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- 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.
The Securities and Exchange Commission should “reallocate its existing resources” in order to boost the number of investment advisors that it examines, as the agency allocates a “disproportionate amount of resources” to policing broker-dealers, the Investment Adviser Association told SEC Commissioner Daniel Gallagher in a letter on Monday.
In the letter — which was also sent to SEC Chairwoman Mary Jo White as well as the three other commissioners — David Tittsworth, president and CEO of IAA, noted comments that the GOP commissioner Gallagher made in a May 9 speech regarding the agency’s failure to find misconduct by advisors as quickly as it finds misconduct by BDs “because the SEC allocates a disproportionate amount of resources to policing the activities of broker-dealers when compared to those we [the SEC] expend policing investment advisors.”
While Tittsworth said that IAA agrees that the SEC “expends significant resources” on broker-dealer oversight, which is in addition to the resources BDs’ primary regulator, the Financial Industry Regulatory Authority, devotes to the same activities, IAA urged the agency to “consider reallocating its existing resources” in order to boost advisor oversight, “which the agency could accomplish without additional legislation or rulemaking.”
Gallagher had suggested in the May 9 speech as well as in comments at FINRA’s annual conference in mid-May that the SEC should consider fixing the exam imbalance by allowing third-party advisor exams — including, “potentially, defining the term ‘third party’ to include” self-regulatory organizations like FINRA.
IAA has been a staunch opponent of FINRA gaining oversight of advisors.
Gallagher argued that while FINRA helps the SEC oversee 4,300 BDs, the commission has no help from an SRO like FINRA to help it examine the 11,100 advisors. This lack of help on the advisor side, Gallagher said, is the main reason why the SEC is failing to catch more advisor wrongdoers.
But Tittsworth challenged Gallagher’s assertion, stating in the letter that the “differences relating to the number of SEC-registered advisory firms and SEC-registered broker-dealer firms do not tell the whole story.”
For example, Tittsworth said that the SEC’s examination of investment advisory firms “covers a significant percentage of total assets under management each year, that [the SEC’s Office of Compliance Inspections and Examinations] OCIE conducts analysis of all investment advisors on an ongoing basis, which informs the risk-based determination of which firms to examine, and that the total number of SEC-registered investment advisors is overstated due to the existence of separate legal entities that essentially operate as a single business.”
Said Tittsworth: “Instead of utilizing apples-to-oranges comparisons, it would be more productive to focus on ways to improve the SEC’s investment advisor examination program to achieve a higher level of investor protection.”
While augmenting the SEC’s advisor exam program with third-party audits is “worthy of debate,” Tittsworth said in the letter, IAA is “concerned, however, about the potential disadvantages of third-party examinations as compared with SEC examinations.”
Such issues include the standards to be applied in such examinations, the scope and frequency of any such examinations, the qualification and SEC oversight of third parties, confidentiality and the cost to advisors, Tittsworth said.
He suggested that the agency consider assessing the types of voluntary third-party reviews that investment advisory firms currently employ, which includes financial audits, internal control reports by third parties, compliance reviews by third parties, mock audits and internal audits.
“Before engaging in any rulemaking that would require SEC-registered advisory firms to undertake an examination or other review by a third party, it would be helpful to understand what practices are already undertaken, how such practices are utilized, the types of third parties retained and the costs involved,” Tittsworth said.
Tittsworth also suggested that OCIE draw on "the unique regulatory and policy expertise" of the SEC’s Division of Investment Management and the risk identification capabilities of the Division of Economic and Risk Analysis to help in boosting its advisor oversight.
Tittsworth told ThinkAdvisor on Tuesday that advisors will be voicing their support to lawmakers during IAA’s Lobbying Day on Thursday for Rep. Maxine Waters’, D-Calif., bill, the Investment Adviser Examination Improvement Act of 2013, which would allow the SEC to collect user fees to fund advisor exams. “It is certainly possible,” he said, “that other issues, including third-party examinations, could come up” during advisors’ discussions with members of Congress.