Investment adviser firms and their legal counsels are bristling at a new SEC rule provision they say imposes a burden on advisers to monitor the Y2K readiness of companies they recommend to clients.
The controversial provision is contained in the new ADV-Y2K form that SEC-registered investment advisers must complete by Dec. 7 and again in June 1999. The form requires advisory firms to detail their plans for dealing with the year 2000 computer problem. Among other items, the form asks whether and by what means advisers take into consideration the Y2K readiness of issuers of securities when recommending those securities to clients. This particular question was not part of the original form put out for public comment in August--and some lawyers claim the addition of the requirement violates the law.
Marianne Smythe, a Washington D.C.-based attorney at Wilmer Cutler & Pickering and former head of the SEC's division of investment management, told a September gathering of compliance personnel that the SEC's inclusion of this provision subsequent to the comment period violated administrative procedure law, which obligates government agencies to publish rule proposals in the Federal Register and to seek comment.
Other attorneys agree. The SEC is "not supposed to be able to promulgate something into law that is not proposed," says one compliance attorney for an advisory firm in the Midwest.
The original proposal asked firms to assess the Y2K readiness of mutual funds the firm deals with or third parties the firm relies on for information, but made no specific mention of gauging issuers of securities.
"We drafted this additional question as a way of helping the industry wake up," says Robert Plaze, associate director of the SEC's division of investment management. The issue of advisers considering companies' Y2K readiness was first raised by Sen. Robert Bennett, R-Utah, "the Y2K Senator" during Senate hearings this year, Plaze says. "The SEC was caught off guard because it hadn't considered this. The commission ... found that Wall Street had not woken up to this issue--stock prices were not taking into consideration companies' Y2K readiness."
Plaze says the SEC was within its powers in adding the provision. "[The new provision] was within the same theme and general thrust of what was proposed. ... The courts have given us flexibility, [otherwise] the commission could never adopt anything that wasn't proposed."
Although the question on the form is not a requirement, Plaze says the SEC will examine issuer readiness during adviser exams. Advisers should be considering the Y2K readiness of the stocks they recommend to clients, he says, even if they report "no" on the Y2K form.
At the September compliance meeting, John Walsh, chief counsel in the SEC's office of compliance inspections and examinations, confirmed that the SEC would be checking on advisers' efforts in tracking issuers. "We can't say exactly what to do, but if a company [isn't responsive], that's going to be a concern," he told compliance pros.
Separately, at a Florida conference in November, Barry Barbash, who this year left his position as head of the SEC's division of investment management, said advisers would need to make a judgment on whether Y2K problems could be material to the investment. Barbash, now an attorney at Shearman & Sterling in Washington, D.C., warned that the SEC will likely be "ratcheting up" enforcement of Y2K compliance.
Yet assessing the readiness of hundreds of companies in which clients own stock would be a monumental task, says Robert Horowitz, president of New England Investment Management in Stamford, Conn. "To suddenly say every adviser registered with the SEC has to develop the expertise to evaluate the Y2K readiness of every company they invest in ... would be impossible."
The SEC plans to make advisers' ADV-Y2K reports available to the public on its Web site as early as this month.