More On Legal & Compliancefrom The Advisor's Professional Library
- Whistleblowers A whistleblower is any individual providing the SEC with original information related to a possible violation of federal securities law. The Dodd-Frank Act established a whistleblower program that enables the SEC to reward individuals who voluntarily provide such information.
- 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.
At press time on January 15, the Senate Banking Committee was holding Mary Schapiro's confirmation hearing to be the next head of the Securities and Exchange Commission (SEC). Most advisors are less than pleased--to put it lightly--that Schapiro was chosen by President-elect Barack Obama as the Commission's first woman chairperson because they worry that her experience at FINRA will skew her judgment when it comes to writing regulation that affects advisors and give her more impetus to push to have FINRA regulate advisors.
But there are industry watchers--like former SEC Chairman Harvey Pitt--who say that Schapiro will use an even hand and will weigh all the issues when it comes to regulating advisors--after all, her career also includes serving at the SEC.
It's looks as though advisors aren't so easily convinced. Here's how Bedda D'Angelo, president of Fiduciary Solutions in Durham, North Carolina, responded to an informal e-mail poll of advisors that I conducted recently. At FINRA, she said, Schapiro "frequently lobbied to have all advisors regulated under FINRA. Essentially, she would like small SEC-registered firms and state-registered firms to be FINRA regulated."
Patrick Burns, an attorney with Advanced Regulatory Compliance, says Schapiro's FINRA experience coupled with the fact that she now heads the SEC "will at least bring up the issue for discussion again." The alternative to FINRA overseeing advisors, and what advisors would definitely prefer, is a self-regulatory organization (SRO) for advisors, which will also be up for debate this year.
D'Angelo also said in her e-mail that Schapiro "makes no provision for insurance agents, who are primarily regulated by their respective state insurance commissioners, and even though most are FINRA registered because they sell mutual funds and variable annuities, insurance-owned broker/dealers are rarely scrutinized by securities regulators." While "Mary Shapiro means well, she has no idea how vastly the services provided by RIAs who combine financial planning with investment management differ from the services provided by FINRA-registered brokers."
Disastrous, or Exactly What the SEC Needs
George Papadopoulos, a planner in Ann Arbor, Michigan, said in his survey response that Schapiro "has the potential to be a disastrous SEC appointment for independent RIAs. Based on her record of many years of not defending a fiduciary standard to apply to all advisors, and her very extensive contacts and relationships with executives from disgraced investment banks and wirehouses, we independent RIAs should be very afraid and threatened by her. Let's all remember that FINRA was supposed to be regulating [Bernie] Madoff, too."
But former SEC Chairman Harvey Pitt told me in an e-mail that he believes "it's a mistake for investment advisors to worry about what the SEC will or won't do under Mary's leadership. There are five commissioners, and each of them gets the same vote." Pitt, who's now the CEO of the global business consulting firm Kalorama Partners in Washington, says that Schapiro "will take the time to understand all of the concerns on both sides of the issue and come up with an appropriate way to resolve the regulatory concerns."
Pitt says Schapiro is "exactly what the SEC needs now," because she's "smart, seasoned, has served at the SEC, and has had a successful record as an outstanding regulator."
Reuters recently reported that SEC Commissioner Kathleen Casey said she "strongly believed" the rules for investment advisors and broker/dealers need to be "harmonized," noting that investors can't distinguish between the two. "In light of the size and growth of investment advisory business and overlap, an SRO could serve as an important enhancement to the SEC's ability to police the markets," Casey told Reuters.
Other industry observers like Cliff Kirsch, a partner in Sutherland Asbill & Brennan's New York office, who focuses on regulatory and compliance issues facing broker/dealers and investment advisors, also believes Schapiro will not approach regulation with "a closed set of ideas." Kirsch believes Schapiro will spark debate about regulations by posing questions like: "'On the broker/dealer side, we do this with regard to client assets. Why isn't this done on the advisor side?'" Kirsch says. And vice versa.
A Delicate Time
As chairwoman of the SEC, Schapiro will take the helm at a critical time. David Kotz, the SEC's Inspector General, told Congress January 5 that his office has been "working at a rapid pace" since December 17 to investigate why the SEC failed to shutter Madoff's Ponzi scheme, which lost $50 billion of investors' money, according to the suit filed against Madoff by the SEC.
This matter, Kotz told members of the House Financial Services Committee, "requires immediate attention," and he promised to issue "rolling reports on various issues" over the next several months to explain why the SEC failed to act. "We will look at situations and rules and policies we can recommend regarding red flags that are out there," Kotz said. "My focus will be on why the SEC didn't take action."
Former SEC Chairman Arthur Levitt responded to the Madoff scandal in a January 5 OpEd piece in The Wall Street Journal, and said that while "a regulatory agency is not omniscient...risk assessment must be central to the SEC efforts." The agency, he said, "needs an office that will collect information from all of the agency's divisions and propose inspection and examination priorities."
Once problem areas or firms are identified, Levitt wrote, "the SEC must have a robust oversight and inspection capability as well as, when needed, an enforcement agency that is empowered and enabled to pursue leads." Since 2002, however, he said, "the number of investment advisors--such as Madoff Securities--has increased by 50%. Yet enforcement resources have been flat or even reduced. The number of SEC enforcement division personnel was cut by 146, to 1,192 in 2007 from 1,338 in 2005." As a result, "only about 10% of investment advisors can expect to be examined every three years, and the goal of inspecting every adviser once every five years--laughably light oversight in its own right--has been abandoned."
Schapiro told members of the Senate Banking Committee during her confirmation hearing on January 15 that one of her first priorities as chairwoman would be to "reinvigorate enforcement at the SEC." (See sidebar.)
Indeed, Harvey Pitt said in his recent e-mail to me that the SEC's examination system is in bad need of an overhaul, and that independent examiners should be hired to examine advisors on a more frequent basis. "The SEC's examination system--put into place in the mid-90s--is badly broken," Pitt wrote. "There are about 11,000 investment advisors, thousands of broker/dealers, clearing agencies, transfer agents, and SROs, all of which the SEC is supposed to examine. There will never be enough people, with enough sophistication, or enough money, to do all that the public and Congress have a right to expect."
Pitt recalls that in 2003, before he left the SEC, he "suggested the need for a new examination paradigm, one that would require all advisors to be examined either every year, or (in the case of smaller firms) every other year, by qualified, wholly independent experts who would issue a report both to the firm being examined and to the SEC. This is a way to provide greater continuity and coverage than the SEC's budget can ever provide, no matter how much it is expanded."
Besides an examination overhaul, Kirsch of Sutherland says the Madoff scandal will likely prompt the SEC this year to consider modernizing the Investment Advisers Act of 1940, particularly custody arrangements under the Act. If the SEC takes this on, he says, the Commission will likely examine if assets should be able to be held by an affiliate custodian. The scandal also raises the question of "how can the Advisers Act help in making sure there's substance to an advisor's books," Kirsch says. The SEC may also "take a very close look at firms' due diligence procedures where an advisor recommends an outside money manager," he says. "I think the SEC is going to want to examine very closely how firms conduct due diligence."