From the March 2016 issue of Investment Advisor • Subscribe!

The SEC's Priorities in a Tricky Year

New commissioners, potential fiduciary proposal and third-party audits are highlight of agency's docket

Securities and Exchange Commission Chairwoman Mary Jo White said in recent remarks that 2016 should be a “very busy” year for the agency in terms of rulemaking, including forthcoming proposals for a uniform fiduciary rule for brokers and advisors as well as a plan to require advisors to get a third-party audit.

Some industry observers have questioned whether a fiduciary rule proposal would actually come out during White's time as SEC chair, given that a new administration will come to Washington next year. (Word is that a third-party audit rule proposal will be out this spring.)

White has publicly stated that she supports the agency moving forward on a fiduciary rule for brokers, and former SEC Chairman Harvey Pitt told me recently that he believes the agency is further along in devising such a proposal than many observers think.

Pitt also believes White could likely stay on — and thus continue pushing a fiduciary plan — regardless of which party wins the White House since she's a “true independent, not a Democrat (or Republican) masquerading as an independent.”

When White was U.S. attorney for the Southern District of New York, from 1993 to 2002, “I believe her tenure was continued for some period of time with the change in administrations,” Pitt said, “and I would not rule that out with White, if she wanted to continue” as head of the SEC.

By the same token, he said, if a Democrat won this year, that wouldn't “mean that White would necessarily be continued until a successor was selected, or that she would be willing to serve in that capacity.”

There's still a chance, too, that White could leave right after the election. She complained in a recent Q&A discussion that the constraints put in place by the nearly 40-year-old Sunshine Act (a topic IA examined in its December 2014 cover story, “The SEC Is Broken”), which prohibits a majority of the agency's commissioners from collaborating on policy issues, has had “more of an impact than I was anticipating.”

White noted that the agency must post the Sunshine Act notices in advance of rulemakings, as the agency is required to discuss them “at an open meeting.” However, “what that actually means in practice, and the SEC really is quite a strict adherent to the requirements, is that neither I, nor any of my fellow commissioners, my other four fellow commissioners, can talk to more than one of each other at a time.”

Added White: “So what you see with envy, frankly, at least I do as chair, is some old photographs with the five commissioners sitting around a table discussing issues, business and policy. We can't do that anymore. It's really a lot of shuttle diplomacy, and I think the transparency piece is great and important,” she said, though she also pointed out that “it isn't built for efficiency and clear communications as I — you’d — like to see.”

As to White's potential departure, Pitt said the “logical thing to anticipate is that any president should consider himself or herself fortunate to have her stay on, irrespective of that president's political affiliation,” as “the issues the SEC confronts aren't ‘Republican’ or ‘Democratic’ issues, but rather issues of investor protection.”

Confirmation Hearings; Third-Party Exams

Sen. Richard Shelby, R-Ala., chairman of the Senate Banking Committee, is expected this month to hold confirmation hearings for the two new SEC commissioners, Hester Peirce (a Republican) and Lisa Fairfax (a Democrat). The death in mid-February of Supreme Court Justice Antonin Scalia, however, could stall such hearings.

While third-party advisor exams will complement SEC exams, the Investment Adviser Association complains such exams will only add to advisors’ compliance costs.

The SEC is hoping that third-party advisor audits will remedy the advisor exam shortfall. That's the case even though the commission plans to shift about 100 of its examiners from broker-dealer exams to advisor exams, and that the SEC would get a budget increase from President Barack Obama's last budget request to Congress. Obama's $4.1 trillion plan for fiscal 2017 would double funding for the SEC by 2021, with the SEC getting an 11% increase to $1.8 billion in 2017.

The SEC would use the 11% increase above the enacted 2016 level to hire 250 additional staffers, including 127 new examination staffers, of which 102 would be added to examine investment advisors and investment companies.

The 102 additional examiners would be in addition to the 100 examiners that the agency is looking to shift from broker-dealer exams to advisor exams. With the additional examiners, the SEC hopes to increase its advisor exam rate (which currently stands at 10% of advisors per year) to 12%.

Helping spearhead these changes in advisor exams will be Jane Jarcho, who was named in late January the deputy director of the SEC's Office of Compliance Inspections and Examinations (OCIE). She retains her previous post as national director of investment advisor exams.

Regarding the shift in examiners, David Tittsworth, counsel with Ropes & Gray and former president and CEO of the Investment Adviser Association, said that while it will “take some time to effectuate the shift from the BD inspection program, to train the examiners and to have the program up and running,” such a shifting of examiners “should result in a significant increase in the frequency of IA examinations.”

The Costs, and Benefits, of Third-Party Exams

Former SEC Chairman Pitt, who championed the third-party advisor audit concept during his time at the agency, said that “utilizing third-party compliance ‘audits’ will enable the public to take some comfort from the fact that the largest financial services firms will be examined yearly, and the rest of those firms will be examined either every other year, or every three years,” a “dramatic improvement.”

But Bob Grohowski, the general counsel at IAA, and Sanjay Lamba, IAA's assistant general counsel, maintain that “however well-intentioned” the third-party exam initiative may be, smaller advisors “would likely pay between $10,000 to $15,000 per engagement for even the most limited type of third-party engagements.”

The two wrote in a recent blog post that these costs “could increase exponentially (e.g., $50,000 to over $100,000) as the size and complexity of the advisor increases,” with “more comprehensive reviews” costing much more. “This alone is a potential game changer, particularly for the smaller firms that constitute the vast majority of investment advisors.”

Costs for third-party exams, the two wrote, “would be in addition to all of the other costs of compliance, including what many advisors already pay to engage third-party firms for various other reasons — for example, to help improve compliance programs, assist with or conduct required annual reviews, or conduct audits as part of a client's due diligence.”

Many advisors, the two argued, “have finite resources” to devote to compliance, and managing the rising costs of compliance is, “in effect, a zero-sum game,” with any “costly” third-party exam requirement cutting into advisors’ existing compliance budgets.

To pay for mandated third-party exams, the two said, advisors might “stop engaging consultants to address ad hoc compliance issues and devote fewer resources to staff training for routine but lower-risk compliance areas.”

--- Check out "SEC Would Add 102 New Advisor Examiners Under Obama Budget" on ThinkAdvisor. 

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