Third-Party Exams Under Consideration
December 29, 2014 by Cyril Tuohy, cyril.tuohy@innfeedback.com.
Investment advisor examinations conducted in the 2014 fiscal year rose 20 percent to 1,126 over the previous year. Meanwhile, the Securities and Exchange Commission (SEC) is evaluating whether to allow third-party reviews of investment advisors, SEC Chair Mary Jo White said.
In a letter to U.S. Rep. Jeb Hensarling, R-Texas, chairman of the House Committee on Financial Services, White also said the SEC had no plans to reallocate examiners assigned to reviewing broker/dealers to financial advisors.
Hensarling and U.S. Rep. Scott Garrett, R-New Jersey, suggested the SEC shift examination funding from private funds and broker-dealers to the investment advisor program instead of asking Congress to boost the SEC’s budget.
Third-party compliance reviews “could be used to quickly identify areas that require attention,” White wrote in a Dec. 16 letter to the Texas lawmaker.
That would allow the SEC to allocate examination resources more efficiently and increase the frequency with which advisors are examined, she said. “I have asked the staff to do a current evaluation of the third party compliance review concept,” White said.
Third-party advisor examinations conducted by private companies and consultants are controversial among SEC-registered financial advisors.
Small advisory firms object to the hiring of third-party advisors because outside examiners would cost too much.
Other advisors have objected to outside examination because differing standards and levels of financial expertise would be difficult to certify, and outside contractors could bring potential conflicts of interest to bear, possibly influencing the outcome of the reviews.
In the fiscal year 2014 ended Sept. 30, the SEC’s Office of Compliance Inspections and Examinations (OCIE), had a staff of 914. The SEC requested a budget of $1.7 billion for the 2015 fiscal year beginning Oct. 1, an increase of $300 million.
SEC examiners have improved examination frequency through the use of more advanced quantitative techniques, enlisting the help of outside experts and implemented more training to hone in on areas that warrant deeper review, White said.
While a 20 percent increase in advisor examinations using the same number of in-house staff is a sign of more efficient personnel usage, the SEC is still far short of conducting financial advisor examinations at a frequency that many would find acceptable.
Rick A. Fleming, the investor advocate, said that while most advisors follow the rules and demonstrate the “highest standards of integrity,” the SEC examined only 9 percent of registered investment advisors in fiscal year 2013.
Examining 9 percent of RIAs equates to a frequency of approximately once every 11 years, Fleming also said.
No advisory firm should go longer than five years without being thoroughly examined and higher-risk firms should be examined more frequently than every three years, said Fleming, a former staffer with the Kansas insurance regulator.
Fleming, who was appointed investor advocate in February, earlier this year came out against third-party advisor examinations and instead backed higher user fees on investment advisors to pay for more advisor exams.
Powerful trade groups, from the Investment Adviser Association to the Financial Planning Coalition to the CFA Institute, have backed more examiners within the SEC’s Office of Compliance Inspections and Examinations (OCIE).
There are approximately 11,500 registered investment advisors (RIAs) overseen by the SEC, an increase of about 40 percent in the past 11 years.
By Sept. 30, 2015, investment advisors will be managing an estimated $55 trillion, more than double the amount of assets they managed 10 years ago, Fleming said.
Investment complexity has grown too. Products and services accessible only to institutional investors years ago are now offered to many retail investors.
New technology, which makes high-frequency and algorithmic trading easier and faster, and the growth of financial services company families that integrate broker-dealer and investment advisor affiliates pose new challenges to examination staff, the SEC said.
