Internal Changes at SEC’s Exam Division

As uncertainty remains in the debate over whether a self-regulatory organization (SRO) should oversee advisors—and a new option of using outside auditors for advisor exams in lieu of an SRO was recently thrown into the mix by a Georgetown professor—changes are afoot within the Securities and Exchange Commission’s exam division.

While those in the advisory world—including trade groups that are lobbying heavily against an SRO for advisors—agree that oversight of the advisory industry needs to improve, the question remains exactly how this “improvement” will occur and whether legislation calling for an advisor SRO to boost the effort will actually come to fruition.

The former associate director and general counsel at OCIE, John Walsh, gave me some telling insights into what he thinks may occur. Walsh, who lived through the Madoff years at OCIE and is now a partner with the law firm Sutherland Asbill & Brennan in Washington, told me that the SEC staff study under Section 914 of Dodd-Frank summed up the SEC’s examination shortfalls really well. As the study noted, he said, “there’s a serious mismatch between the requirements that the [SEC] exam program is expected to meet and the resources that are available to it.” Looking at the current situation at OCIE, he said, “there probably is some role for self-regulation” of advisors via an SRO because “raising the money needed for user fees or [boosting] the SEC’s budget is going to be problematic in the current [political] environment.”

The bottom line, Walsh said: “Something has to be done, that’s pretty clear.”

Yet another insightful comment on the SRO debate came to me recently from David Tittsworth, executive director of the Investment Adviser Association (IAA) in Washington, who says that he expects the House Financial Services Committee to consider “in the near future” SRO legislation proposed by the committee’s chairman,  Rep. Spencer Bachus, R-Ala. Bachus’ bill would shift oversight of advisors to the Financial Industry Regulatory Authority (FINRA) or another private regulator, except for certain advisors whose assets under management are concentrated in mutual funds, private funds or large clients.

As it stands now, “there does not appear to be any current appetite” for mandating third-party compliance audits of advisory firms, as put forth in a recent white paper by James Angel, the Georgetown University professor who studied the issue with backing from TD Ameritrade, Tittsworth says. Rather, the main alternatives being debated on Capitol Hill are increasing the SEC’s resources or expanding FINRA’s jurisdiction to investment advisors.

The Letter and Spirit of Compliance

Given its lack of resources, however, OCIE is moving forward with enhancements to its examinations program. Carlo di Florio, director of OCIE, laid out at a recent conference some central components to OCIE’s new National Exam Program (NEP). Di Florio said that because ethics is fundamental to securities laws, “ethical cultural objectives should be central to an effective regulatory compliance program.”

That’s why when NEP staff examines an advisor’s adherence to its fiduciary obligations or a broker-dealer’s effective development, maintenance and testing of its compliance program, examiners are assessing “how well firms are meeting both the letter and spirit of these obligations,” he said. What’s more, OCIE examiners also “examine specific requirements for ethical processes, such as business conduct standards.”

The “ethical environment” within an advisory and BD firm is also central to OCIE’s new emphasis on risk-based examinations, di Florio said. “How we perceive a registrant’s culture of compliance and ethics informs our view of the risks posed by particular entities.” In this regard, he said, OCIE has begun meeting boards of directors, CEOs and senior management to share perspectives on the key risks facing the firm, how those risks are being managed and the effectiveness of key risk management, compliance, ethics and control functions. This, he said, “provides us an opportunity to emphasize the critical importance of compliance, ethics, risk management and other key control functions, and our expectation that these functions have sufficient resources, independence, standing and authority to be effective in their roles.”