Episode 3: Welcoming the Podfather and New SEC Director of Enforcement

In this episode of Asset Management Corner, Andrew Dean and Chris Mulligan are joined by Patrick Hayes, the podfather of securities compliance podcasts. They discuss Patrick’s NSCP podcast; the SEC’s new Director of Enforcement and coming changes; a very active Division of Examinations; how SEC enforcement actions impact industry compliance and SEC examinations; and advisers’ focus on the retailization of private funds and artificial intelligence.

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Transcript

Andrew Dean: Hello and welcome back to Asset Management Corner. We are your hosts, I'm Andrew Dean. He's Chris Mulligan. We are partners at the law firm Weil. This is the podcast where we bring our experience as former senior SEC officials in the division of exams and Division of Enforcement and talk all things SEC and asset management. On today's podcast, lots discussed, including a new director of enforcement at the SEC.

Chris Mulligan: And to help us today, we're joined by the original podfather of securities compliance podcasts. Yes, Patrick Hayes, Patrick is well known in the compliance community. He's a partner at Calfee Halter. He's also chair of National Society of Compliance Professionals Board of Directors and has his own podcast on compliance issues across the compliance industry. I've been fortunate to be a guest on his podcast a number of times. And it's just fantastic to have him today to talk through some of the really important issues that are happening. So welcome.

Patrick Hayes: It is a pleasure to be here. Chris and Andrew and thank you very much. Although I will say Podfather, I think doth protest too much, but nonetheless very excited to be here and excited to dive into some exciting topics.

Chris Mulligan: So before we talk about some of the recent issues that have been coming out of the SEC and that we're observing in our own practices. I thought it just might be helpful to understand your podcast and what it covers and how it got started and how it informed your role and your legal practice and how it helps you.

Patrick Hayes: Yeah. No, thank you for that and certainly happy to share. Podcasting has always been kind of a love, a labor of love now, but a love of mine for a long time, getting involved with it. And I remember kind of talking with the National Society of Compliance professionals at one point about, you know hey, there's not really a podcast out there that's covering these kinds of topics, might that be something that the organization might be interested in doing, and those conversations kind of went on hiatus for a little bit. And then I remember watching one of the Super Bowls about 10 years ago and seeing for the first time one of those master class advertisements. And I thought that was so the violins. We're playing in the background and they were showing these experts in their fields and I just. Like I came alive with like enthusiasm about hey, like as my fellow legal and compliance moves on, this podcast can probably attest to how cool it would be if there was something out there, a personal master class for those folks that are in the kind of legal securities and compliance base and so. Ultimately, that that really was the inspiration. And so I went back. I talked with folks internally here at the firm, but that kind of developed over a long period of time and I really one of the things I love about it is that this there is this excellent community. Of folks that are out there in the legal and compliance base around the asset management and the investment management industry and it's really great to have that kind of community of people that can really dive into this stuff. Yeah, it was unexpected. I thought you were going to say now you can play the violin after watching the yeah, the twist.

Chris Mulligan: But that was a surprise ending to that story.

Andrew Dean: I'll just say just to under score this. So when I became Co chief of the Asset management unit at the SEC several years ago, my first ever panel that I was on in that position was with Corey Schuss. There it was, NSCP, and for folks who haven't been to these events, they are in these huge, huge rooms with giant screens behind the speakers, very intimidating. My first time Patrick was moderating, and when they were doing introductions, the crowd of like 1000 people, when they introduced Patrick, they just started hooting and hollering. And I was like, who is this? He's like a rock star amongst the asset management space. It was. It was fantastic. It was intimidating. It was a lot of fun and it was a very gracious moderator at that event.

Patrick Hayes: That that's a fantastic story. I would probably quibble a little bit with the amount of hooting and hollering that was going on, but nonetheless, I will say it's good that at least you know somebody is out there listening. Cause I will tell you and I you know, I I've shared this story with others before. I travel a lot with the podcast microphone. And so I'm constantly. Going in and out of airports. And you would never see how disappointed the security folks are. When I go through security and they see all my stuff and they're like, oh, that's cool. And they investigate it and then they're like, OK, this guy's, you know, seemingly legit. Right. And then they're like, oh, cool, you got that mic. What do you do? Like, I host a podcast. We're like, what about? And I'm like, securities. Compliance. They're like ohh like physical security like for the building. And I'm like no like about investments and other stuff and they immediately turn their head and forget that I existed. So it's good. It's good that there's somebody out there listening, I said.

