More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- Nothing but the Best Execution Along with the many other fiduciary obligations owed by RIAs, firms owe a duty to seek best execution of clients transactions. If they fail to do, RIAs violate Section 206 of the Investment Advisers Act.
As the Jan. 21 deadline approaches for the Securities and Exchange Commission (SEC) to deliver its report to Congress regarding fiduciary duty and enhanced examinations for investment advisors, the Financial Industry Regulatory Authority (FINRA) is engaged in a full-court press to convince the SEC that it should be the SRO for advisors.
FINRA’s mid-November comment letter to the SEC regarding Section 914 of the Dodd-Frank Act, which mandates a study of BD and advisor standards of care, including enhanced exam requirements for advisors, laid out its case for how FINRA would be the ideal regulator to develop and implement a new exam qualification and continuing education program for advisors, as well as a program for specialized exams.
The report that the SEC will hand this month to Sen. Tim Johnson, D-S.D., the new chairman of the Senate Banking Committee, and Rep. Spencer Bachus, R-Ala., the new chairman of the House Financial Services Committee, will include the report mandated under Section 913 of Dodd-Frank, fiduciary duty, as well as harmonization of advisor and BD rules, including whether there should be an SRO for advisors.
Separate Rulemaking for Harmonization
Under Section 914, the SEC must determine whether it will seek Congressional authority to designate “one or more self-regulatory organizations to augment the Commission’s efforts in overseeing investment advisers.” However, “comprehensive harmonization,” an SEC official told me in an interview, will require a separate rulemaking that goes beyond a fiduciary duty rule.
FINRA argues in its comment letter that it’s the perfect candidate to create and implement an “investment advisor personnel qualification examination program,” because it already maintains more than 30 FINRA and New York Stock Exchange (NYSE) qualification exams and delivers more than 40 qualification exams on behalf of not only FINRA but the North American Securities Administrators Association (NASAA), NYSE, the Municipal Securities Rulemaking Board (MSRB), and the National Futures Association (NFA). FINRA has “been focusing on how it can leverage its existing programs, systems and procedures” to demonstrate why it should become the SRO for advisors, says Brian Rubin, a partner in the law firm Sutherland in Washington.
In creating a “qualifications program” for advisors, FINRA tells the SEC in its comment letter that the Commission should consider a program “tailored to the law, regulations, services and products” offered by advisors. “This structure would provide for the qualification and registration of investment adviser representatives (lARs) and supervisory personnel,” FINRA says. While the structure would “resemble FINRA’s model for broker-dealers,” the letter says, “there would be major differences in the content of the qualification examinations and CE programs to reflect the differences between broker-dealers and investment advisers.”
While Rubin is just one of many officials who believe that the SEC may choose FINRA as advisors’ SRO, the SEC official that I spoke with recently said that FINRA isn’t necessarily the only option. To be sure, the SEC is being very tight-lipped publicly about where it stands regarding fiduciary duty and an SRO for advisors.
An Advisor SRO a ‘More Costly Alternative’
FSI supports creating an SRO for advisors, unlike other industry trade groups like NASAA, the Investment Adviser Association (IAA), the Committee for the Fiduciary Standard, and Fiduciary360. Even the Investment Company Institute (ICI), the Managed Funds Association (MFA), and the American Institute of CPAs told the SEC in comment letters that an SRO for advisors is a bad idea.
David Tittsworth, executive director of the IAA, told the SEC in his comment letter that while the IAA agrees that investment advisor exams “should be bolstered,” IAA disagrees with FINRA “that an SRO is the most effective and efficient way of achieving this result.” Tittsworth went on to cite SEC Commissioner Luis Aguilar’s comments that an SRO “is an illusory way of dealing with the problem of resources. The issue is really one of hiring, training, and overseeing an adequate program to examine advisers… . [An SRO] would end up being a more costly alternative than if you simply provided the SEC with adequate resources.”
But having adequate funds is still a major issue for the SEC. The SEC has already deferred plans to launch a number of offices created under Dodd-Frank, like the whistleblower, credit ratings agency, investor advocacy and municipal securities offices, due to “budget uncertainty” (see sidebar).
The IAA also takes issue with FINRA’s statement that “an adviser SRO should have some rulemaking authority,” Tittsworth said, particularly given FINRA’s acknowledgement that the “concerns regarding investment advisers primarily relate to the lack of examination resources.” The SRO model, he continued, “with its emphasis on specific check-the-box rules, is not appropriate for the principles-based framework of advisor regulation.”
But there are still others like Aimee Toth, a lawyer in Pittsburgh who says she holds Series 7, 24, 63, and 65 licenses, who believe that FINRA, as an SRO, has the “greatest ‘hands on’ industry knowledge.” Toth, who says she has served as an enforcement attorney for a state securities commission, as well as chief compliance officer for a dually registered broker-dealer and RIA, told the SEC in her recent comment letter that FINRA should perform “overall examinations of broker-dealers, dual registrants, and ‘small’ RIAs.”
One area that needs further oversight, Bellaire of FSI says, is advisors’ advertising materials. Advisors affiliated with broker-dealers “are required to have their advertising and sales literature approved by the firm’s trained compliance staff,” he says. “When these materials discuss certain products (e.g., mutual funds or variable annuities) the advertisement must also be submitted to FINRA for review.” However, at your typical retail investment advisory firm, “the firm’s founder develops and approves his own advertising. The result is that advisors frequently run advertising material which would not pass professional compliance or FINRA scrutiny.”