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.
- 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.
The SEC released its Dodd-Frank-mandated “Study on Enhancing Investment Adviser Examinations” late Wednesday, along with a very unusual statement, about the Study from SEC Commissioner Elisse B. Walter.
In what is most akin to a dissent opinion from a Member of the Supreme Court, Walter who is “quite disappointed,” in the Study recommendations, has offered an additional voice from the SEC and insight into the defining paradox that the SEC finds itself in. It is being called upon to gear up to oversee and register many additional entities, and conduct many additional tasks, but the funding it receives has been cut from what was promised in Dodd-Frank. And this is political, not deficit-cutting.
Funding Cut From Authorized 2011 level
The SEC receives an annual appropriation from Congress that is a subset of the fees the SEC takes in and must hand over to the Treasury each year. In some years, the SEC receives hundreds of millions of dollars less in its appropriation from Congress than it takes in. Both Walter and Commissioner Luis A. Aguilar are on the record about the stranglehold lawmakers have on the agency when it comes to the funding issue. Other agencies such as the FDIC, etc., are “self-funded,” meaning they keep the fees they take in from those they oversee. Not the SEC.
What makes the yearly congressional appropriation issue worse is that the SEC cannot make multiyear budget plans—for instance to upgrade technology or hire more examiners—if it doesn’t know what its funding will be from year to year. “The fact that the Commission is not currently receiving the funding previously authorized in the budget is having very significant consequences for the Commission overall and for OCIE,” says Walter (left) in her statement.
What’s more—if the SEC were allowed to be “self-funded” this would not add a penny to the U.S. deficit or budget; the SEC already makes much more in fees than gets in its annual appropriation. What the annual congressional appropriation does is allow for Congress to starve the SEC of resources, allowing the flow of funding to be a proxy for the amount of regulation that the agency is able to perform. So the SEC becomes victim to whatever way political sentiment blows.
While Dodd-Frank requires numerous implementations for the SEC: studies, rulemakings, reports — according to a SIFMA estimate, 124 “actions” as a result of Dodd-Frank—the millions of dollars in funding promised in that legislation to help the SEC conduct these actions has been withdrawn, as has the 2011 budget appropriation. The SEC is back to its 2010-level funding, at least through March, Walter notes.
At the same time, Walter’s statement says, the SEC is required to oversee many more, larger and more complex or “high risk” entities, including an estimated 1,000 “municipal advisor” firms and potentially 20,000 individual advisors; examinations of “private fund advisors such as those advising hedge funds and private equity funds;” and “clearing agencies;” as well as, “annual examinations of credit rating agencies,” registration and oversight of “security-based swap dealers, major security-based swap participants, and security-based swap data repositories;” and exams in response to the “whistleblower” program.
The funding issue is not new, but may be more acutely felt now; as Walter states: “I believe that the Commission is not, and, unless significant changes are made, cannot fulfill its examination mandate with respect to investment advisers.”
“An option relying on industry funding seems the most likely to provide a solution, and the options set forth in the study support this,” she adds. This means advisors are likely to pick up the tab for their exams. Some investment advisors, speaking in off-the-record meetings, have said they were willing to do this, and would use the more-frequent exams as they would a consultant, and implement the examination’s recommendations as they would best practices.
Boosting Exam Numbers
The Study recommends three options to boost the number of advisor examinations:
“(1) imposing user fees on SEC-registered investment advisers to fund their examinations by OCIE; (2) authorizing one or more SROs to examine, subject to SEC oversight, all SEC registered investment advisers; and (3) authorizing the Financial Industry Regulatory Authority (“FINRA”).”
Walter favors the SRO and user fee options, stating: “In addition to providing OCIE with the resources to perform more frequent examinations of investment advisers, they would both enable it to improve and modernize its investment adviser examination program. They would also provide the adviser examination program increased flexibility to reach developing and emerging risks associated with advisers and to direct staffing and strategic resources. Significantly, they both would provide a more facile capability to develop and employ needed technology to strengthen the examination program. The result of these improvements would be a greater level of deterrence of wrongdoing. In addition, under the SRO option as well as user fees, the cost of regulation would be shifted to the advisers themselves.”