The SEC released its report to Congress on enhancing investment adviser examinations on Wednesday night. The 40-page report, delivered two days after the Jan. 17 deadline set by Dodd-Frank, clearly states the SEC’s preference for imposition of user fees on investment advisers as the best method for improving investment adviser oversight. Many industry watchers and lobbyists had been predicting the SEC would recommend handing oversight responsibilities to one or more SROs instead.

The study and report were meant to address a trifecta of problems: a history of weak oversight of investment advisers, current shortfalls in SEC funding and the regulator’s rapidly expanding responsibilities under Dodd-Frank.

At the very end of the report, the SEC recommends that Congress consider three alternatives: 1) authorize the imposition of user fees on SEC-registered investment advisers, 2) authorize one or more SROs to examine, subject to SEC oversight, all SEC registered investment advisers, or 3) authorize FINRA to examine dual registrants for compliance with the Advisers Act. But in the guts of the report, where it examines the benefits and downsides of each option, the SEC makes a strong case for user fees as the best option.

The report may have been delayed for a number of reasons, including the Jan. 17 Martin Luther King Day holiday. But the decision was clearly a contentious one. In a separate letter accompanying the report, Commissioner Elise B. Walter, who supported giving oversight to an SRO, wrote that she was so disappointed with the results of the SEC’s study that she felt she had to make her opinions on the matter known to Congress separately. Walter worked for many years at FINRA, the current SRO for broker/dealers, which has been vocal about wanting to act as the SRO for investment advisers. Walter had already made her support for the SRO option public in a speech last summer.

“Although I voted to release the study, for the first time in my tenure as a Commissioner, I feel that it is necessary for me to write separately in order to clarify and emphasize certain facts, and ensure that Congress knows that the current resource problem is severe, that the problem will only be worse in the future, and that a solution is needed now,” she wrote. “I have spent many years considering these issues, and have definite and clear views on them.”

A number of investment adviser groups and others have voiced support for user fees as an alternative to an SRO, including the Investment Adviser Association, the Managed Funds Association and the American Institute of Certified Public Accountants, all of which wrote letters to the SEC on the subject.

It’s impossible to know when Congress might act on today’s SEC report on investment adviser examinations, said David Tittsworth, executive director of the Investment Adviser Association. “The first step would be for the House or Senate to have some meaningful hearings on this report,” he said. Thus far, nothing is scheduled. “The Democrats haven’t even formalized who is on the financial services subcommittees and stuff like that yet.” He’s hopeful, however, that the user-fee proposal could find enough support among legislators to become reality.

“It could be a lot sooner than 2012. There will be a fair number of hearings related to Dodd-Frank in 2011, especially in the House [of Representatives]. But it’s hard to know what the other priorities are.”

User Fees Versus SRO

The SEC cites a number of reasons why user fees would be a better solution than an SRO for enhanced investment adviser oversight. First, imposing user fees could be a less expensive option than an SRO, the SEC staff write in the report. Farming out some of the responsibility to an SRO could create inefficiencies, while there would be costs associated with SEC oversight of an SRO.

Giving the SEC sole responsibility for investment adviser examinations would also make it less likely that there would be inconsistencies in interpretation or application of the Advisers Act and its rules, the report’s authors write. Meanwhile, the SEC already has examination staff with experience and expertise in oversight of investment advisers, and in the past year, the Office of Compliance Inspections and Examinations has also made significant changes that will improve its effectiveness, the SEC argues in the report.

“Importantly, imposing user fees would avoid the difficult scope of authority, membership, governance, and funding issues raised by an SRO….It would avoid the need for the Commission to use resources to staff an expanded SRO examination program,” says the report. “User fees also would shift the cost of regulation to the advisers themselves. Registered investment advisers currently bear little of the cost of their regulatory oversight as compared to other groups of participants in the financial services markets.”

Obstacles to success for a single SRO, the SEC argues, are numerous. First, the scope of authority, membership, governance and funding of the SRO or SROs would be “complicated by the diversity of the investment adviser industry, strong opposition among investment advisers, investment company and accounting trade associations, state regulators and investor advocates to any SRO, and tension about the prospect of FINRA,” says the report. Because the profession is so splintered, the SEC thinks a diversity of SROs for different groups might be needed—for instance, one for financial planners, another for money managers. But multiple SROs could lead to inconsistencies of regulatory interpretation and would require “vigorous” oversight by the SEC.

The SEC’s report emphasizes the agency’s need for “adequate” sources of funding that are also “scalable,” in order “to prevent adviser examination resources from periodically being outstripped by growth in the number of registered investment advisers.” It notes that user fees are an important source of fees for many other federal government agencies, such as the Office of Comptroller of the Currency, the National Credit Union Administration and the Nuclear Regulatory Commission.

Today user fees support the IARD, the electronic registration system through which investment advisers make fillings with the Commission and state regulators. So the infrastructure to collect such fees is already in place. In addition, the idea of user fees to fund investment adviser oversight is not new: it was floated in 1992 in a bill introduced to the House of Representatives, says the SEC report.

Walter’s Dissent


In her letter concerning today's SEC report, Walter voices concern about the severe funding shortages at the SEC, which she says are paired with dramatic increases in the group’s regulatory responsibilities. Such responsibilities could not be met even if additional funding authorized under Dodd-Frank were made available, she writes.

A majority vote was needed to approve the SEC report, and SEC Chairman Mary Schapiro recused herself due to her previous tenure at FINRA.