Over the last year, a considerable amount of attention has been given to reducing the regulatory burden, which is welcome. There is no doubt that addressing outdated, duplicative and unduly burdensome requirements benefits industry participants and investors alike. But, while progress has been made, there is still work to be done.
One area that continues to present an opportunity to reduce regulatory burden is the securities regulators’ requirement to report outside business activities.
While outside business activity rules are intended to identify activities that may impact a registered individual’s ability to act objectively, the accompanying guidance from the regulators is so broad and all-encompassing that it is difficult to understand what activities need to be reported.
Employment outside of the sponsoring firm, paid activities, acting as an officer or director, or being an insider of a public company are clear examples of activities that should be identified and understood if they are going to be permitted. However, the guidance goes further, identifying personal holding companies, rental properties and any position of power or influence. In fact, the requirement is broader than business-related activities, potentially including any activity where a registered individual may come in contact with a client or a potential client.
To complicate matters further, regulators have taken a disharmonized approach to the interpretation of their own guidance. Some regulators have tried to distinguish between activities that should be reported and those that should not. For example, coaching a child’s house league sports team does not need to be reported, unless it is a competitive team, at which point it might need to be reported.
Other regulators have taken the position that everything must be reported, leaving firms to wonder exactly what “everything” includes when considering activities in which a registered individual may come into contact with a client or potential client.
These unclear requirements are being interpreted inconsistently, resulting in an unnecessary regulatory burden. While the intent of the rule is certainly reasonable, the guidance raises more questions than it answers. Further, the practical application of the guidance is almost impossible, leaving registered individuals and firms uncertain and uncomfortable. It is our view that a risk-based approach is a better use of firm and regulatory resources than requiring the firm to report “everything.”
Although the rule does not intend to deter registered individuals from actively contributing to their local communities, this could effectively be the outcome. Absent a way to confidently apply the rule, some firms may simply prohibit any outside activities, which could include volunteering, coaching and mentoring.
It is time to return to first principles on outside business activities and apply a materiality lens. A clear list of those business-related activities that could result in a material conflict should be developed so that firms can be certain about their application of the rule. The remaining business-related activities should be left to the discretion of firms to manage in accordance with their conflict of interest policies and procedures. This approach aligns with the robust conflict of interest expectations set out in the client-focused reforms, which came into effect at the end of December.
Effective regulation must balance efficient and competitive markets with investor protection. In the case of outside business activities, the time and infrastructure required to comply with the rule, without any comfort in the result, are certainly not in line with a corresponding benefit to investors, communities or the capital markets.