More On Legal & Compliancefrom The Advisor's Professional Library
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
Are you up to speed on Sarbanes-Oxley? That's the law Congress put in place after Wall Street was rocked by the corporate scandals at Enron Corp. and other companies. Sarbanes-Oxley, or SOX as it's often called, sets out reporting mandates that directly affect public companies, but did you know that the law also reaches into the advisory world? What's more, the act actually benefits advisors on the competitive playing field--as one advisor has found.
First, Title 11 Section 1106 of the Act stiffens criminal penalties under the Securities Exchange Act of 1934, while Title 9 Section 904 increases penalties under ERISA. The act also increases penalties for violations of the Securities Exchange Act of 1933. "Anybody who's involved in the securities business has to be aware" of those facts, says Larry Byrnes, CEO of Competence Software Inc. in Clearwater, Florida, which develops finance and investing courses that promote financial literacy.
Rick Cortese, VP and executive director of National Regulatory Services (NRS) in Lakeville, Connecticut, agrees that advisors should "not be indifferent to Sarbanes-Oxley." Advisors should "at least have a basic understanding" of the act, he says. If an advisor is a publicly held company, then the act directly applies to them, he says, or if an advisor is a broker/dealer dual registrant, then some of the act's analyst conflict-of-interest provisions apply. But even if neither of those descriptions applies, "as a fiduciary, an advisor needs to [understand the act] because they are dealing with companies that should be compliant with Sarbanes-Oxley," he says. Advisors should have a grasp of whether the fund companies that they're doing business with are compliant, and also be comfortable that the publicly held companies in which they are taking investment positions are compliant, Cortese says.
Up to Speed
If you're not well versed on Sarbanes-Oxley, now is as good a time as any to brush up on it. Since its passage in 2002, corporate executives have characterized the act as burdensome, expensive, and basically ineffective. The two former top execs at Enron are now on trial, and the Act's Public Company Accounting Oversight Board (PCAOB), which acts as accounting firms' regulator, faces its own lawsuit. In February, The Free Enterprise Fund and Beckstead & Watts, a small accounting firm in Nevada, filed suit in U.S. district court in Washington challenging the legitimacy of the PCAOB. The groups say the PCAOB is unconstitutional because it wields regulatory powers and can levy fines yet goes unchecked by the government. It's been rumored for some time that Sarbanes-Oxley is due for an overhaul, but Paul Nikolai, a CFP with Deloitte & Touche Investment Advisors in Cincinnati, doubts the Act will "change radically, if at all." Senator Paul Sarbanes (D-Maryland), who co-authored the legislation with Representative Michael Oxley (R-Ohio), recently defended Sarbanes-Oxley, arguing that the law is working as intended.
When delving into the specifics of the Act, advisors should focus on Title 11, which addresses corporate fraud accountability and amends federal criminal law to establish a maximum 20-year prison sentence for tampering with records, and also increases penalties for violations of the '34 Act, Cortese counsels. Advisors "need to understand there are some serious outcomes here, and if you're dealing with publicly held companies in a consulting capacity and you're working with the management of those companies, you want to be very comfortable that everything is moving forward as it should because you could get nailed as aiding and abetting another party that's violating the law," he says. If an advisor is a dual registrant and works as a research analyst, or has an investment banking function, they need to review Title 5 of the Act, which is the conflict-of-interest section, he says. If you're doing due diligence on funds or other publicly held entities, it's important to grasp "some of the concepts [under the Act] that deal with auditor independence, corporate responsibility and governance, and financial disclosures," he adds. The Act includes "mandated enhanced financial disclosures, so if you're on an investment committee and you're an analyst doing research, you need to be on top of how financial disclosures have changed under Sarbanes-Oxley."
Sarbanes-Oxley also stiffens penalties for violations of ERISA--that's under Title 9, Section 904. The law now sets out a fine of $100,000 and 10 years in prison for an ERISA violation, with a maximum fine of $500,000 for corporations. A criminal penalty for someone who willfully violates ERISA would likely be a case of embezzlement, says David Pratt, who's been an ERISA lawyer for the past 30 years and has been teaching law at the Albany Law School in the New York state capital for the last 10 years. Embezzlement is fairly rare, he says, "but it does happen." Advisors who are fiduciaries to a retirement plan are more likely to face civil penalties under ERISA for a "fiduciary breach" that involves providing improper investment advice, he says. Under Section 502(L) of ERISA--which is enforced by the Department of Labor--an advisor "would be liable for losses to the plan, plus an additional 20% penalty," Pratt says.
If you think Sarbanes-Oxley is just another government overreaction to corporate scandals, you've got lots of company. Byrnes of Competence Software says that Sarbanes-Oxley is "a one-size-fits-all solution, but there's a relatively small percentage of ethics-deficient individuals." A recent study by the Securities Industry Association (SIA) found that total compliance costs incurred by the U.S. securities industry reached $25.5 billion in 2005--a huge jump from $13.1 billion in 2002. The SIA study listed Sarbanes-Oxley compliance as one of the most burdensome rules, along with the SEC's Books and Records rule, the USA Patriot Act, mutual fund sales charge breakpoint self-assessment, e-mail review and archiving, and fee-based brokerage accounts. Still, there are others who argue that Sarbanes-Oxley doesn't go far enough.
The Opportunity for Advisors
There is another side to the Act that, as luck would have it, is actually beneficial to advisors. Alan Goldfarb knows this for a fact. Goldfarb, a CFP in Dallas, merged his practice with the largest independent CPA firm in Texas, Weaver and Tidwell, about five years ago--becoming Weaver and Tidwell's wealth management arm. When Sarbanes-Oxley was enacted, it made it "more difficult for an accounting firm that's doing the auditing of a public company to work for the senior executives of that company in terms of executive perqs, financial counseling, and money management," Goldfarb says. Since accounting firms have been "knocked out" of providing these services to these executives, this opens the door for RIA firms with no conflicts to fill that gap, he says. "Executives of many companies are looking for someone to do their counseling and planning, and they're not able to go back to [big CPA firms like] Ernst & Young, KPMG, or PriceWaterhouseCoopers," he says. "So we've become a very viable alternative." Goldfarb's advisory firm is now going after executives--his marketing staff is positioning the firm as one that specializes in this area.
Another benefit is that Weaver and Tidwell is affiliated with an international association of independent accounting firms, which gives the firm a multi-location status. "One of the appeals of using an Ernst & Young would be that the client can be serviced in many locations," Goldfarb says. "That's part of the problem with just a regional RIA firm or local accounting firm. We've been able to capitalize on the best of both worlds--the fact that we have this international affiliation with other independents like us where we can service the multi-location corporate client."
Nikolai of Deloitte & Touche Investment Advisors, which is part of Deloitte Tax, says the company has indeed lost clients as a result of Sarbanes-Oxley. "There is a broad definition of tax planning in the [act], and whether that falls under financial planning is still very unclear, but investment advisory work is, for the most part, okay," he says. "However, a lot of the companies are playing it very safe and they didn't want any signs of impropriety, so in a lot of incidences we had to discontinue relationships with executives and employees of companies that we did audit work for." Companies "don't want their executives to wind up on the front page of the Wall Street Journal with a story about them getting tax advice or other advice from the same firm that's doing their audit," he continues. Deloitte had worked with a couple of large companies headquartered in Cincinnati, he says, "and we've had to discontinue work with some of them."
Familiarize yourself with Sarbanes-Oxley. Even if you've read through it before, it might be a good time to run through it again.
Washington Bureau Chief Melanie Waddell can be reached at email@example.com.