IAA cautions SEC Commissioner Gallagher about third-party adviser exams

Tittsworth letter encourages agency to reallocate existing resources to bolster examinations

Jun 10, 2014 @ 1:00 pm

By Mark Schoeff Jr.

A leading investment-adviser organization raised concerns about regulatory examinations being conducted by private-sector firms instead of the Securities and Exchange Commission in a letter to the SEC member who is championing the change.

In speeches and public appearances over the last month, SEC Commissioner Daniel Gallagher has recommended the SEC write a rule that would require advisers to hire an examiner to review their operations. The measure 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 the funds are safe.

Third-party exams would allow the SEC to reach more advisers, according to Mr. Gallagher. The agency says it has the resources only to examine annually about 9% of the approximately 11,000 registered investment advisers.

In a June 9 letter to Mr. Gallagher, the Investment Adviser Association cautioned him about drawbacks of his proposals.

“We are concerned about the potential disadvantages of third-party examinations as compared with SEC examinations,” wrote David G. Tittsworth, the IAA executive director. “Such issues include the standards to be applied in such examinations, the scope and frequency of any such examinations, the qualification and SEC oversight of third parties, confidentiality and the cost to advisers.”

Prior to considering a rule, the SEC should assess third-party reviews voluntarily used by advisers such as financial audits, internal control reports, compliance reviews, mock audits and internal audits, the letter stated.

“Before engaging in any rulemaking that would require SEC-registered advisory firms to undertake an examination or other review by a third party, it would be helpful to understand what practices are already undertaken, how such practices are utilized, the types of third parties retained and the costs involved,” Mr. Tittsworth wrote.

In an interview on June 6, Mr. Gallagher defended third-party exams for advisers.

“It’s the best idea I’ve heard,” Mr. Gallagher said. “I’m the only person out there I see proposing something we can do ourselves rather than begging Congress for money.”

He is confident that he can build support for his proposal.

“I’ve heard from a lot of people on this issue,” Mr. Gallagher said. “I think it has legs.”

Although the SEC has not received from Congress the funding it says it needs to hire 250 additional investment-adviser examiners, Mr. Tittsworth said the agency could increase adviser coverage by shifting some of the money it spends on broker-dealer oversight to investment advisers.

“We encourage the commission to consider reallocating its existing resources to increase investment adviser examination activity, which it could accomplish without additional legislation or rulemaking,” Mr. Tittsworth wrote.

He also took issue with Mr. Gallagher's assertion that the SEC is finding more broker-dealer violations than investment-adviser infractions because it has the help of a self-regulatory organization, the Financial Regulatory Authority Inc., to oversee brokers.

Mr. Tittsworth said SEC examinations of advisers cover a significant amount of assets under management; that the agency analyzes all advisory firms on an ongoing basis, even if it doesn't formally examine them; and that the total number of registered advisers is overstated because many are separate legal entities that operate as one business.

“We submit that instead of utilizing apples-to-oranges comparisons, it would be more productive to focus on ways to improve the SEC's investment adviser examination program to achieve a higher level of investor protection,” Mr. Tittsworth wrote.


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