SEC Publishes Report about RIA Oversight

Before outlining its three recommendations, the SEC’s report highlights how the current oversight process is struggling:

• Between October 1, 2004 and September 30, 2010, the number of RIAs increased 38.5%, from 8,581 advisers to 11,888 advisers. 
• In the same period, the number of SEC staff dedicated to examining RIAs decreased 3.6%, from 477 staff to 460 staff, falling as low as 425 staff at certain points in 2008. 
• The number of examinations of RIAs conducted each year between 2004 and 2010 decreased 29.8%, from 1,543 examinations in 2004 to 1,083 examinations in 2010. 
• The percentage of RIAs examined each year has decreased over the past six years. While 18% of RIAs were examined in 2004, that fell to 9% in 2010. At the rate that RIAs were examined in 2010, the average adviser could expect to be examined less than once every 11 years, compared to approximately once every six years in 2004. 

The study also said that as a result of Title IV of the Dodd-Frank Act— the Private Fund Investment Advisers Registration Act – the report predicts a decline in the number of RIAs, which could likely result in the remaining RIAs being more thoroughly examined.  (The report drew this conclusion based on similar results after the enactment of the National Securities Markets Improvement Act of 1996.) The amount of any potential increase in examination frequency, however, may be offset by the need to divert resources to fulfill new examination obligations that the Commission was given by the Dodd-Frank Act. 

The study recommends that Congress consider three options that would strengthen the SEC’s ability to conduct thorough oversight of RIAs. They are:

• Imposing user fees on SEC-registered investment advisers to fund their examinations
• Authorizing one or more SROs to examine, subject to SEC oversight, all SEC-registered investment advisers
• Expanding the jurisdiction of the Financial Industry Regulatory Authority (FINRA) to examine dual registrants for compliance with the Advisers Act (along with the Exchange Act as they currently enforce).

The arguments supporting the user-fee idea center on its simplicity.  The fees can be scalable depending on changing circumstances; the fees can be solely used for improving and expanding the Commission’s existing oversight program; many other federal agencies have user-fees (three examples given were inspections of banks conducted by the Office of Comptroller of the Currency, examinations of credit unions by the National Credit Union Administration, and inspections of nuclear facilities by the Nuclear Regulatory Commission); and it would be less expensive and less complicated than forming a new SRO–this would improve procedures already in place.  

A self-regulatory organization (SRO)–a privately funded entity with market-specific expertise that, subject to Commission oversight, can have the authority to adopt rules, examine member firms for compliance and enforce those rules and laws–has been debated vigorously from different corners in the industry.  The report noted that “proposals to create one or more SROs for investment advisers have been considered by Congress, the Commission and members of the investment advisory industry for over 45 years.” 

An SRO would be funded by user-fees and would require oversight from the SEC, which as the report discussed, is badly in need of strengthened resources already. The report recognized that an SRO could increase the frequency of examinations–in 2009, FINRA examined 54% of its registered broker/dealers; in 2009, the SEC examined 11% of RIAs.   

Creating an SRO is complicated due to the vast diversity in the investment adviser industry, as well as strong opposition among advisers, the report said.  Some in the industry have suggested multiple SROs that can be divided in consideration of advisers’ varied practices; one SRO could cover financial planners working in small, local practices, another could regulate money managers working for large global firms.  However, multiple SROs would be very expensive, the report noted.

Arguing for the expansion of FINRA, the report states: “Authorization of FINRA to enforce the Advisers Act would free existing Commission resources spent examining dual registrants to be re-directed to other investment advisers. Moreover, it would partially address the inefficiencies that result from subjecting a dual registrant to two separate examinations, one by FINRA and the other by [SEC]. Finally, it would permit a single regulator (FINRA, subject to existing SEC oversight), having obtained a more holistic view of dual registrants’ client activities and compliance environment, to conduct a more effective examination of a dual registrant. Such examinations also could be more cost efficient.”

The 40-page SEC report can be read here.