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Regulation and Compliance > State Regulation

State Advisor Landscape Snapshot

By Melanie Waddell

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The North American Securities Administrators Association released its first annual report in early May, providing a snapshot of state-registered investment advisors, their top exam deficiencies — including cybersecurity-related infractions — and the priorities of state securities regulators.

As it stands now, there are 17,688 state registered advisors, the report says — 44 more than last year — with 78% of state-registered advisors being part of shops with one to two people. The top five states with the most state-registered advisors are California, 2,998; Texas, 1,279; Florida, 1,099; New York, 876; and Illinois, 778.

The top five exam-deficiency categories for advisors last year, according to the report, were books and records, 64.6%; registration, 54.3%; contracts, 45.4%; fees, 27.2%; and custody, 27.2%. The report states that cyber-infractions “made its debut as a deficiency category and came in a close sixth place,” with state securities examiners reporting almost 700 cybersecurity-related deficiencies during 1,200 examinations of state-registered investment advisors in 2017.

The top five infractions were: no or inadequate cybersecurity insurance, no testing for potential cybersecurity vulnerabilities, inadequate procedures with securing or limiting access to devices, failure to retain an IT or technology consultant, and inadequate procedures related to hardware/software upgrades. Cyber is “always going to be a big issue for regulators,” explained Joe Borg, NASAA president and Alabama Securities Commissioner, at the group’s public policy event in Washington in early May.

Indeed, Robert Cohen, head of the Securities and Exchange Commission’s Cyber Unit (created last fall with 30 employees in five offices), told NASAA attendees that his unit is focused on three key areas: digital assets, trading-related cyber issues and cybersecurity. The regulator sees “more and more trading misconduct having cyber issues in it, and often that conduct is coming from overseas,” Cohen explained. As for cybersecurity reviews, these involve “controls at financial institutions that the SEC regulates and also cybersecurity issues at public companies,” he said.

NASAA’s Cybersecurity and Technology Project group created a cybersecurity checklist for advisors last year. The self-assessment lets small firms identify, respond and recover from cybersecurity weaknesses; it mirrors the National Institute of Standards and Technology (NIST) framework. According to its report, NASAA’s Cybersecurity and Technology Project Group will “continue to monitor the industry in the area of cybersecurity, develop and reassess practices and procedures.”

Cryptocurrencies to Stay?

The “idea of digital currency is probably here to stay,” Borg said, adding that “regulation always follows technology.” Blockchain “certainly is here to stay,” he continued.

“I think the cryptocurrencies, possibly down the road, backed by U.S. government control [and] proper IDs, might have some space,” he explained; initial coin offerings could serve as a way to raise funds, “assuming you comply with the securities laws, the commodities law and the money transmitter laws.

At some point, Borg surmised, “there’s going to be some regulation that says ‘here’s the path forward.’” He added: “I do think that digital currencies are here to stay, I just can’t say it’s the ones that are here now.”

Fintech as a disruptor is really “an evolution,” he said, stating that state securities regulators will be performing “basically the same jobs we’ve done with new tools” in a decade.

NASAA’s Project Group, in collaboration with the Operations Project Group, is now working to develop new tools for examiners that provide information for better assessment of unethical business practices, fiduciary duty and advertising, the report says.

The Project Group also conducted extensive research into investment advisor policies and procedures, including the need for more guidance regarding supervision, compliance, ethics and cybersecurity.

Another priority for state securities regulators this year, according to Borg, is voicing their opinions on the SEC’s new conduct standards — namely Regulation Best Interest, which “is a good first start,” but “has a long way to go.”

Borg and state securities regulators also will be watching H.R.5037, the Securities Fraud Act of 2018, which he told The New York Times “is going to put investors at not only a disadvantage, but deep in harm’s way.” He later explained to IA, “This is a prememption bill. You’ve got a clear preemption of any state action — securities regulators, state attorneys general, anybody.”

Types of Services Provided

While state advisors offer a wide variety of services, individual portfolio management tops the list (14,511), which the NASAA report states “makes perfect sense” given state advisors’ heavy focus on retail (82%) vs. high-net-worth (18%). A majority of advisors, the report adds, round out their practice by offering broader financial planning services (14,511).

Most state advisors (14,755) still charge their clients a fixed percentage of assets under management as their fee. Over half (9,868) also charge clients on an hourly basis for core or supplementary advisory services, while comparatively few charge a commission (839) or a fixed fee (672), the report states.

Wall Street Pads Congress’ Pockets Wall Street lobbying groups pumped $719 million in 2017 into fighting battles over cutting corporate taxes, rolling back consumer protections, and easing regulation of large banks, according to a report by Americans for Financial Reform. The AFR report notes that the 2017 figure puts Wall Street lobbying on pace to outstrip the record $2 billion it spent during the 2015-2016 campaign cycle.

The biggest spenders within the financial services industry include the American Bankers Association ($13.1 million), Citigroup ($5.9 million), Paloma Partners ($5.6 million), Goldman Sachs ($5.2 million), Renaissance Technologies ($5.6 million), and the Securities Industry & Financial Markets Association ($8.5 million), according to the 57-page report, “Wall Street Money in Washington.”

Lisa Donner, AFR’s executive director, told IA that “Wall Street shifted its campaign into a higher gear to reverse or undermine the [Labor Department’s] fiduciary rule the moment it saw an opening after the 2016 election. It is not surprising to see one of the industry’s biggest lobbying organizations ranking high on the list of groups that put millions of dollars into the political system.”

The report draws on a special data set compiled by the Center for Responsive Politics for AFR “in order to provide a more precise look at financial services industry spending.” As the data does not include “dark money” that goes mostly unreported, the actual sums of Wall Street spending are “surely much higher,” according to the report.

Historically, in the first year of a non-presidential election cycle, only 25% of contributions came in the first year, and lobbying expenditures don’t generally vary much over a cycle. “That pattern suggests the 2018 cycle will be, once again, a record-breaking example of Wall Street’s determined efforts to suffuse the political process with money — and get a payoff from its investment,” the report states.

The financial services industry reported spending $472,618,066 on lobbying in 2017, placing it in third place behind the “health” sector, which spent $555,010,906 and “miscellaneous business” companies and trade associations, which spent $503,758,285. —Melanie Waddell

Washington Bureau Chief Melanie Waddell can be reached at [email protected].

Melanie Waddell

@Think_MelanieW

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