Chris Mulligan: Patrick, next time say it's about the SEC and they'll just think it's about the Southeastern Conference football and then that'll be a lot better.

Patrick Hayes: Exactly. Exactly. Exactly.

Andrew Dean: Well, it's slightly more exciting news than Asset Management podcast. We have a new enforcement director at the SEC now. So on Thursday, August 21, the SEC announced that Judge Margaret Meg Ryan. Has been named director enforcement effective in September after the holiday, she comes to the SEC's a senior judge of the US Court of Appeals for the Armed Forces as best as we can tell, Judge Ryan has at least no recent securities law experience as the securities laws are not within the jurisdiction of the armed forces. Patrick, what do you make of the new? SEC enforcement director?

Patrick Hayes: Yeah, it's a really interesting pick. Honestly, I don't have a whole lot to really add, you know, substantively right now, but I am really interested to get to learn a little bit more about her background and pedigree. I'd actually be interested to know, you know, what you all think of the pick and any additional thoughts that that you have on her.

Andrew Dean: Yeah, I got a couple of reactions. So first of all, from what I hear, everything that I've heard so far has been very complimentary. Very smart, good colleague, well respected, not coming in with like, you know, her own agenda for things. I would say like on the more speculative side and thinking about what she's gonna do, I think she's gonna come in. I think she's gonna listen. I think there's a lot of people she can talk to you. I mean the same thing with when your. Beer. Great. Well, came and he. Came not from a real like strong like securities law background, but he came in and listened to people, you know. Look, I think we're gonna see some changes for sure. And that's, you know, coming from the top, they wanna see changes on the wells process. I think when the sea. You know, more guidance to staff, so there's consistency around well processed across matters. Those are just a couple of things that I foresee and you know while we're here to just a quick note of thanks and appreciate to a guy who had been serving the acting role during the transition, Sam Walden, he returns to his position as chief counsel of the division. You know, Sam, for anyone who's worked at the SEC. In the past decade, plus no Sam. And for those don't know that the chief counsel's office at the SEC and enforcement is the Council, they're the lawyers for the division of enforcement. And that's Sam to at he is a counselor. Someone who gives great advice, support to the staff. One of the nicest people you'll meet. Highly respected by the defense barn. Not sure what his plans are but he's one of those people who I think in the transition to Judge Ryan I think would be very helpful as a sounding board for some of the. Things that she wants to do going forward.

Chris Mulligan: Moving from division of enforcement to the division of exam, where we still have an acting director, Keith Cassidy, who is a longtime veteran of the division, we certainly saw some departures in the division of examinations, but I have to say, Patrick, that I am not seeing a slowdown at all on examinations. This spring and summer have been very, very busy focused on very complex issues, fee and expense. Issues we saw an enforcement action in this space on manage if the offsets last week it was announced that it's a very traditional ambiguity in the LPA cuts against the general partner on management fee offsets, the type of issues that I'm seeing on examinations constantly. And so you know on the examinations. Well, I know there have been departures. I'm not really seeing a slowdown and I'm continuing to see very, very deep dives on complex private fund fee and expense issues, among other issues. But I'm curious what you're seeing from your spot in the Midwest.

Patrick Hayes: I could not agree with that sentiment more we have seen in incredibly active SEC over the last several months and that's across all fronts rather that's for you know existing kind of long standing registrants to those folks may be involved with like the NBE program and those newly formed registrants. We see an incredibly active SEC and to your point, they're continuing to dig in on a lot of the stalwart type of compliance issues, right. So you know for private funds, you know, allocation of expenses and fees, absolutely digging in on that conflicts of interest that they're diving into. You know, we're continuing to see adequacy of disclosures. For some of the wealth managers and other folks that are out there, whether that matches. Advisory agreements to form ADV. Part 2A. Brochures and form CRS, Part 3. Type stuff, but a very very active SC and one other thing that we're seeing that I would say has completely, you know, the pendulum has swung back the other way is that it's now a rare occurrence these days to have a. Completely virtual. Exam I would say we are seeing on site exams at a much more frequent clip and in fact I would say that's the overwhelming majority are you seeing that as well on your side? Chris and Andrew.

