Advisers worry about potential costs of third-party exams

Estimates range from $5,000 to $20,000; sharp opposition to Finra getting involved

May 21, 2014 @ 12:34 pm

By Mark Schoeff Jr.

Finra, SEC, CFP Board of Standards, Investment Adviser Association, adviser oversight
+ Zoom

Investment advisers are wary of the costs involved in a proposal by a Securities and Exchange Commission member that would require advisers to hire third-party contractors to conduct examinations now performed by the SEC for free.

At the annual conference of the Financial Industry Regulatory Authority Inc. in Washington on Tuesday, SEC Commissioner Daniel Gallagher recommended that the SEC write a rule that would require advisers to hire an examiner to review their operations.

The rule would be similar to one the agency adopted in 2009 that mandates that advisers who maintain custody of client assets bring in an auditor to verify that the funds are safe.

Jonathan Roberts, senior vice president of Klingenstein Fields & Co., said that his firm is subject to custody audits. He said the system “works pretty well” on “a narrow and defined scope” but that “it's expensive.”

The bill for an audit is about $20,000 — a price that would rock small advisory firms, he said.

“Some would find that tremendously crushing in terms of the financial cost of it,” Mr. Roberts said.

David Edwards, president of Heron Financial Group, prefers to pay a surcharge to the SEC to fund examinations. A bill that would implement such a charge has been introduced in the House but has not gained much support.

“I'd rather have a fixed annual cost of, say, $2,500 to the SEC rather than a cost of $10,000 to $20,000 that I can't budget for and therefore, have to pass on to my clients,” Mr. Edwards said.

Steven Thomas, director of compliance at Lexington Compliance, a division of RIA in a Box, said that a routine audit could be done for much less than $10,000. He estimated that it would cost about $5,000 for most advisory firms.

“The marketplace will drive the cost of the exams because prices will be set by competition,” said Mr. Thomas, former chief compliance examiner for South Dakota. “What better way to keep the cost down? What better way to benefit the consumer?”

The fiduciary duty training firm Fi360 offers a “fiduciary assessment” that could be a cost-effective way of conducting the third-party exams, according to Duane Thompson, senior policy analyst at Fi360.

He said the SEC should do a cost-benefit analysis of such a proposal.

“We like the idea, but it needs to be reviewed, particularly when it comes to costs for firms that are small businesses,” Mr. Thompson said.

Even if third-party examiners are used, it's not a free ride for the SEC, according to Marilyn Mohrman-Gillis, managing director of public policy and communications at the Certified Financial Planner Board of Standards Inc.

“The SEC will still have to provide oversight, perhaps more oversight than in an SRO model,” Ms. Mohrman-Gillis said. “We don't believe it would be the most cost-effective solution.”

Mr. Gallagher said that Finra would be among the candidates to conduct the exams — a notion that meets resistance from advisers.

Two years ago, adviser opposition to legislation that would establish a self-regulatory organization to oversee advisers helped kill the measure. The argument was that Finra oversight would be too costly and that Finra, the broker-dealer regulator, wasn't qualified to monitor the fiduciary standard that governs advisers.

“I think Finra's a very bad choice,” Mr. Roberts said. “They are not fit to do it.”

Mr. Gallagher came up with the proposal because the SEC currently examines annually only about 9% of the approximately 11,000 registered investment advisers. It says it lacks the resources to increase that number substantially.

It's good to explore other options for adviser oversight, said David Tittsworth, executive director of the Investment Adviser Association.

“The idea of third-party examinations of advisers is worthy of debate,” Mr. Tittsworth said. “The idea of Finra doing it is not appropriate.”

First, though, Mr. Tittsworth said that the SEC should shift funding it now spends on broker-dealer examinations to investment adviser reviews.

“The SEC, within its own resources, has the ability to bring additional bodies to bear on these issues,” Mr. Tittsworth said. “You don't have to bring in Finra.”

It's not clear whether Mr. Gallagher has support for his proposal among the other four SEC commissioners. None was available for comment on Wednesday.

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