Forget Advisor SRO; Use External Auditors for Exams, Academic Study Urges

Angel argues in his paper that an SRO could take on two “extremes”: it could become a “’selfish regulatory organization’ that functions as an industry cartel to the detriment of the consumer.” Or it could become “an off-budget government agency with neither the industry expertise nor the checks and balances of the political system.” Because of FINRA’s long history of regulating broker-dealers, Angel opines that “it’s doubtful that the procedures and culture of FINRA would provide optimal regulation of advisory firms.”

What’s more, he says, the United Kingdom has abandoned the SRO model and turned over such responsibility to government agencies.

Angel concludes that because it’s unlikely the SEC will devote more resources to “routine examinations” and the “problems” with SROs, routine advisor exams should be “outsourced to third parties.”

Qualified third parties to perform the external compliance reviews would be:

• PCAOB registered accounting firms;
• Self-regulatory organizations such as FINRA or national stock exchanges;
• Compliance consulting firms with qualified personnel;
• Qualified individuals acting as compliance consultants;
• Other RIA firms as part of a peer review process similar to that used in the accounting profession.

“The report from the external auditors would get filed with the SEC, and then the SEC would step into action,” if need be, Angel told AdvisorOne. Use of external auditors “would leverage SEC resources so they can go after bigger fish.”

Angel explained that the audits would verify information on Form ADV and verify that the firm has procedures in place to comply with U.S. securities laws. The frequency and depth of the exams, he said, would be based on a risk-adjusted basis. Smaller firms “with a clean regulatory history,” Angel says, would be subject to less frequent audit requirements than “larger riskier firms.” This, he says, “would free up SEC resources to conduct higher-level for-cause examinations.”

As for the cost of an SRO, Angel notes that because approximately 72.1% of FINRA’s operating revenue comes from broker-dealer user and regulatory fees, this means that the assets in place related to broker-dealer regulation are approximately $455 million, or about $718 per representative. This implies, he goes on to say, that an SRO would need to have assets of about $198 million to oversee the approximately 275,000 advisor representatives.

When asked by AdvisorOne if he consulted with lawmakers about the idea of external auditors examining advisors, Angel said he did not.