Chris Mulligan: Yeah, definitely part in person. I think that the olden days of, you know, coming on site for weeks at a time and doing an. Exam from beginning. And you know, not seeing that, but absolutely there's an on site component to a lot of examinations that we're seeing. But look, there's just a lot of issues like we're still dealing with the marketing rule, hedge clauses, whistleblower provisions. There's just a lot more to look at now than I would say 10 years ago. And so there's just a lot of focus. On you know the bread and butter issues that have generally driven enforcement activity on fees and expenses. But continuing to dig it on this have newish issues. It all sort of emanate from the marketing rule, but it's expanded into different places. That's interesting. You're seeing that as well. That's definitely what we're seeing here, more in in New York and Washington, Northeast area. And we're continuing to see that.

Patrick Hayes: Yeah, it's been a super super active SEC out of some of the major regional offices in the Midwest.

Andrew Dean: Patrick, do you see the exams and what you're seeing like focus on the specific issue or is it kind of the traditional? Way they've done them in the past.

Patrick Hayes: I would certainly say that it's more of the traditional side. If I had to choose one specific answer there. Although I will say obviously and this is certainly a trending topic area, we've seen certainly a large uptick in focus on AI and AI related technologies. And I would also add in there. Things regarding kind of how firms are implementing AI, what types of activities they're using them for. And again, for a lot of firms, and there's this, you know, phrase of art keeping a human in the loop, so to speak, to determine who the arbiter of that stuff is or whether the AI, the generative AI itself, is providing kind of thoughts or recommendations and others that get immediately passed along the clients, but making sure that kind of having adequacy of disclosures. There has been a. A major topic as well.

Chris Mulligan: Yeah, absolutely. I think you're seeing just generic interest in all things. Yeah, your policies and procedures just are you using it all sorts of things. And so I think there's a lot of interest from. Staff just educationally trying to understand what firms are doing with AI. But then you're seeing I think, very aggressive reviews of statements to investors about how you're using AI through the marketing rule. So it's sort of a dual get to know what's happening out there, mandated appears, but also really focused on those representations. Clients and extent there's any sort of exaggeration or issues with those, no hesitation and going after those types of representations of the market will.

Patrick Hayes: Oh 1000% a couple of key things that I think I've really noticed over the last few months that would be, you know, for those legal practitioners and compliance officers that are digging into this post. Yes, #1 is figuring out for any of those service providers that you're bringing in, that you're hiring that have or utilize some type of AI technology. It's making sure that like in those service agreements that you're looking at what they're gonna use your data for and if it's ultimately going to get plugged into the broader AI learning. Technology or algorithm, right? Because you can easily ask for that to be carved out into more. Have your own specific instance of that. So that's something that we're absolutely digging into and trying to help firms with. And then I think the other big issue that we see a lot of firms struggling with. If I would imagine examiners are also trying to dig in on is how firms are approaching the AI stuff from a books and records standpoint, right? And specifically with regard to some of those note taking tools, the summaries, there's a lot of technologies out there. There's a big boutique market out there for these AI technologies to support registered investment advisor. And broker dealers with the types of conversations that they're having and the kind of time saving utilization you can get out of that. But you gotta make sure that you're properly keeping those records. And I think that's a big question.

Andrew Dean: Mark too. Yeah, yeah. Huge topic. Chris and I talk about it a lot. We're gonna have an upcoming podcast Real soon on a I, you know, my background. Enforcement, and I think a lot of the what you need to get out. Of like the exam. Side what's happening in in exams is you gotta talk to people who on the other side of exams enforcement's a little bit more of a blood instrument in terms of the lessons, right cause there's,you know, an actual enforcement action that's out there, right. And you can kind of look at it and to use your turn, Patrick, pick it apart and figure out like, what the lessons are in your experience, what role do enforcement actions have on compliance? How does compliance respond when your clients see a new enforcement action?

Patrick Hayes: Yeah, it's a great question. And I think to your point, right and everybody knows that kind of phrase of art regulation by enforcement and folks have differing views on the effectiveness of that and not. Obviously, you know again without even getting into the merits of that, I still think that the enforcement actions can be really helpful. And I would even say you know, sometimes they become really good case studies that folks can use as good training grounds, right to help educate advisors, even just on like what are the issues, right? Because I think sometimes. It's hard for CEO's and compliance officers and other legal practitioners that are directly involved in the asset management or investment management. Cases to be able to articulate well, hey, here are what some of the issues are, right. And even if you find an enforcement action, it may not be directly on point or even if it is on point with something that you as a firm are looking at, it can really help synthesize a lot of what are the potential conflicts here, what are the legal issues involved here? What other compliance issues or the practical application issues involved here and use that to help educate not only those persons potentially on your? With staff, but also those folks on the business side, on the operations side, on the investment side to better understand really how we should be thinking about these things?

