More On Legal & Compliancefrom The Advisor's Professional Library
- The Few and the Proud: Chief Compliance Officers CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations. When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.
- 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.
On April 25, 2012, Rep. Spencer Bachus (R-Ala.) and Rep. Carolyn McCarthy (D-N.Y.) introduced HR 4624, the “Investment Adviser Oversight Act of 2012.” The bill would authorize the SEC to designate one or more “national investment adviser associations” that would have broad authority to regulate and oversee thousands of investment advisory firms. Here are some questions—and answers—about this important legislation.
Q. Does HR 4624 specifically name FINRA as the investment adviser SRO?
A. No, but let’s be real: FINRA is the only viable option that has been identified. Rep. Bachus clearly contemplates that the SRO will be an offshoot of FINRA. FINRA is lobbying heavily in favor of the legislation in an effort to expand its revenue base and jurisdictional turf.
An economic analysis prepared by the Boston Consulting Group in December 2011 estimates set-up costs alone for a new SRO would be in the $255 million to $310 million range. An analysis of the bill prepared by the law firm Jorden Burt states that, “as a practical matter…the broad functions…that this bill envisions for an SRO will probably increase the resources required and discourage non-FINRA-related applicants for SRO status.” The bottom line is that no realistic alternative to FINRA exists. In fact, the 38-page bill largely mirrors the 1938 law that spawned the creation of NASD (which merged with the regulatory arm of NYSE in 2007 to become FINRA).
Q. How will the SRO fund its operations?
A. Through membership and other fees paid to the SRO. Trying to get a handle on all of FINRA’s current fees to its broker-dealer members is no easy task, and it’s a moving target. Last month, FINRA’s CEO Rick Ketchum notified his members that the “broader economic downturn continues to affect trading volumes and industry revenues, which in turn has led to a decrease in Finra's revenues and resulted in a significant loss for fiscal year 2011.”
As a result, FINRA is “proposing adjustments to a number of user-based fees,” which will include advertising reviews, corporate financing, new-member applications, a 25% increase in the trading activity fee and an unspecified “regressive tiered rate” for branch office assessments. Under HR 4624, the SRO would have broad authority to set the fees its members would have to pay to finance the SRO’s operations. My guess is that, at first, FINRA’s fees for an investment advisor SRO will be relatively modest. But over time, one should realistically expect the fees to go up and up…
Q. Which investment advisory firms will have to belong to the SRO?
A. Okay, stick with me here. First, all state-registered investment advisors must be members of the SRO (another part of the bill states that the SRO will not have authority to inspect advisors that are in states that have a program to inspect advisors at least every four years, but that doesn’t appear to negate the requirement to join the SRO).
The legislation is more complicated for SEC-registered advisors. It exempts two major categories of advisory firms.
First, an advisory firm with at least one mutual fund client is exempt from SRO membership (and would continue to be subject to SEC jurisdiction). Second, an advisory firm will be exempt from SRO membership if 90% or more of its assets under management is attributable to private funds, qualified purchasers (individuals with at least $5 million in invested assets or institutions with at least $25 million in invested assets), non-U.S. investors; other investment advisors and broker-dealers, or certain other types of institutional investors.
So if this bill became law, you could have two firms with virtually the same characteristics (AUM, number of employees, investment style, etc.), except that one has a small mutual fund client and the other does not. he one with the mutual fund would be exempt from SRO membership, the other would not. Under HR 4624, many larger advisory firms will likely be exempt from SRO membership. While there are no precise data to determine which firms are in and which are not, it seems safe to say that the thousands of advisory firms that must belong to the SRO generally will consist of smaller businesses.
As Professor Mercer Bullard has written, “the bill would impose a tax on small advisory businesses and, indirectly, the mainstream investors they advise, from which large advisors and their high net worth clients would be exempt.”
I have much more to say about this ill-advised legislation but for now, I’ve reached the word count that Jamie Green gives to me.
As always, I welcome your thoughts and feedback. And I hope that you will communicate your views on the Bachus bill to members of Congress.