From the April 2011 issue of Investment Advisor • Subscribe!

April 1, 2011

An Alternative to FINRA Oversight

More On Legal & Compliance

from The Advisor's Professional Library
  • 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.
  • Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communications—to clients, from clients, and about client accounts.  To comply with fiduciary obligations, communications must be thorough and not mislead.

Following the Securities and Exchange Commission’s release of the much-anticipated “Study on Enhancing Investment Advisor Examinations,” Investment Adviser Association Executive Director David Tittsworth wrote for AdvisorOne that while the number of SEC-registered advisors will temporarily fall, the number of SEC examiners will not keep pace with continued growth. As a remedy to the lack of resources, the SEC’s report suggests establishing one or more self-regulatory organizations to examine advisors. Alternatively, advisors could pay a fee to fund their examinations by the Office of Compliance, Inspections and Examinations (OCIE), or authorize FINRA to examine dual registrants for compliance with the Advisers Act.

“Whatever happens, I expect FINRA and its allies to continue to push to extend its jurisdiction to some or all investment advisors. SEC Commissioner Elisse Walter, a former FINRA executive, filed a separate letter expressing her disappointment that the SRO option was not cited more favorably in the report. SEC Chairman Mary Schapiro, who recused herself from the SEC report due to her former employment as head of FINRA, is likely to participate in further discussions when her two-year recusal period ends,” Tittsworth wrote.

The SEC, like any organization, likes to protect its own turf. OCIE does not desire to cut staff should it lose oversight of investment advisors. However, Congress is unlikely to be so receptive.

One possible outcome is that OCIE retains direct oversight over investment companies and their investment advisors, as well as indirect oversight over BDs and all RIAs—while shifting primary oversight for SEC-registered RIAs to FINRA. OCIE still would have its hands full with SRO oversight, private equity funds, credit rating agencies, and investment companies and their advisors, and this would permit OCIE to retain its staff.

FINRA’s lobbying prowess (and that of its members) should never be underestimated. As the old saying goes, “follow the money.”

While the ordering of the options was a surprise, all three options exist—and even more.

An SRO for RIAs is the second option, and it remains viable as an alternative to FINRA oversight.

Additionally, some of the language of the SEC’s report suggests other alternatives could be considered. For example, what about an SRO to compete with FINRA, which would be limited to certain BDs and RIAs who engage in financial planning and investment advice (and who eschew activities such as underwriting, acting as a dealer or market maker, clearing, etc.)? In this manner, BDs and RIAs could choose who to join. Also, SROs could compete in the marketplace. An SRO which has adopted a bona fide fiduciary standard of conduct for its members could advertise that its members “are governed by a higher standard,” for example (as long as such is true). Surprisingly, the SEC’s report did not point out the benefits of such a form of “regulatory competition.”

There are many paths present, going forward. One thing is for certain—this SEC report will not put to rest FINRA’s aspirations to expand its oversight to encompass all RIAs.

Keep up the good fight.

Ron Rhoades
Private Wealth Manager
Director of Research
Chief Compliance Officer
Joseph Capital Management LLC

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