Collective funds are by law on the turf of bank regulators. But the SEC’s new anti-Madoff crusade now wants to put collective products on agency’s hit list.

“The SEC can’t get into the bank, but I can get into the advisors. It’s important for me to see if the banks are using their exemption properly … or merely renting a space [to advisors] inside a trust company,” says SEC’s Andrew “Buddy” Donohue, head of the SEC’s investment management unit.

Donohue fired a warning shot at bank regulators by threatening to go after the advisors who sell collective investment trusts. Experts say a move like that may just be saber rattling, but it pits the SEC against bank regulators over oversight of about $1.6 trillion in the collective funds market.

On the surface, these vehicles—also known as collective trusts, commingled funds or common trust funds—look a lot like institutional mutual funds and invest in all the conventional asset classes. Advisors do brisk business selling them to retirement plans.

But while mutual funds are SEC-registered, collective investment trusts are managed by a bank trust department and so falls under the jurisdiction of the Office of the Comptroller of the Currency, which is part of the Treasury Department.

If Donohue gets his way, that may change. In a speech at Practicing Law Institute’s Investment Management Institute in New York, he said he’s got his eye on these bank products. If he decides they need tighter regulation, he’ll make it happen, one way or another.

“I can’t get into the bank,” he reportedly elaborated in an off-script comment after the speech. “But I can get into the advisors.”

The OCC has refused to rise to the bait so far. All I got out of them was a terse “we’re aware of it and no comment.”

Rattling the Chains

Longtime agency watchers are a lot more expansive, but on the whole they’re a little mystified at what you could read as an SEC power grab.

“Collective investment trusts used to be considered a settled matter,” Maureen Young, a partner at high-powered law firm Bingham McCutchen, told me.

“If the SEC is really concerned about these products, maybe they’re hoping that they can get some response by rattling the chains and going after the brokers,” she added.

George Washington University law professor Arthur Wilmarth filled me in on the long struggle over who would regulate these products following the repeal of the Glass-Steagall Act over a decade ago.

“As they say, nothing is as precious in Washington as a bit of turf,” he told me. “They fought for years and just couldn’t agree,” he added. “It took Congress basically threatening to bang the agencies’ heads together to get the job done.”

By the time the last dust settled, it was already 2007 and the once-obscure collective investment trust was becoming big business in retirement plans.

There’s about $1.6 trillion invested in these trusts now, according to Morningstar data. About half of it is in traditional pension funds; the other $800 billion—the real growth market—is in 401(k)s and other defined contribution accounts.

Getting Tough

Some of the people I interviewed for this story suspect that the size of this marketplace is the factor that brought it to the SEC’s attention after years of letting the OCC tend its own knitting.

Others wonder whether the SEC is looking for ways to prove that it’s indispensable in a world where the Obama Administration seems intent on reshuffling the regulatory deck and all the agencies have made mistakes.

In any event, Donohue isn’t alone in talking tough.

“We simply show up,” said Gene Gohlke, associate director of the SEC’s Office of Compliance, Inspections and Examination, speaking at the same conference as Donohue.

“If there are allegations of wrongdoing, we don’t want to give firms a good deal of lead time to clean up,” he added.

But while statements like this paint a tough picture of the commission as a sort of rapid-deployment vigilante regulator, it’s going to be tough to put that rhetoric into practice, former Nevada banking commissioner L. Scott Walshaw told me.

“From a bank regulator’s perspective, the OCC or whoever else is being stepped on is going to have something to say about this,” Walshaw, now a regulatory advisor at Advisors Institutional, says.

“Common sense would dictate that it makes more sense to just sit down with the OCC and maybe see if they can express their concerns without infringing on anybody’s turf,” he added.

Headed for the Mainstream

Meanwhile, there are already 1,200 collective investment trusts in Morningstar’s database and more launching all the time.

“We talk to established money managers about these vehicles every week,” says Steve Deutsch, who leads the company’s research in this area.

Deutsch sees collective trusts heading for the mainstream of the asset management marketplace very quickly. That’s probably why the SEC is getting involved, he says.

“If you want to be mainstream, you’ve got to have all the features of a mainstream product, and I think that’s what the SEC is concerned about,” he added.

As Deutsch notes, these trusts already walk and talk a lot like mainstream investment products. Improved record-keeping capabilities allow them to report NAV on a daily basis. They trade on Fund/SERV. And since Morningstar tracks them, there’s third-party transparency.

Last but not least, they are already strictly regulated—not only by the OCC, but in so far as collective trusts are essentially retirement plan options, by the IRS, ERISA and the Labor Department.

For example, Victory Capital Management is a substantial player in this space with about $3 billion in collective trust assets under management.

“It’s not like there’s no oversight,” says John Kutz, the head of the company’s retirement plan business.

“There’s tremendous oversight. There’s a lot of auditing. These are fiduciary products. The OCC makes sure every ‘i’ is dotted and every ‘t’ is crossed, at least where we’re concerned.”

Victory is still bullish on the business, expecting its AUM to double in the next few years. Evidently, a little oversight is worth the effort.

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research.

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