any authorization to regulate private funds in this manner in Title IV, but included an obscure authorization in Section 913(g)?

Over-reaching assertions of government jurisdiction is a problem for all market participants. When contemplating the administrative state, persons should be concerned if there is no practical limiting principle on the scope of an agency’s authority and the dangers associated with that method of governance.

Section 211(h) has three important components: (1) sales practices, conflicts of interest and compensation schemes; (2) investors; and (3) brokers, dealers, and investment advisers.

The first component is “sales practices, conflicts of interest, and compensation schemes.” These areas can be broadly construed. In the capital markets where every participant has its own self-interest, conflicts of interest are everywhere. Nearly any form of communication can be deemed a sales practice and any payment can be part of a compensation scheme. The Investment Company Act of 1940 – which regulates registered investment companies (RICs) – already contains provisions that address sales practices,[7] conflicts of interest[8] and compensation schemes.[9] Does Section 211(h) allow the Commission to superimpose the provisions of the Investment Company Act onto the Advisers Act for non-RICs? Read broadly, Section 211(h) could permit the Commission to prohibit or restrict any type of advisory activity that might fall into these categories. For example, could Section 211(h) be used to prohibit or restrict the ESG activities of a fund, because it involves a sales practice, conflict of interest, and/or compensation scheme? Could Section 211(h) be used for government mandated price caps on funds?

The second component is investors. The Commission argues that Section 211(h) makes no distinction between retail investors and institutional investors. What are the implications of this assertion? If it means that entities such as private funds, which are statutorily excluded from regulation under Sections 3(c)(1) and 3(c)(7) of the Investment Company Act,[10] can be indirectly regulated through the Advisers Act, then why wouldn’t the same argument apply to other excluded funds? After all, the Private Funds Rules require providing investors with fund-level – not adviser-level – disclosures such as quarterly statements about private funds adviser compensation, fund fees and expenses, and performance,[11] and audited financial statements.[12] For instance, could the Commission use Section 211(h) to regulate church plans[13] excluded by Section 3(c)(14) of the Investment Company Act? What about collective investment trusts that are excluded by Section 3(c)(11) of the Investment Company Act? What about private pension plans that are also excluded by Section 3(c)(11)?

The third component is brokers, dealers, and investment advisers, though I will focus only on investment advisers. Section 211(h) does not differentiate among Commission-registered investment advisers, state-registered investment advisers, and investment advisers exempt from registration. The National Securities Market Improvement Act of 1996 (“NSMIA”) provides that the states cannot impose substantive regulations on Commission-registered investment advisers,[14] but is silent on the Commission’s ability to impose regulations on state-registered investment advisers. Does Section 211(h) give the Commission the authority to regulate state-registered investment advisers? Section 203(b) provides a list of “investment advisers” who need not register. This list includes advisers to insurance companies,[15] advisers to charitable organizations,[16] commodity trading advisers registered with the Commodity Futures Trading Commission (CFTC) whose business does not otherwise consist primarily of acting as an investment adviser,[17] and advisers to small business investment companies and rural business investment companies.[18] Can the Commission now regulate these advisers under Section 211(h)?

Thus, the purported reach of Section 211(h) under the Commission’s approach appears to go beyond what Congress intended given the context of Section 913. For the Commission’s jurisdictional claim to be valid, Congress must have intended Section 211(h) to be a blank check that subsumes the other federal securities laws, which I find implausible.

Definition of Dealer

The Commission’s broad assertion of jurisdiction is not limited to private funds. The Commission’s recent rule on dealers has many market participants asking the question – are they dealers? The heart of the rulemaking was whether liquidity providers, like proprietary trading firms without customers, were dealers because they provided a function similar to market making. The Commission answered affirmatively. Pension plans might take comfort that under the rule, they are unlikely to be dealers because they are not regularly posting bids and asks at or near the market price. But the Commission also made it clear that just because a person does not fall within the rule’s definition as a dealer, that person still could be a dealer under the statutory definition.[19]

The Exchange Act defines a dealer to mean any person engaged in the business of buying and selling securities for such person’s own account through a broker or otherwise.[20] There is an exception for any person who conducts such activities “not as part of a regular business.”[21] But isn’t it part of the regular business of a pension plan, a mutual fund, an exchange-traded fund, a collective investment trust, and a charitable endowment, to buy and sell securities? Indeed, the final dealer rule recognizes that investment companies registered under the Investment Company Act might fall within its scope and thus provided a specific exclusion for them. However, while excluding registered investment companies, the final rule did not exclude private funds, investment advisers, collective investment trusts, and pension plans.

