Due Diligence

Long Awaited SRO Legislation Stirs the Pot

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The long-awaited and much-debated SRO (self-regulatory organization) bill finally hit the floor Wednesday. Financial Services Committee Chairman Spencer Bachus (R., Ala.) and Rep. Carolyn McCarthy (D., N.Y.) introduced the Investment Adviser Oversight Act of 2012, which would allow one or more SROs to oversee investment advisers. The legislation provoked heated reactions from state securities regulators and investment adviser groups.

Today, the Securities and Exchange Commission oversees all investment advisers with more than $25 million in assets but only has the resources to examine them once every nine to 11 years. The states oversee the rest. But come July, the states will take on an additional 3,200 investment advisers with between $25 and $100 million.

No individual organization was named as the best possible candidate for the SRO job, but FINRA, the self-regulatory organization that currently oversees broker/dealers, has lobbied hard for it. (FINRA examines its broker/dealer members approximately once every two to four years.) It is also currently the only group that would meet the conditions set forth in the bill.

The bill provides for states to continue overseeing small investment advisers with fewer than $100 million in assets, as set out in Dodd-Frank legislation, as long as they successfully conduct periodic on site examinations of the firms in their purview. But it requires state-regulated RIAs to become members of the new SRO regardless. Bachus introduced draft legislation last fall that would have taken away examination responsibility entirely from the states, which resulted in some uproar from state securities regulators.

State securities regulators were not pleased with the revised bill, however. “The creation of an SRO for state-regulated investment advisers is a misguided solution to a problem that does not exist,” wrote Jack Herstein, President of the North American Securities Administrators Association (NASAA), an umbrella group for state securities regulators, in a response Wednesday. “There has never been any evidence to suggest that states have failed in their mission of regulating smaller investment advisers. Nonetheless, this bill dictates how each state should regulate smaller advisers and requires state-regulated advisers to join a national SRO. The Bachus bill is an astonishing attack on our system of federalism with no demonstrated justification.”

Investment adviser groups were also hostile to the bill, with the Investment Adviser’s Association calling on its members to take action, contacting their elected representatives to express their opposition. Investment advisers oppose the SRO legislation because they fear that FINRA will indeed get the job and believe FINRA is biased in favor of its broker/dealer members, their business rivals. They would prefer that the SEC receive the funding it needs to continue to do the job itself. FINRA has responded that the investment adviser SRO would be independent, and the current bill delineates this. Meanwhile, a Boston Consulting Group study released in December suggested that giving the job to an SRO would be more costly than giving the SEC adequate funding.

“Conceptually, we have concerns about taking the SRO approach to this,” said Dan Barry, managing director of government relations and public policy with the Financial Planning Association, one of three organizations in the Financial Planning Coalition. “It essentially boils down to a resources issue and the fact that it’s a resources issue suggests that we should be looking for the most effective and efficient way to resolve the oversight issue. If we’re looking at the costs to advisors and the people who have to fund the oversight, whether at the SEC or an SRO, I think we’re talking about a limited bucket of money that could be put to better use at the SEC. If we go with an SRO option it’s going to take some time to get that ramped up.”

FINRA announced its support for the bill Wednesday saying that it “is an important and thoughtful effort to address a serious gap in investor protection.” The Financial Services Institute, an advocacy organization for independent brokers/dealers and their financial advisors, also expressed its support for the bill. “Hard-working American investors shouldn’t have to be regulatory experts to know whether their financial advisor is getting the proper oversight needed to ensure they’re protected,” FSI President & CEO Dale Brown said. “From a business standpoint, retail investment advisers have an unfair advantage over independent broker-dealers, who are examined by FINRA every two years. It’s time to protect investors and level the play field.”

More Oversight

Under a Dodd-Frank mandated study released in January of 2011, the SEC recommended a number of possible options for increasing the frequency of these exams: the SEC could continue to do the job, raising additional resources with self-funding; multiple SROs could oversee all investment advisers; or a single SRO could oversee dually registered investment advisers. In order for the SEC to transfer its examination power to an SRO, the securities laws would need to be amended. Thus the need for legislation.

The Bachus-McCarthy bill would amend the Investment Advisers Act of 1940 to provide for the creation of what it is calling NIAAs, or national investment adviser associations, registered with and overseen by the SEC. It stipulates that the NIAAs would be funded with member fees.

All investment advisers that work with retail investors would have to become members of a registered NIAA. The legislation would allow the SEC to suspend or revoke the registration of an NIAA, or censure or impose limits on an NIAA’s activities and operations, if it found that the NIAA had violated the Advisers Act, SEC rules or its own rules. The SEC would also be able to suspend or revoke an NIAA’s registration if the association failed to enforce compliance with any provision by an NIAA member firm or associated person.

The proposal requires the SEC to determine whether an NIAA has the capacity to carry out the purposes of the Advisers Act and to enforce compliance by its members and their employees with the Advisers Act.

Barry does not expect Congress to approve more funding for the SEC, so an SRO may be the only alternative. But getting this bill through the Congress before the election is also unlikely. Some industry observers say there is little appetite to take up the issue in the Senate.

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