State regulators like William Galvin in Massachusetts and Attorney General Eric T. Schneiderman of New York regularly make headlines for their oversight of broker-dealers and advisors and their actions against brokers who behave badly.
Meanwhile, California regulators have issued a brief report that shows the very limited level of reviews they are conducting.
In the fiscal year ended June 30, about 1% of the state’s roughly 24,430 investment advisor firms, broker-dealers and branch offices were examined.
The Department of Business Oversight conducted exams of 232 of the roughly 3,740 IA firms in the Golden State – or 6%.
But its review of the state’s 2,900 BD firms during the period covered only about 0.8% of them. Meanwhile, less than 0.1% of branch offices were examined.
The report shows the DBO is “way short of examining broker-dealers and only examines a minimal amount of investment advisors, based on the data,” said attorney Keith Bishop of Allen Matkins Leck Gamble Mallory & Natsis, in an interview.
On the other hand, “You can look at the data and say the glass is half full, since they are making progress,” explained Bishop, who was head of the state’s Department of Corporations in the mid-1990s.
A year earlier, the office examined only 0.3% of the state’s 24,720 licensed securities entities. Thus, the number of examined licensees rose from 72 to 269 — a roughly 375% increase.
“The bigger questions are: Is it cost effective for state to be doing more examinations, and how should it be doing them?” Bishop asked.
While cost effectiveness is “in the eye of the beholder,” more examinations “would be a benefit to investors,” according to DBO spokesman Tom Dresslar.
The regulatory office is “making progress,” Dresslar said in an interview, pointing to the fact that is has done 232 examinations in the first seven months of the current fiscal year, which puts it on track to top last year’s 269.
According the DBO, which is led by Commissioner Jan Lynn Owen, of its 269 exams, 10 cases were referred to its enforcement division for license revocation due to violations.
“The remaining 259 examinations identified various violations for which the licensees took corrective action to bring themselves into compliance,” the report stated.
The report’s finding show that the number of IA firms rose by 26, or 1%, to 3,737, while the total broker-dealer population dropped by 74, or 2.5%, to 2,906. At the same time, the number of IA representatives is growing. It stood at 52,580 as of June 30.
The BD agent population is expanding as well and is roughly 286,150.
California’s Department of Business Oversight has 66 employees and seven open positions in the broker-dealer investment advisor program. The regulator has allocated 47 staff members to examinations, seven to licensing and 19 to program support.
“Approximately 15% of our examination time is dedicated to risk-based exams,” Desslar explained. “Whenever we get a referral from [the Financial Industry Regulatory Authority] or the [Securities and Exchange Commission], that goes to the top of the pile, as is the case when we receive a consumer complaint. In other words, we prioritize based on risk-based analysis.”
Based on current information, the DBO estimates that at least 256 additional examiners are needed for it “to meet expected four-year examination cycle requirements.”
Such a move “means a huge increase in personnel,” says Bishop. “What should the DBO be doing, what should its goal be? The report does not address these matters.”
According to Desslar, a four-year exam cycle is not a statutory mandate for the DBO, although this goal was outlined in a bill two years ago. “We have no [mandatory] four-year cyle,” he said. “There’s no such thing.”
The current 2016-17 budget is $27 million for the department’s BD and IA oversight work.
The state has been giving the office more funds, Desslar says, so it could add 36 positions over the past two fiscal years and hopefully another 15 in the upcoming two fiscal years.
Still, he acknowledges that the department has “a long way to go to get the staffing levels we need to do an even better job.”
— Check out SEC’s Top 5 Advisor Compliance Failures on ThinkAdvisor.