More On Legal & Compliancefrom The Advisor's Professional Library
- The Few and the Proud: Chief Compliance Officers CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations. When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.
- Disaster Recovery Plans and Succession Planning RIAs owe a fiduciary duty to clients to prepare for disasters and other contingencies. If an RIA does not have a disaster recovery plan, clients financial well-being may be jeopardized. RIAs should also engage in succession planning, ensuring a smooth transaction if an owner or principal leaves.
Following is an excerpt of Pitt's e-mail message.
By Harvey Pitt
Progress of financial services reform
We need regulatory reform because our system is badly broken. It's disappointing, however, that in the last year, we've spent trillions of dollars but haven't addressed the systemic problems that caused the current crisis and threaten additional rounds of disasters. Nor have we improved the ready availability of necessary credit, especially for middle and small companies. ... I believe there are a number of critical deficiencies in these [House and Senate] reform bills:
-- Much of the legislation addresses last year's crisis, but does nothing to prevent the 'next' crisis.
-- Both the House and Senate bills are 'too big to succeed'.
-- The legislation unwisely would permit the growth of financial institutions to be capped; neither Congress nor regulators can set ceilings above which no financial institution should go. Like a clock that's stopped working, the standards may be correct for two brief periods every day, but the rest of the time they'll be wrong.
-- Structural problems with our regulatory problems are not being fixed; government isn't given appropriate tools.
-- Instead of eliminating regulation, the bills would add additional layers of regulation.
-- The Country needs something compact and flexible to adapt to new instruments that the marketplace will create before regulators understand how they work.
-- Housing the proposed Consumer Financial Protection Agency (CFPA) within the Federal Reserve Board will encumber the agency and divert its attention from monetary policy/systemic risk. In any event, the proposed CFPA will create havoc and overlapping jurisdiction.
-- The additional burdens being imposed on the Fed pose a threat to its effectiveness and independence.
-- The SEC will be given authority it can't possibly implement--expanding its jurisdiction, but requiring it to perform compliance examinations for thousands and thousands of additional regulatees poses serious threats. The bills will reflect the law of unintended consequences; a prime example of this is the Senate proposal to create an independent 'Investor Advocate' at the SEC; apart from the fact that that is already the SEC's mandate, the legislation would create a position that could trump the five Commissioners and any other staff member.
Derivatives, private equity and hedge fund reform
There certainly should be no significant financial instruments or services that escape appropriate oversight and monitoring. But, adding private equity funds and hedge funds to the SEC's responsibilities now has two potential basic flaws. First, the agency should first get data about how these entities function before it crafts regulations that will potentially restrict the ways in which they're able to do business. Second, it will be impossible for the SEC to examine and assure the compliance of these entities, in addition to the 6,000 broker/dealers and 11,000 investment advisors already registered with it, as well as all the other organizations for which it has examination responsibility.
Entities that take funds from the public, or can have a significant impact on our economy or financial markets, should be examined either every year or, in the case of smaller firms, every other year, to make sure they are doing what they are supposed to be doing. There won't be enough money, people or expertise to provide the kind of compliance audits the public has the right to expect. That is why the Commission should have been seeking authority to require capital markets firms of all sorts to undergo a compliance audit by an expert, completely independent entity, where the SEC dictates the standards of expertise and independence, as well as the subjects to be examined.
There also should be increased oversight of derivatives. In 2000, Congress prohibited the SEC and CFTC from regulating derivatives, although they were permitted to enforce laws prohibiting fraud. The SEC has a great Staff, but it is an over-lawyered agency. It needs people who've actually managed portfolios, traded complex derivatives instruments, and who know first-hand how markets operate. That's the kind of talent that the SEC is now looking for and that it must obtain. It can't serve its myriad regulatory functions solely with legal talent, although legal talent is certainly necessary.
Fiduciary Duties for Brokers
I agree with Chairman [Mary] Schapiro's statement that there should be harmonization of the standards that apply to those market professionals who act on behalf of customers. Brokers should not be held to paternalistic standards in some cases, however. For example, if a client utilizes a broker solely for execution purposes, and expressly disclaims any reliance on the broker's expertise in selecting the client's investments or determining its suitability, it seems hard to justify imposing an absolute obligation on the broker to refuse to execute the client's desired trade. As a general rule, however, those who manage the funds of others, and on whom their clients rely, should be subject to rigorous fiduciary standards and act in their clients best interests, whether they are denominated investment advisors or broker/dealers.
The Dodd bill directs the SEC to study the issue--but the SEC already has examined this issue, and calling for another study only delays action and expends valuable resources that could be devoted to critical problem areas. Mary Schapiro makes a significant point that, at the end of any study, the SEC will need to take action. Yet, neither the Senate nor House bill grants the SEC that authority. Before regulatory reform is enacted, the SEC should be given express authority to avoid lengthy litigation.
Virtually every SEC Chairman since 1934 has supported SEC self-funding, as did I, for several reasons. Self funding would:
-- Create flexibility to respond to unanticipated market developments;
-- Permit better market surveillance;
-- Enhance the SEC's technology resources;
-- Enhance the agency's ability to recruit individuals with relevant skill sets;
-- Put the SEC on a par with other financial regulatory agencies; and
-- Ensure the SEC's critical independence.
Harvey Pitt is a former SEC Chairman who's now the CEO of the global business consulting firm Kalorama Partners in Washington.