The Advisor's Professional Library

Where Are We Headed?

January 1, 2012

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As this book goes to press, the question remains as to whether broker-dealers who give investment advice will be subject to the same fiduciary standard as RIAs. The Dodd-Frank Act did not resolve the issue of which financial services professionals will be held to a fiduciary standard. The law authorized the SEC to impose a fiduciary duty on registered representatives who provide investment advice to clients. Before doing so, however, the SEC was required to conduct a six-month study of the fiduciary issue as it applies to RIAs and broker-dealers. The SEC’s report recommended that a strict version of the fiduciary standard be imposed on broker-dealers. It also recommended that regulations be harmonized to achieve a more consistent regulatory regime.

According to Melanie Waddell’s December 9, 2011 posting on AdvisorOne, Mary Schapiro of the SEC indicated in an interview with Bloomberg that the Commission will publish a proposed fiduciary rule in 2012. Schapiro is quoted as saying that the fiduciary rule will be business model neutral, meaning that brokers working with retail investors will be permitted to charge commissions and sell proprietary products. The Dodd-Frank Act stated that charging commissions and selling proprietary products do not, by themselves, breach the fiduciary standard. Until that proposed rule is published, the fiduciary issue will remain unresolved.

Along with the fiduciary standard issue, we really do not know if state securities regulators will have enough resources to effectively regulate currently registered firms, as well as RIAs making the transition from federal to state registration. The level of oversight will certainly differ from state to state. In some states, examinations may be very intense to show RIAs that examiners mean business. State securities regulators may believe they need to send a message that non-compliance will not be tolerated.

The regulatory climate for RIAs will be significantly impacted by the SEC and state securities regulators’ budgets. Eileen Rominger, director of the SEC’s Division of Investment Management, summarized the problems in her prepared testimony before a Senate subcommittee on November 16, 2011. Based on her testimony, the SEC desperately needs enhanced examination resources to oversee investment advisors who are registered with the Commission. To obtain a stable and scalable source of funding, there are three options:

  • Imposing user fees on SEC-registered investment advisors to fund their examinations
  • Authorizing one or more self-regulatory organizations (SROs) to examine, subject to the oversight of the Commission, all SEC-registered advisors
  • Authorizing FINRA to examine dually-registered investment advisors and broker-dealers for compliance with the Investment Advisers Act

States securities regulators may also be looking for new sources of revenue to make up for budget shortfalls. Aside from user fees imposed on RIAs, states may quickly fine investment advisors who violate securities laws and rules.

In his testimony on November 16, 2011 before a Senate subcommittee, Carlo di Florio, director of the SEC’s Office of Compliance Inspections and Examinations (OCIE), testified that only eight percent of RIAs were examined in 2011, and 38 percent of SEC-registered investment advisors have never undergone an examination by the Commission. He told the Senate panel that OCIE will not have sufficient resources in the near or long term for effectively conducting timely examinations of RIAs, even with more advisors becoming state registered.

Although the number of SEC-registered investment advisors is likely to go down, the amount of assets they manage will be much higher. OCIE will also have new responsibilities, such as the registration and examination of previously-unregulated entities. For example, because of the Dodd-Frank Act, the SEC will now regulate municipal advisors. A municipal advisor is any person or entity providing advice to or on behalf of a municipal entity or undertaking a solicitation of a municipal entity with regard to municipal financial products, investment advisory services, or the issuance of municipal securities.

Compelling Reasons to Be Compliant

On November 9, 2011, the SEC announced that the Commission filed a record 735 enforcement actions during the fiscal year ending on September 30, 2011. Investment advisors and companies were the target of 146 enforcement actions—a thirty percent increase over fiscal year 2010.

According to a report from the North American Securities Administrators Association (NASAA) published on October 19, 2011, there were 3,475 enforcement actions during the previous year—a 51 percent increase in enforcement actions brought by state securities regulators. In addition, regulators initiated many investor protection actions by removing or barring investment advisors and registered representatives. In 2010, actions taken by state regulators resulted in 3,242 licenses being withdrawn, denied, revoked, suspended, or subjected to conditions.

It is doubtful that enforcement actions will decline in 2012, especially if fines become a new source of revenue for securities regulators. According to NASAA’s enforcement report, states levied fines or penalties of $171 million in 2010.

No matter how much the regulatory environment changes, RIAs can cope with these new developments by being committed to compliance. At every firm, the attitude toward compliance of the people at the top sets the tone for other advisory personnel.

It is very common for investment advisors to believe their job is finished after a document, such as a contract, has been approved from a compliance perspective. The problem with that approach, however, is that an RIA’s compliance obligations change as a result of new rules and regulations. Furthermore, as an RIA’s business model changes, the firm must address any new compliance risks. More than likely, the RIA will need to revise its Form ADV, policies and procedures, contracts, and other documents. As we saw in Advertising Advisor Services and Credentials, previously-approved website content may become misleading as an RIA’s strategy, personnel, and assets under management change.

Investment advisors should not be lulled into a false sense of security by having few issues arise during prior compliance examinations. A typical SEC deficiency letter warns RIAs that other compliance problems may exist, even though they were not pointed out in the document. Deficiency letters clearly state that RIAs should not assume they are in full compliance with federal securities laws or other applicable rules and regulations, even if their exam went smoothly. Many RIAs will be examined by a new regulator who might have a very different perspective on the quality of their compliance program.

Like quality improvement programs for other than advisory services, the process is ongoing. An RIA’s compliance program must be constantly evolving—addressing new regulatory challenges and protecting investors. Ultimately, an effective compliance program can help an advisory firm be more efficient and potentially increase customer satisfaction. In the end, that makes good business sense for an RIA.

Compliance and Ethics

The ultimate compliance goal is to help ensure that everyone associated with an advisory firm acts ethically at all times. In a speech at the NSCP National Meeting on October 17, 2011, di Florio said that ethics is fundamental to the securities laws and an effective regulatory compliance program. Mr. di Florio also stated that, “ethics are not important merely because the federal securities laws are grounded on ethical principles. Good ethics are also good business. Treating customers fairly and honestly helps build a firm’s reputation and brand, while attracting the best employees and business partners. Conversely, creating the impression that ethical behavior is not important to a firm is incredibly damaging to its reputation and business prospects. This, of course, is equally true for individuals, and there are plenty of enforcement cases that tell the story of highly talented and successful individuals who were punished because they violated their ethical and compliance responsibilities.”

As the story goes, Bobby Jones, the legendary golfer, was playing in the 1925 U.S. Open at the Worcester Country Club, and was getting ready to hit his shot, his club caused the ball to move ever so slightly. Jones called a two-stroke penalty on himself, even though no one else saw the ball move. He lost the tournament by one shot. When he was lauded for his honesty, Jones replied, “You may as well praise a man for not robbing a bank.”

The ideal investment advisor will follow Jones’ example. Advisors and RIAs should do the right thing, even when regulators are not looking over their shoulders.

Les Abromovitz

Les Abromovitz

Les Abromovitz is the author of The Investment Advisor’s Compliance Guide, published by The National Underwriter Company/ALM Media.

An attorney and member of the Pennsylvania bar, Les has handled hundreds of consulting and publishing projects for National Compliance Services,, a leading compliance and regulatory services firm. He has conducted a number of seminars and training sessions dealing with compliance subjects. Les is also the author of several white papers that analyze compliance issues impacting Registered Investment Advisors (RIAs)‎.

To contact Mr. Abromovitz, email or call 561-330-7645 Ext. 213‎.