The SEC’s examinations of independent advisors have become as rare as they are dreaded, thus adding potentially unfair pressure to the few who are scrutinized while disserving the public by letting most advisors go unaudited.
The only practical solution may be to privatize advisor audits, making them more frequent as well as more constructive and less prosecutorial.
So say former SEC chairman Harvey Pitt, now an attorney in private practice, and TD Ameritrade’s Skip Schweiss, who runs the custodial firm’s trust company and directs its advisor advocacy program.
In a panel discussion on advisor regulation at the MarketCounsel conference in Las Vegas, the two men agreed the current system is broken and beyond a practical repair given the agency’s current priorities and budget allocations.
Schweiss put the problem in perspective by noting the SEC has about 450 personnel devoted to advisor examinations, yet accomplishes just 1,000 audits a year.
“Something’s wrong with that picture,” the TD Ameritrade executive argued, suggesting that a “week in an advisor’s office” together with pre- and post-audit activities should presumably generate more activity.
But therein lies the problem, Pitt chimed in, noting that his clients are complaining about audits lasting months.
Pitt attributed the intensity and duration of the audits to the natural bureaucratic response to all the “bashing” the agency endured for not preventing the Madoff and other high-profile scandals.
“So they ask for more documents,” Pitt says. “And if they don’t go through all of [the material], they worry…someone else will see something after they finish their work and there’ll be a problem.
“We’re not going to get efficiency, and give the public what they want without moving to a different regimen,” he added.
The current model, Pitt continued, results in needlessly adversarial audits:
“The examination process should be a process to help firms, not to crucify them, helping them understand why their approach may not live up to the standards SEC would like to see. So much is riding on these 1,000 audits, that exams often become a precursor to enforcement actions.”
Schweiss spoke approvingly of legislation proposed by Rep. Maxine Waters, D-Calif., to fund more SEC audits through advisory firm-paid user fees, but he said the idea had “very little political viability.”
Pitt disagreed with the Waters proposal, saying the “money could be better used for advisors to select a truly independent expert, a compliance audit firm, as their designated biennial examiner”—echoing a proposal recently made by SEC Commissioner Dan Gallagher.
“No matter what the charges were for user fees, I think it’s not going to be possible for the fees to pay for enough people to get the kinds of examinations we want. That money is not as productive as going out and hiring, as public companies do, an audit firm to do an independent audit,” Pitt said.
Schweiss seconded the idea, showing the hundreds of advisors in the audience a chart showing how much the SEC’s budget has risen over the past decades even while its emphasis on advisor examinations has waned. “They don’t think you’re the problem,” Schweiss told the audience, “so they don’t dedicate resources to you,” citing former SEC chairman Chris Cox’s statement at a session earlier on Tuesday in which he noted that over 50% of the agency’s resources are devoted to securities markets enforcement actions.
In light of the agency’s current priorities and realistic budget considerations, Pitt called Gallagher’s third-party audit idea “the best, most viable alternative we have” to expand advisor exams from their measly thousand-a-year base.
“I know none of you want to be examined more often,” Pitt told the audience, but “I don’t think status quo is tenable.”
Another virtue of the idea, according to Schweiss, was that it “doesn’t require congressional authorization,” and so could be readily implemented if the industry organized to do so.
In another hot-button regulatory issue, the two men also agreed on the need for a common fiduciary standard applying to all advisors.
Pitt derided the notion heard in industry circles that there is a key distinction between broker-dealers and investment advisors.
“You regulate functions, you don’t regulate labels,” said the former SEC chair, noting that ordinary investors are never going to understand the difference and will expect that the firm to which they have entrusted their assets will be acting in their best interests.
“Instead of bickering over whether suitability is the equivalent of fiduciary, adopt a generic standard of the customer comes first,” a proposition to which Schweiss heartily responded “amen.”
The TD Ameritrade exec offered a pointed illustration, citing an SEC commissioner who gathered with staffers to watch the Super Bowl. A large brokerage firm ran a Super Bowl add touting the financial advice it provides its customers.
That was the talk of the office the next day, he said:
“How could they do that?” was the common cry in reaction to a firm that hides behind its brokerage affiliation so that it not be held to a fiduciary standard, yet lures customers with publicly prominent ads touting its financial advice.
And the answer given was that the firm could legally get away with that because it is dually registered, that is that the firm was merely advertising its registered advisory business.
But Schweiss was having none of it:
“Ask somebody who uses a full-service broker ‘What does he do for you?’ They’ll tell you he gives great advice, not just executes trades brilliantly.”
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