What is the limiting principle on who is a statutory dealer? For the statutory definition, liquidity provision or market making are irrelevant. In fact, the Commission has launched enforcement cases against numerous entities for being statutory dealers, even though they had no customers and bought and held securities for relatively lengthy periods of time before selling.[22] While it is unclear how these court cases will turn out, and one court of appeal recently ruled in favor of the Commission’s view,[23] what is clear is that the guidance released by Commission staff in 2008,[24] which lists a number of factors to consider when determining whether a person is a dealer, did not and would not have put these types of entities on notice of their requirement to register as dealers.

Historically, one limiting principle has been that dealers have customers. Since the adoption of the Exchange Act, the terms “broker” and “dealer” have generally referred to the method by which a securities business effectuates customer securities transactions. However, that no longer appears to be a requirement in the eyes of the Commission. The new dealer rule fails to provide a definitive test to determine dealer status. With no limiting principle, how does an institutional investor know that they are not a dealer? After all, institutional investors are in the regular business of buying and selling securities. At the very least, institutional investors may need to have policies and procedures to make regular determinations as to their status as a dealer.

Cryptocurrencies and the Definition of a Security

There is one more area where there appears to be no limiting principle – what constitutes a security under the investment contract test in Howey, which has arisen for cryptocurrencies and digital assets. Under Howey, an investment contract exists when there is an investment of money in a common enterprise with the expectation of profits based on the managerial efforts of others.[25] Council members are likely not invested in crypto or digital assets, so why should they be concerned about how the Commission defines a “security”? However, the Commission’s approach to this analysis for cryptocurrencies and digital assets has been that any item sold whose value is based on the efforts of others is a security. In September 2023, the Commission found that the purchase of a digital image via a non-fungible token (NFT), the proceeds from which was used to finance the creation of an animated series was an investment contract, even though only those users who had purchased the digital image could gain access to watch the content.[26] This broad reading of Howey would appear to scope in many common transactions in the non-digital world, including pre-purchase commitments, collectibles, art, and land.

For example, based on the Commission’s broad interpretation – could real estate be considered a security? Many real estate holdings of pension plans are not raw land. They often are projects with development rights, zoning rights, and permits, among other things. Also, let’s not forget that the original Howey case involved orange groves. Under the broad definition of an “investment contract” being applied to the crypto space, could those interests in real estate be deemed as securities? If so, does your real estate broker also need to be registered with FINRA? Does your real estate appraiser have to be registered as an investment adviser? What about commodities holdings? Should they be treated as securities?


In conclusion, market participants need to know when their conduct implicates the securities laws and when it does not. The Commission’s broad jurisdictional claims in Section 211(h), the definition of “dealer,” and the definition of “security” without any practical limiting principle should be concerning for all. The Commission was designed by Congress to have a degree of independence from the political process. In return, the Commission’s jurisdiction is limited to only those areas specifically authorized by statute.

Our capital markets have historically thrived because, absent a statutory or regulatory restriction, market participants are able to act without government approval in advance or fear of enforcement without proper notice. The rise of the administrative state presents a challenge to this historical norm. When a regulator can, without practical limitation, promulgate, interpret, and enforce rules and guidance, including retroactively, the temptation to be arbitrary in the exercise of administrative power and enforcement can be great.

I look forward to having a continuing dialogue with the Council and its members in the years to come. Hopefully, you won’t need to change the name of your organization to the “Council of Institutional Dealers and Investors.” Thank you and enjoy the rest of your morning.

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