Andrew Dean: Yeah. And it's a great point, Patrick. The other comment I'll make on this is people need to appreciate the amount of effort and thought that goes into every word in those enforcement actions. Right. So just to give folks a sense. It's. And sometimes it's a little bit Frankenstein, but it's basically it's a negotiated document with defense counsel between the SEC and then it goes through a significant level of review at the SEC. So folks, if there was an SEC exam the examiners look at it, the chief counsel's office we talked about before looks at the general Counsel's office, looks at the division of Investment management, looks at it. And then, you know, obviously then Commissioners look at it and there are times when you know things may or may not change after Commissioners look at it. So there's a lot of review that goes into these enforcement actions and getting the wording right and making sure what message is going to go out to. That being said, it's not always perfect. There are some things that you know. I think folks wish they had a Mulligan on. So sometimes, like there are definitely some things that could be done differently. But I do think that there is real thought that's put into them and from our standpoint too, lets us all write a lot of client alerts when they do.

Chris Mulligan: Come out, for what that's worth. Then I think an underrated part of the impact that. Enforcement actions have is actually on the exam staff. Right. Because you know, often these come from examinations, but it's maybe a small group of examiners that have been sort of citing the same type of issue for a while, doesn't have a lot of attention. And then there's an enforcement action and examiner see that as well. And so it's often after an enforcement action that you begin to see a much greater focus on examinations on a specific issue. They know that enforcement is interested in it. Obviously the issue just much better understood by exam staff, so there's a lot of impacts that happened from an enforcement action, both within the industry and frankly within the SEC and in terms of how people think about particular issues that maybe they weren't focused on. So another hot button issue I don't want to get your take on Patrick, just because we're hearing so much about it is this term retaliation. I feel like I hear that term many, many times a day and it means a lot of different things. But in general, it's the idea that alternative investments, hedge funds, private equity funds, there is a larger. Group of investors, however, you want to define that that may be investing in these types of products that historically had only been for institutions or very wealthy investors. You're hearing a lot about those opportunities expanding. We saw President Trump's executive order trying to promote access from 401K's to alternative investments. You hear a lot from the SEC about trying to expand these opportunities. What are you seeing in your practice in terms of how people are trying to actually operationalize this term? Retaliation.

Patrick Hayes: Yeah, you are speaking directly to my heart right now, Christopher Mulligan. So I will tell you that like you. I've heard this term thrown around all the time, and in fact, to offer even a little bit of a tease, it is definitely a topic area that we're going to be digging into on the Securities Compliance Podcast compliance and context, which is that like looking at a miniseries, talking about the democratization or retaliation of alternatives. I think a couple of things. Number one, obviously, it continues to grow in its kind of market share, right. And the importance of it in the space as more and more people become accustomed to understanding a little bit more about how private markets work as more people wanna play and. Those areas you're continuing to obviously see increased focus on both the regulator side and on the advisor and the business side of the investment side. A couple of things come to mind though, and I've talked about this with folks that are on both the issuer side of that, that are on the distribution side of that. And then to your point, now adding in a third prong like with this retirement investor. Stuff, which is that there's a lot of work from a compliance perspective that has to go into each part of that process. To like get an offering up to the point where it's ready to go to market. Then the due diligence needs to be conducted and something has to happen in order to put it on the platform or to be have it ready or be available or open it up to your investor population. And then there's ongoing monitoring and due diligence and ongoing stuff that you see. So I guess I say a little bit of those. Examples only to paint the. After that, it's harder than it looks to make complex some of these sophisticated and complex products available to the retail investor, and then the other thing that I would say that I think. Is interesting is that. There was this perception out there and I think to some extent there are some stereotypes that would fall in line that you can get much better returns in the private markets than you can in the public. It's, but I again like look, I'm not an investment guy. I'm part on the legal compliance and 3rd side of this House. But I think if you looked at the last 10 years of the S&P and across also what you were getting in private markets, I'm sure we could find firms that did better. But I'm sure there's also a lot of folks that would say just being in the public areas over the last 10 years. With the levels of returns that they were getting would have gotten you the same or similar type results. So I guess I would say it's great. I'm excited and obviously to dig into the president's order, but I think there are some stereotypes around the asset class that I think others could really benefit from some additional education on.

