Views on improving the integrity of global capital markets
21 May 2012

Bring It On! Investment Advisers Want Heavier-Touch Regulation

Given the opportunity to operate in a world of lighter-touch regulation, most companies and industries would jump at the chance. Can you imagine the relief and rejoicing within the oil and gas pipeline sector if the Environmental Protection Agency were to “lighten up a bit”?

Not so with investment advisers, though. To many in the industry, it seems, the tougher the regulation, the more nebulous the legal requirement, the higher the standard of care threshold, the better. And they aren’t shy about letting the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, Congress, and anyone else who will listen know it.

You’d be hard-pressed to find anything like it elsewhere in the business world.

The situation is this: under pressure to find ways to reduce deficits and the national debt, Republicans on the House Financial Services Committee are looking for ways to cut government spending. Oversight of investment advisers is an area seen as an easy target. The SEC has made a botch of it in recent years, admitting in a staff report in January 2011 that adviser examinations have fallen by nearly one-third, even as the number of firms supposedly under surveillance grew by nearly 50 percent. Some advisers were examined just once in 11 years. It was during this period that the Madoff scandal reached its pinnacle.

Making matters worse, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 loaded the Commission with a host of new obligations, as forcefully documented in a rebuttal to that SEC staff report from Commissioner Elise Walter. The new obligations included:

  • Registration of hedge fund and private equity fund managers
  • Registration and oversight of municipal advisers
  • Examination and regulation of central clearing firms
  • Oversight of dealers, major market participants, and data repositories for security-based swaps
  • Creation of a new Office of Credit Ratings

The Act also imparted on the Commission new systemic risk oversight obligations as part of the Financial Stability Oversight Council.

So the House FSC has introduced the Investment Adviser Oversight Act of 2012 as a means of relieving the pressure, both on the budget and the SEC. It also is seen as a means, at the least, of increasing the frequency of adviser examinations in the process, if not the quality of those exams. My view — and it is just my opinion — is that while the bill probably will make it out of the FSC and may even win in the full House, its chances are dim in the Senate, where many a House bill has gone into hiding. That is the case — unless the same kind of aligning of distant galaxies that developed for passage of the JOBS Act last month occurs again. Again, I think that’s unlikely, but even if it dies in the Senate this session, it could create the foundation for another attempt when the new Congress convenes in January.

As written, the Investment Adviser Oversight Act would lower the pressure largely by outsourcing SEC oversight of advisers to a registered national investment adviser association, otherwise known as a self-regulatory organization, or SRO. The SEC would have authority to register any entity that wishes to fill the role of an SRO so long as they meet the minimum requirements for investor care and examinations set by the Act and implemented by the Commission. At this time, however, there is just one entity that meets those criteria: FINRA.

FINRA, however, is seen by many in the adviser industry as the enemy of the fiduciary standard of customer care. Part of the concern is that its primary purpose to date has been to regulate securities dealers and brokers who have a lower suitability standard of care when it comes to selling investment products to investors. Independent advisers fear that FINRA oversight of advisers would mean a lower threshold for client care — perhaps higher than the current suitability standard, but expected to be well short of the fiduciary standard imposed upon advisers currently. The SEC has studied adoption of a single standard of care and has authority under Dodd-Frank to impose one, but hasn’t acted yet. FINRA contends that it already adheres to a fiduciary standard in its exams.

There also is concern that FINRA’s examiners have less experience than their counterparts at the SEC. Perhaps so, but many advisers also see the SEC’s exams as perfunctory tick-the-box affairs. So there seems to be plenty of room for improvements, regardless of who does the exams.

Despite the potential for lighter-touch regulation, many advisers don’t want it. Rather than operate in a less-onerous world with clearer operating guidelines, they prefer the more onerous, principles-based oversight route. Indeed, under the current system, they have been able to point to that higher standard of care as a selling point to compete against the giant broker/dealers.

But the world cannot and will not remain the same for much longer. The problems highlighted by the Madoff affair means that neither the industry nor any regulator will again get away with the kind of indifferent oversight that both regulators displayed toward the notorious schemer and the industry in general. The question is which way it will turn.

Ultimately what is needed is better and more consistent examinations of advisers. A revamp of the exam process would need to incorporate examinations as often as once every two years. It should hold all who provide personalized investment advice to the higher fiduciary standard of client care. It should include oversight by examiners who have experience in investment management, and while it should include tick-the-most-important boxes, the exams should focus on asking relevant and important questions about RIAs’ operations and investment management activities, the kind that RIAs, themselves, believe are important.

The Advisers Act, written more than 70 years ago, was intended to ensure that everyone involved — advisers and regulators, alike — approach the business from the perspective of the investment clients. It is important that that perspective returns to adviser oversight, regardless of who does the overseeing.

About the Author(s)
Jim Allen, CFA

Jim Allen, CFA, is head of Americas capital markets policy at CFA Institute. The capital markets group develops and promotes capital markets positions, policies, and standards.

1 thought on “Bring It On! Investment Advisers Want Heavier-Touch Regulation”

  1. BetaRules says:

    The Pack (of advisors) views regulation as an insurance policy. The more regulation, the better as it leaves less scope for an advisor to go out on a limb with a truly independant call. There are less consequences for an advisor who moves in a pack getting it wrong, than the lone wolf. A perfect way to promote mediocrity, and to hide behind a the system.

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