More funding won't boost SEC's exams

Defending inspection program, OCIE's new boss says commission will stress quality over quantity

Feb 14, 2010 @ 12:01 am

By Sara Hansard

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Despite being on track to receive a whopping 12% budget increase for next year, the Securities and Exchange Commission plans to inspect just 9% of the 11,000 investment advisory firms that it oversees — the same percentage of firms it expects to examine this year. Instead, the SEC, which was publicly flogged last year for botching numerous opportunities to uncover Bernard Madoff's Ponzi scheme, will focus on improving the depth and breadth of its examinations, said Carlo di Florio, the new director of the SEC's Office of Compliance Inspections and Examinations. “Seventy-two new staff [and] a stronger risk-based examination program is going to improve our coverage over the registered investment advisers,” said Mr. di Florio, who joined the OCIE last month from PricewaterhouseCoopers LLP, where he was a partner in the financial services regulatory practice. One of his mandates is to assuage long-held concerns about the depth of the OCIE's exam process. “There's been concern about how effective the examination process has been,” said Thomas Gorman, a partner in Porter Wright Morris & Arthur LLP, where he is chairman of the securities litigation group. Recruiting Mr. di Florio, along with increasing the OCIE's budget, suggests that the SEC is taking its advisory firm inspections more seriously, he said. “They're really looking at OCIE as an adjunct of enforcement,” Mr. Gorman said. On Feb. 1, the White House proposed to Congress that the SEC's budget for fiscal 2011, which begins Oct. 1, be raised to $1.26 billion, from $1.12 billion in fiscal 2010. The OCIE would receive a 12% increase in its funding, raising its budget to $257 million and allowing it to increase its examination staff to 912. The SEC campaigned for the additional funding in part because of the increase in the number of investment advisory firms that the OCIE is expected to examine. Indeed, the number of firms has climbed 50% from fiscal 2003 to about 11,500 at the beginning of fiscal 2010. Meanwhile, assets under management at those firms jumped 57% to $33 trillion during that time period. At the same time, the products sold by those firms have grown increasingly complex. Going forward, the OCIE will pay more attention to firms that sell products and provide services that are considered more risky, Mr. di Florio said. Examiners will also be encouraged to act more quickly on tips and complaints, a reaction to the black eye the SEC received for not responding to tips about the massive Ponzi scheme perpetrated by Bernard L. Madoff Investment Securities LLC. Factors in determining risk include whether advisers' investment recommendations are consistent with disclosures and client objectives, whether their compliance systems are adequate, whether they get best execution from the brokers they work with and whether they favor some clients in allocating investment opportunities, Mr. di Florio said. The OCIE is focusing more on advisers' custodial arrangements and how effective advisers' programs are for preventing insider trading, he said.

<b>Carlo di Florio:</b>
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Carlo di Florio: "Our approach is going to be sharper. Those resources will help us do more-qualitative oversight of the investment advisory industry."

The increased budget will allow the OCIE to invest more heavily in technology that will allow it to conduct surveillance and analyze data to identify risks.

“Our approach is going to be sharper. Those resources will help us do more-qualitative oversight of the investment advisory industry,” Mr. di Florio said.

Certain products also will receive greater scrutiny, including derivatives and structured products.

“Those are all areas where we want to make sure disclosures are comprehensive, products are suitable and fiduciary responsibilities are fulfilled,” Mr. di Florio said.

The slump in the financial services industry is making it easier for the SEC to recruit industry professionals with a depth of understanding of the markets and the business itself, Mr. di Florio said.

“We're looking at skill sets that we haven't traditionally had,” he said. “We're looking at people who understand risk management, understand trading strategies, understand operations and understand quantitative analysis.”

The extra money would also help the SEC overcome the derision it has received because of its past goal of annually inspecting 9% of the investment advisory firms it oversees. By contrast, the Financial Industry Regulatory Authority Inc. inspects 55% of broker-dealers it supervises.

More funds could be freed up if Congress enacts financial-reform proposals that would move about 4,000 advisory firms from SEC oversight to the states.

In addition, Finra is pushing to take on the role of overseeing advisory firms.

“[A self-regulatory organization] would bring significant benefits to the oversight regime for federally registered investment advisers, and enhanced protections for customers who invest through an adviser,” said Finra spokesman Herb Perone. “First and foremost, it would greatly increase the number of examinations of [investment advisers] over the level that the SEC, with its many resource demands, can perform on its own.”

Mr. di Florio, for his part, is not worried by the prospect of more involvement by Finra. “We are looking for ways to allocate our resources to best use,” he said.

“If it's us doing the oversight, we want to increase our resources and provide more coverage. If it's teaming with SROs, and that's an area that gets further attention in Congress, we'll adjust and figure out a way to do that more effectively,” Mr. di Florio said.

E-mail Sara Hansard at shansard@investmentnews.com.

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