Andrew Dean: Yeah, it's definitely a big topic and I'll just second you there not being an investment guy. So alright, so look. So we've talked about a lot democratization of private funds AI. You've been at this for Wild Patrick. What other topics, trends are you hearing from your clients? What else is going on that gets your ear?

Patrick Hayes: Yeah, I would say, you know, marketing rule stuff and Chris mentioned it earlier. Obviously firms are continuing and I feel like it will forever more be continuing to find new and innovative ways to try to advertise their services and market themselves in a way that they're trying to draw differentiation from their peers, right. And so. That tends to lend itself towards obviously more creativity, but then also potential greater risk, right? And so I think whether that. Some of the performance related aspects of the marketing rule to the client, testimonials and endorsements, and how firms are approaching that. I think we're certainly seeing a lot of activity on that front and you know I did a training recently and we were going back and looking at a lot of the risk alerts from the division of exams. Over the past few years and it was like, what do you think the division of exam is focused on? And it was like September of 22 marketing role. You know I forget the month in 23 marketing rule, OK, April of 24 marketing rule and it's like, yeah, they're definitely focused on that. So we should make sure to pay attention. I don't know. Chris and Andrew are, are you seeing some of that as well?

Chris Mulligan: Yeah, absolutely. And look, I wrote most of those risk alerts, so I know them well. But I will say being on this side, it's different, like operationalizing it right, like really it's one thing to review these on the exam side. It's one thing to do this, but when you're trying to create them, you're trying to market your firm to places. It's a very complicated rule, but there's also a lot of flexibility in it. And so it's a rule with some hard and fast rules, but then a lot of flexibilities you always have to be thinking about the general prohibitions and making sure you're complying with all the specific requirements. But it's something that just continues to sort of grow in the complexity. I think to your point. Patrick, it grows because firms are trying to do so much. They're trying to create different slicing and dicing different performance in different ways. Market, you know, certain types of services, they do. And so you're just sort of eternal questions that always come up with that and basically you have to be prepared to respond to examiners who are still very, very focused on these issues in a way that you know. Makes sense?

Patrick Hayes: Yeah, one thing I'll add too, because I have found it kind of an effective way to look at testimonials and endorsements. And I really like the way and this came out of conversations I was having with an advisor who was looking at. Which is when you can use the testimonial or the endorsement to add transparency to your investment process, or to the way that you approach clients or to the types of services that you provide that can be really effective because then you're really giving additional credibility. To the idea that you wanted that prospect. To have the most complete picture of you as a firm and what you're gonna do and how you're gonna do it. So where the testimonial or endorsement can relate to those activities and really again add transparency to the way that you approach the investment or portfolio management process or the holistic financial plan that you're doing or whatever it is, right, whatever your suite of services is. That can be a really effective approach to it.

Chris Mulligan: Yeah, I totally agree. Especially for those testimonials and endorsements because people complain about the new marketing rule. But of course, remember testimonials were actually completely prohibited right under the old advertising rule. And so I think people are still finding their way with some of these new features. Right. I think there was some fear early on about using some of these features that were prohibited under the. The rule and now I think people are sort of finding their way like how best to use this. You know these some of these new tools that we have in a way that doesn't run afoul of some of the new specific requirements. But in a way that can be helpful and can send a better or more as you say a more complete and accurate picture of the advisor. But it still really is early days on some of these techniques.

Andrew Dean: It's early days and enforcement is still there as we know, right? I think so far today I think a lot of the actions that have been brought in the marketing world space have been 50 Commission votes, so not controversial under any, any Commission, a couple of dissenting votes here and there. And I think that's in part because the staff was looking initially for actions that were just kind of on their face, you know, obviously violative of the rule. I think when we start to see closer calls, I think those are cases that I'm not sure this Commission is gonna bring. So I think as long as people kind of try to work through the rules. Really trying to be thoughtful about what they're doing, why they're doing it. You know, we see clients spend a lot of time and for some of the provisions, it's kind of a slog to like figure out what you know, extracted performance and some other things to make sure you're doing it the right way. But I think for the most part, folks are and if they continue to. Try and follow the rule. I think this enforcement staff will stay away. That's my general take on it. Anything else, guys? All right. Well, thank you to Patrick for joining us today. That was great. I really appreciate it. Your thoughts. Thanks for joining us on Asset Management Corner and hope to talk to you soon.