The SEC's next regulatory target could be index providers

Few ideas hold sway over U.S. markets and the economy today more than the wisdom of passive index investing. Vanguard founder Jack Bogle’s once-eccentric belief — that an individual investor’s best recipe for long-term gains is a diversified portfolio of securities and a relentless focus on keeping fees low — is now the market’s most widely held philosophy.

The Center for American Progress, a left-leaning think tank, issued a report Friday, previewed exclusively to MarketWatch, that argues that the SEC and other financial regulators “should adopt a comprehensive regulatory regime for financial products tied to indexes,” including setting minimum standards for governance of indexes and mandating transparency regarding methodology, licensing fees and potential conflicts of interest.

In November, academics Kun Li and Xin Liu of Australian National University and Shang-Jin Wei of Columbia University published research which argued that S&P Global’s index division has significant discretion over which firms ultimately end up in the S&P 500 and that “the discretion is often exercised in a way that encourages firms to buy fee-based services from the S&P.”

“They are being created really for the use of the fund,” she said in an interview, adding that this practice of stock selection on the part of index companies should force the SEC to consider them investment advisers and regulate them as such. If the SEC were to enforce the law, she added, index providers that act like investment advisers would need to register with the SEC and assume a fiduciary responsibility to their clients.

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