Roundtable Urges SEC to Exempt Real Estate from Proposed Safeguarding Advisory Client Rule

Securities and Exchange Commission building

The Real Estate Roundtable urged the Securities and Exchange Commission (SEC) this week to exempt real estate from a proposed Safeguarding Advisory Client Rule that could severely limit advisory clients’ ability to invest by fundamentally changing the ownership and transfer rights of real estate. The proposed rule currently includes a conditional exception for real estate assets, which would impose a new layer of unclear and unnecessary oversight—and inject significant confusion into well-established transaction protections, rules, and procedures governing real estate transactions. (Roundtable letter, Oct. 30 and SEC Proposed Rule)

The “Proposing Release”

  • The Oct. 30 letter from Real Estate Roundtable President and CEO Jeffrey DeBoer reiterated current legal protections that promote the safe-keeping of real estate assets held in advisory accounts or funds. DeBoer urged the SEC “… in the strongest possible terms to exclude real estate from the scope of any final [Safeguarding] rule,” citing the ample set of existing protections that prevent real estate assets from fraudulent transfer.
  • The letter also emphasized that the SEC has not coherently explained how the Proposed Safeguarding Rule would apply to real estate.
  • Current law (the “Custody Rule”) under the Investment Advisers Act of 1940 requires an investment adviser to maintain clients’ funds and securities with a qualified custodian. The new proposed SEC rule would expand this requirement to maintain all advisory client assets with a qualified custodian.
  • Since it is not possible to maintain real estate and certain other physical investments with a qualified custodian, the proposal includes a conditional exception that includes the following language:

“In the real estate context, a deed or similar indicia of ownership that could be used to transfer beneficial ownership of a property would not qualify for the exception, but the physical buildings or land would qualify.”

  • The Roundtable’s letter challenges this “Proposing Release” as confusing, impractical, and unworkable for holding and transferring real estate deeds. It also conflicts with current state and country chain of custody legal requirements that govern real estate transactions.
  • The letter also notes the SEC could chose to make the conditional exemption available to real property, because a physical asset cannot be maintained with a qualified custodian. Additionally, the requirement to maintain custody of deeds with a qualified custodian—compared to recording the interest with a governmental authority—serves no regulatory purpose.

Existing Layers of Safeguards

SEC logo and text
  • Other existing safeguards come into play. State laws currently require signature verifications, notarizations, and accompanying IDs that provide significant hurdles to an attempted fraudulent transfer.
  • Modern real estate transactions in the United States also require buyers and lenders to obtain title insurance, which involves a title insurance company to engage in substantial due diligence of the chain of ownership. Real estate lawyers representing the buyer and/or seller represent yet another intermediary, since they are often involved in these asset transactions to provide yet another source of gatekeeper protections.
  • The Roundtable letter states the SEC must explain how it would be possible to maintain title or deed with a qualified custodian since the “Proposed Rule would fundamentally change the ownership and transfer rights of real estate.” The letter states the SEC should avoid any final rule that would limit clients’ access to, or unduly burden, investment in the real estate asset class.
  • The Proposing Release also contains no evaluation of any risk of loss for real estate assets—it only asserts such risk as a theoretical matter.
  • The Roundtable and a diverse group of 25 trade associations previously wrote to SEC Chair Gary Gensler to oppose the Safeguarding Advisory Client Rule proposal and explain the negative impacts it would have on investors, market participants, and the financial markets. This week’s letter from The Roundtable focused exclusively on the proposal’s impact on real estate assets. (Roundtable Weekly, Sept. 15)

The Roundtable’s Real Estate Capital Policy Advisory Committee (RECPAC) Custody Rule Working Group developed this week’s comments and met today with the SEC’s Division of Investment Management about the proposal. RECPAC is scheduled to meet Nov. 8 in New York City.

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Roundtable and Business Coalition Urge SEC to Withdraw Proposed Safeguarding Advisory Client Rule

The Roundtable and a diverse group of 25 trade associations this week wrote to Securities and Exchange Commission (SEC) Chair Gary Gensler to oppose a proposed Safeguarding Advisory Client Rule—in its current form—and explain the negative impacts it would have on investors, including their access to various services, assets, and markets with well-established rules and procedures. (Coalition letter, Sept. 12)

Inconsistent and Duplicative

  • The coalition letter notes how the proposal creates requirements that are inconsistent with certain recent or preexisting Commission requirements—and duplicative of, existing safeguards enforced by the Commodity Futures Trading Commission (CFTC), federal banking agencies, and state insurance regulators.
  • The letter emphasizes that substantial, material flaws in core elements of the proposal require changes that would make the proposal no longer meaningful in its current form. The letter states, “Should the Commission decide to make such changes and move forward with rulemaking, we strongly recommend withdrawing and re-proposing the [Safeguarding Advisory Client Rule].”
  • The Commission acknowledged this fact on August 23, 2023, when it re-opened the comment period on the proposal to give the public 60 days to provide additional feedback in light of separate final rules adopted by the SEC regarding the regulation of private fund advisers. (SEC news release, proposed rule, fact sheet, and comments received)
  • The proposal’s range of new custodial requirements would create significant operational and practical challenges to the custody of real estate, even though these assets cannot be misappropriated and are easily tracked by deeds and mortgages recorded by municipalities. These challenges would materially inhibit adviser clients’ access to investment strategies relating to real estate, compounding the pressures that high interest rates and vacancies are placing on commercial and residential markets.

Policymaker Pushback

Sen. Tim Scott (R-SC)
  • During a Senate Banking Committee hearing this week, Ranking Member Tim Scott (R-SC), above, questioned Gensler about the proposal. Sen. Scott noted in his opening statement that the SEC has put forward 47 proposals and adopted 22 of them in the first several months of Gensler’s leadership, not allowing a reasonable amount of time for the public to provide input on proposed rules and for the widespread impact and confuse on created by agency’s proposed rules.
  • During Q&A with Gensler, Sen. Scott stated “…your proposed revisions to the current rules for safeguarding are so overreaching, you’ve placed your fellow regulators at the CFTC, the Fed and Treasury between a rock and a hard place. These proposals and rule makings will have a tremendous effect on our capital market system. Yet under your leadership, the SEC has failed to conduct thorough cost benefit analysis, much less look at the overall impacts of these proposal and has limited the time the public can have—the time to analyze and then comment on these rules and the proposals.” (CQ transcripts)

The Roundtable’s Real Estate Capital Policy Advisory Committee (RECPAC) established a Custody Rule Working Group, which is working on comments about the SEC proposal that are due October 30. The working group also plans to meet with the SEC’s Division of Investment Management.