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.
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
House Financial Services Chairman Spencer Bachus reintroduced in late April his draft bill calling for a self-regulatory organization (SRO) for advisors. The same day, the Financial Industry Regulatory Authority (FINRA), the potential lead candidate in assuming the SRO role, released its projections on the costs of examining advisors, which was far below projections released by the Boston Consulting Group (BCG).
Bachus said that his draft bill, which he introduced with Rep. Carolyn McCarthy, D-N.Y., is in response to an SEC study that revealed the agency lacks resources to adequately examine the nation’s nearly 12,000 registered advisors. As part of its study, which was a requirement of the Dodd-Frank Act, the SEC recommended an SRO for Congress to consider as it looks for ways to help the agency monitor the industry.
The Investment Adviser Oversight Act of 2012 would authorize “one or more self-regulatory organizations for investment advisors funded by membership fees.”
The two lawmakers noted in introducing the proposed legislation that investment advisors and broker-dealers “often provide indistinguishable services to retail customers, yet only 8% of investment advisors were examined by the SEC in 2011, compared to 58% of broker-dealers.”
Said Bachus: “Bad actors will naturally flow to the place where they are least likely to be examined. Therefore, it is essential that we augment and supplement the SEC’s oversight to dramatically increase the examination rate for investment advisers with retail customers.”
The legislation would amend the Investment Advisers Act of 1940 to create National Investment Adviser Associations (NIAAs), registered with and overseen by the SEC. Investment advisors who conduct business with retail customers would have to become members of a registered NIAA, and the SEC would have the authority to approve the registration of any NIAA.
The proposal also preserves states’ authority granted in the Dodd-Frank Act over investment advisors with less than $100 million in assets under management, so long as the state conducts periodic on-site examinations.
Reactions to the proposal were swift and varied. David Tittsworth, executive director of the Investment Adviser Association (IAA), said that IAA “strongly opposes this ill-advised legislation that is intended to expand” FINRA’s jurisdiction. “Outsourcing the SEC’s critically important role in regulating and inspecting investment advisory firms is not the right solution, particularly when FINRA has demonstrated its lack of accountability, lack of transparency and poor track record.”
Dale Brown, president and CEO of the Financial Services Institute (FSI), said that from a business standpoint, “retail investment advisors have an unfair advantage over independent broker-dealers, who are examined by FINRA every two years. It’s time to protect investors and level the playing field.”
FINRA released a statement just after the proposal was released stating that the “bipartisan bill […] is an important and thoughtful effort to address a serious gap in investor protection. The bill recognizes the need for regular exams of investment advisers, while rightly focusing on retail accounts.”
The same day, FINRA released its projections for assuming an SRO role. Covering a universe of 14,500 advisory firms out of the current population of more than 26,000, FINRA estimates that its one-time startup cost would be approximately $12 million to $15 million, while its ongoing costs would total approximately $150 million to $155 million annually. This compares to BCG’s startup investment projection of $200 million to $255 million and an ongoing cost of $460 million to $510 million.
FINRA says it used the 14,500 advisory firm total in an attempt to reflect an approximate number of firms that could be subject to SRO examinations, given that Bachus’ pending SRO legislation “provides exemptions for IAs with institutional customer bases as well as for state-regulated IAs for which examinations are conducted by state regulators an average of once every four years.”
The problem with BCG’s cost projections, FINRA said, is that it based its startup cost estimates on firms that were starting from scratch. “BCG used these figures—set-up costs for organizations that didn’t even have one desk or employee to start with—and provided for only a 20% discount off the from-scratch startup costs to allow for efficiencies in FINRA’s existing infrastructure,” FINRA said.
The annual ongoing cost, FINRA said, reflects the full staffing estimate, “even though the staffing is unlikely to be complete in the first year.” This ongoing cost estimate also includes overhead and support costs for examinations and enforcement, FINRA said. However, “it does not include costs for testing, advertising review or dispute resolution,” FINRA said. “If Congress or the [Securities and Exchange] Commission determine that those functions should be included, then the annual ongoing investment would increase by approximately $10 million.”
In addition, FINRA says “BCG used existing FINRA regulatory and user fee totals to estimate examination program costs. [...] Secondly, they used current SEC numbers to estimate the number of annual exams per examiner, which is less than current FINRA ratios.”
But the Financial Planning Coalition says FINRA’s estimate “lacks any analysis, backup assumptions or data, [compared] with the comprehensive, 38-page BCG study” released in December 2011. BCG’s data, the Coalition says, “utilized publicly available data, including FINRA’s actual costs and the SEC’s actual IA examination costs, and was based on rational and fully disclosed assumptions.”
FINRA, the Coalition says, shows “no accounting for enforcement costs, which are required under the Bachus-McCarthy legislation and which BCG estimated at $130 million annually. They also left out the cost estimates for the legally required oversight by the SEC, which BCG estimated at $90 [million] to $105 million annually and which is an essential component of the overall cost of an SRO.”
The Coalition concludes that when FINRA’s “very brief cost estimates are set beside BCG’s comprehensive Economic Analysis, we are not comparing apples to apples.” FINRA’s estimate “raises more questions than it answers. The limited budget that they attribute to setting up a FINRA IA-SRO raises concerns about its independence and ability to understand and meet the unique needs of IAs and their clients.”