How do you know if your math is fuzzy or if it all adds up? Will any old math do? That is a question being posed by adviser groups, which released a report the Boston Consulting Group today. It’s part of a kind of game of “he said, she said” being played out over differences in cost estimates between the investment adviser and broker/dealer factions of the wealth management industry. And that game is part of the larger fight over who will oversee investment advisers—FINRA, which now regulates broker/dealers, some other SRO like the recently minted SROIIA, multiple SROs, or the Securities Exchange Commission (SEC), which currently oversees investment advisers but does not have the resources to do the job with the frequency desired.
In a Dodd-Frank-mandated report released early last year, the Securities and Exchange Commission recommended three ways to increase investment-adviser examinations: allow the SEC to charge user fees for exams, establish a number of SROs to regulate advisers, or give a single SRO authority over dually registered investment advisers. Each alternative would require congressional authorization.
Last December, a number of investment adviser industry groups as well as TD Ameritrade hired the Boston Consulting Group (BCG) to estimate how costs would differ if the job were given to the SEC versus FINRA. In its 21-page report, BCG concluded it would be much cheaper to provide the SEC with sufficient funding to do the job. These industry groups include NAPFA, a trade group for fee-only advisors, the FPA, a trade group for financial planners, the Investment Adviser Association, which represents investment advisers and the CFP Board, an organization that provides Certified Financial Planner credentialing.
Then in late April, FINRA released its own one-and-a-half page cost estimate, which suggested it would be much cheaper for it, FINRA, to take on the oversight role than BCG had suggested—cheaper than allowing the SEC to do it. FINRA released its estimates on the same day that House Financial Services Committee Chairman Spencer Bachus proposed a bill that would give oversight of investment advisers to an SRO (with the most viable SRO being FINRA.)
Their numbers are vastly different. FINRA calculated setup costs for itself at $12 to $15 million and ongoing annual costs at $150 to $155 million a year. BCG had estimated setup costs for FINRA of $200 to $255 million and ongoing costs of $460 to $510 million. Today, the same groups that hired BCG in the first place issued a release that challenges FINRA’s math–or lack thereof.
According to a review by BCG, FINRA omitted from its calculations both the cost of SEC oversight of FINRA ($90 million to $100 million) and the cost of enforcement ($60 to $70 million), both of which are required by Dodd-Frank legislation. BCG also notes in its review that FINRA’s estimate of $12 to $15 million in setup costs does not include staff costs incurred during the 12-month setup period, specifically the cost of examiners and support staff. These omissions account for $180 to $230 million of the difference between BCG and FINRA estimates.
Further, “FINRA’s estimate of the ongoing annual cost of examining 14,500 IA firms once every four years assumes that FINRA’s IA examiners would be able to nearly double the productivity rate of SEC IA examiners, by performing 5 or more examinations per examiner per year. This compares to SEC IA examiner productivity of 3.0, and FINRA broker/dealer examiner productivity of 2.8.” This accounts for another $150-$170 million of the difference between BCG and FINRA estimates.
Finally, FINRA’s estimate does not include overhead costs in its estimate of $150 to $155 million of ongoing annual investment. Overhead costs account for $135 to $140 million of the difference between BCG and FINRA estimates, says the BCG review.
“We think it would be a mistake to add an unnecessary layer of regulation and cost on small businesses that deliver sound advice to investors,” wrote the groups sponsoring the BCG review in a press release.
FINRA called the BCG’s numbers amusing. Said Nancy Condon, FINRA spokeswoman, “Concerning the release of BCG’s review of the FINRA’s cost estimates—until the Boston Consulting Group has at least one conversation with the SEC and FINRA about what it takes to run a nationwide examination program, their numbers should be viewed with skepticism and amusement. They are inventing the numbers out of thin air.”
When asked for a response, David Tittsworth, executive director and executive vice president of the Investment Adviser Association, said he was “disappointed with FINRA’s extreme reaction.” He continued, “The BCG research was commissioned at our expense, and not that of the taxpayer, in the spirit of contributing to a constructive debate about the best way forward with regard to investment adviser oversight.”
Whereas BCG is an independent and well-respected consulting group, FINRA is clearly biased in this matter, he said, given that it is “spending millions of dollars lobbying Congress to expand its revenue base and jurisdictional turf.” The BCG estimates are not derived from “thin air,” he continued, as its report was based on publicly available data. It is the FINRA report that one should view with skepticism, not only due to its bias, but because unlike BCG, it does not disclose its methodology and “has provided only a one-and-a-half page ‘cost estimate’ to support its assertion that it would be the most cost-effective solution and in the best interest of the investor,” said Tittsworth. Further, FINRA’s cost estimate calls into question its claims that it could operate an IA SRO independently of its current broker-dealer operations. “That is laughable under FINRA’s cost estimates unless you have new employees using shared resources that violate the pledge and spirit of having two independent shops.”
Finally, Tittsworth asked why a meeting with FINRA should be required to learn about its operations. “A member of the public shouldn’t have to meet with FINRA to learn about its operations if it were truly an organization acting in the public interest…With regard to meeting with FINRA and the SEC, we believe that there is ample publicly available data and research to inform a rigorous economic analysis of the options.”
In a response to BCG’s review of FINRA’s cost analysis, the Financial Services Institute, which represents broker/dealers, made the following statement: “FSI has long championed the small business needs of all financial advisors and, at the same time, worked to protect consumers. Instituting even basic RIA examination will level the playing field for all advisors, protect consumers and help RIAs flourish as trust is gained in their business model.”