Should Index Providers Be Regulated as Investment Advisers under the US Investment Advisers Act of 1940

Abstract

The increasing importance of the index industry to the financial marketplace has drawn the attention of the US Securities and Exchange Commission (SEC). The use of custom, foreign, and narrow-based indexes and self-indexing has generated regulatory concerns, including possibilities of improper index selection procedures, misleading index descriptions, inadequate or misleading custom index disclosures, and self-dealing. Suggested remedies include requiring index providers to register with the SEC as investment advisers under the Investment Advisers Act of 1940 (act). Historically, index providers have relied on an exclusion from registration under the act; this proposal queries their entitlement to rely on the exclusion. If index providers are required to register, it is unlikely that regulation under the act would prove useful. Rather, enhanced disclosure and the application of existing securities laws, including those dealing with disclosure and antifraud concerns, and current SEC investigative and enforcement activities in appropriate cases should be sufficient to deal with the SEC’s concerns.

TOPICS: Mutual funds/passive investing/indexing, information providers/credit ratings, legal/regulatory/public policy

Key Findings

• ▪ Regulatory concerns are focused on possible abuses occurring in connection with custom, foreign, and narrow-based financial indexes, as well as self-indexing procedures, used by ETFs. These abuses include improper index component selection procedures, index manipulation, misleading index descriptions, inadequate or misleading custom index disclosures, self-dealing and blurred functions between ETF advisers and third-party index providers when creating custom indexes.

• ▪ One suggested remedy is to deem index providers “investment advisers” under the Investment Advisers Act of 1940 (act). This result would deprive index providers of their current ability to rely on the act’s “Publisher’s Exclusion” and, therefore, require their registration with the US Securities and Exchange Commission (SEC), as well as subject them to the act’s regulatory provisions, including its fiduciary duties and obligations.

• ▪ It is likely that index provider regulation under the act would not provide satisfactory solutions to the SEC’s concerns but, instead, would cause disruptive effects in the current financial index ecosystem, such as increased investor costs and diminished product innovation. Rather, the application and enforcement of existing securities laws, especially those dealing with disclosure and antifraud concerns and current SEC investigative and enforcement activities, where warranted, should be sufficient to deal with the SEC’s concerns.