More On Legal & Compliancefrom The Advisor's Professional Library
- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
- 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.
In case you missed it as you were preparing for the holidays, the Boston Consulting Group (BCG) released a report on December 15 that compares the costs of overseeing investment advisory firms by: (1) the SEC, (2) FINRA, the self-regulatory organization (SRO) for broker-dealers, and (3) a new SRO. The study was commissioned by the Investment Adviser Association (the organization that I head), the CFP Board, NAPFA, FPA, and TDAmeritrade Institutional.
The full text of the BCG report, along with a survey of investment advisory firms, is available on the IAA web site.
The debate about how to enhance oversight of investment advisory firms has been raging for some time. A year ago, the SEC issued a report required by the Dodd-Frank Act that suggests three basic Congressional options:
- authorize the SEC to collect user fees from SEC-registered IAs to fund their examinations
- authorize one or more SROs to examine all SEC-registered IAs; or
- authorize FINRA to examine dual registrants for compliance with the Advisers Act.
Until now, no one has come forward with any credible information about the costs involved.
The results of the BCG report are crystal clear: enhancing the SEC’s ability to inspect investment advisory firms is absolutely the most cost-efficient solution.
The report finds that FINRA or a new SRO would cost advisers at least twice as much as funding an enhanced SEC examination program. According to BCG, augmenting the SEC’s current examination program (to provide for comprehensive examinations of all advisory firms no less than once every four years) would cost $240 to $270 million per year. In contrast, the costs of FINRA establishing a examination and enforcement program for investment advisory firms (including the costs of appropriate SEC oversight) would be $540 to $610 million per year. Not
Here are three of my initial observations regarding this important report:
- According to the BCG report, the incremental cost of enhancing SEC oversight amounts to $100 to $110 million/year. Stated differently, this is the cost if investment advisory firms only had to pick up the tab for any additional SEC resources that would be needed to achieve a higher examination frequency rate (but would not have to pay for the SEC’s current level of IA examination resources). I believe this would be the most equitable solution for IA firms.
- FINRA immediately objected to the findings of the BCG report, calling the report’s estimate of FINRA costs as “wildly inflated.” I suppose it’s not surprising that FINRA would react negatively to any suggestion that potentially diminishes its prospects for expanding its revenue base. But FINRA should come forward with its own cost estimates so that policy makers and interested parties (including thousands of advisory firms that may have to pay FINRA membership dues) can review them. BCG clearly laid out its methodology and its estimate of FINRA’s costs may actually be on the low side.
- If you’re trying to figure out how much your firm might have to pay under any likely scenario, don’t forget that the draft legislation released last fall by Rep. Spencer Bachus (R-Ala.), chairman of the powerful House Financial Services Committee, takes the SRO approach instead of SEC user fees. You also should be mindful that the Bachus draft would exempt the largest advisory firms from SRO membership (if 90% of their assets are attributable to mutual funds, private funds, or very large clients). If this approach were to become law, the deepest pockets would continue to be subject to SEC oversight while the remaining smaller firms would have to pay any and all costs associated with SRO membership. We’re expecting to see another draft from Chairman Bachus in the near future and I would not be surprised if it exempts even more firms from SRO oversight (which would obviously drive up the per-firm costs of those who would have to pay for SRO oversight).
Stay tuned…it certainly will be another fun-filled year in Washington, DC!
As always, I welcome your thoughts and feedback.