SEC wilts on surprise adviser audits

Investment division relents after field input

Nov 22, 2009 @ 12:01 am

By Sara Hansard

+ Zoom
The SEC is backpedaling on a proposal that would require advisory firms that deducted fees from client accounts to undergo costly surprise audits. A recommendation the agency's Division of Investment Management sent to the five commissioners this month would eliminate last May's controversial proposal, according to a -Securities and Exchange Commission official with knowledge of the recommendation. The official would not speak for attribution. Final action on the rule, which is aimed at strengthening adviser custody requirements to prevent a recurrence of the Madoff debacle, is expected in mid-December. The proposal drew hundreds of comments, many from advisers who strongly opposed it, saying that it would not accomplish the SEC's aim of protecting customers with firms that did not hold physical custody of assets.

Andrew "Buddy" Donohue: "The comments have been listened to." (Bloomberg)

“There was a fair amount of comments that were given us with respect to that point,” said Andrew “Buddy” Donohue, director of the SEC's Division of Investment Management. “The comments have been listened to.”

While the commission has not made a decision on the final rule, it is not likely to approve the “surprise-audit” provision, said the SEC official, who spoke on condition of ano-nymity. “I don't think that provision is particularly popular with anyone.”


The rule proposal stated: “A surprise examination by an independent public accountant would provide "another set of eyes' on client assets and thus additional protection against their misuse.”

But the surprise-audit proposal for advisers that debit fees from client accounts but do not hold physical custody was misplaced, advisers said. “That was the main point of contention for independent-advisory firms,” said Ron Rhoades, chief compliance officer and director of research at Joseph Capital Management LLC, which manages about $100 million. “It seems to fail any cost benefit analysis, and there was no evidence of any abuse in that area,” he said, referring to fee deductions from client accounts.

While the SEC estimated that the average cost of the audits to advisory firms would be $8,000 a year, the Financial Planning Association questioned the accuracy of that estimate in its comment letter, filed July 28. Estimates received by the FPA from accounting firms ranged from $15,000 to $24,000 per year to perform the audits.

“It always seemed like an expensive solution for something that's not a problem,” said Dan Barry, director of government relations for the FPA. “The whole rule was designed to address concerns that firms with custody would make away with clients' funds. There was never any indication that there were any abuses related to fee deductions.”

Nearly 6,000 of the approximately 11,300 advisory firms registered with the SEC would be brought under the surprise-audit requirement because they deducted fees from client accounts, according to figures compiled by the Investment Adviser Association. Currently, the 190 advisory firms that are subject to surprise audits are those that send statements to clients themselves.

The IAA opposed the surprise-audit proposal. “It's just not tailored to the risk that they want to try to address,” said David Tittsworth, executive director of the organization for SEC-registered advisory firms.


It is not known what provisions may be adopted to replace the proposal. As an alternative to surprise audits, the IAA suggested in its July 24 comment letter that advisory firms that deduct fees from client accounts should be required to provide clients with documentation of fee calculations.

To prevent possible abuses from advisory firms that deduct fees, advisers could be required to provide duplicate copies of bills to custodians and clients, or obtain written authorization from clients in order to deduct fees, the IAA suggested. They also could be required to obtain limited audits only of advisory fees, the IAA said in its letter.

While the surprise-audit proposal appears to have been shot down, there is still strong support for the SEC to strengthen its custody rules for investment advisers that hold custody of assets. Only about 370 advisory firms or their affiliates have such custody, according to the SEC's estimates.

“Unless the SEC deals meaningfully with the dangers of letting an investment adviser use an affiliated custodian, you are going to have repetitions of the Madoff experience,” said John Coffee, a professor at Columbia Law School.

E-mail Sara Hansard at


What do you think?

View comments

Recommended for you

Sponsored financial news

RIA Data Center

Use InvestmentNews' RIA Data Center to filter and find key information on over 1,400 fee-only registered investment advisory firms.

Rank RIAs by

Upcoming Event

Sep 26


Investing 2017: Industry at a Crossroads

The advice industry is at a unique inflection point, as the way clients are investing has changed dramatically: Technology has evolved, access to innovative products has changed, and the active vs. passive debate continues to rage on. Advisers... Learn more

Featured video


Ed Slott: Tax strategies to help clients take advantage of market declines

When the markets decline or are volatile, it is an opportunity to put a few retirement savings strategies to work, according to Ed Slott, founder of Ed Slott's Elite IRA Advisor Group.

Latest news & opinion

Emerging issues affecting financial advice

The profession will need to adjust to enormous shifts in the socioeconomic environment in the coming decade.

Odds are, the $700M Powerball winner will need lots of advice

A good financial adviser — or, better yet, a team of them — would provide a sense of perspective and calm that would hopefully prevent this winner from following in the footsteps of so many past winners who wound up broke just a few years.

Cetera broker-dealers to pay back $3.3 million to clients overcharged for mutual funds

Over an eight-year period, the B-Ds failed to properly supervise sales charge waivers to clients in retirement plans and charitable organizations.

Fiduciary advocates press CFP Board for specifics on standards changes

Meanwhile, few brokerages and their trade associations, which blasted the DOL's fiduciary rule in comment letters, are responding to the CFP Board's proposal.

Big gains attract new money to emerging markets, but should investors stay?

An estimated $6.7 billion has flowed into emerging-market stock funds and ETFs so far this year, according to Morningstar.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print