FPA, NAPFA and IAA to fight SEC's pop-quiz proposal

Focus on financial advisers who deduct fees is misguided, the organizations say

May 24, 2009 @ 12:01 am

By Sara Hansard

The financial advisory industry is bracing for a battle over the Securities and Exchange Commission's efforts to subject thousands of investment advisers to surprise exams by outside auditors. SEC commissioners on May 14 voted 5 to 0 in favor of a proposal that would require the roughly 6,000 federally registered investment advisory firms that deduct their fees from client accounts to undergo surprise audits. The move is part of a wider effort by the regulator to crack down on advisers with direct custody over client holdings. That effort was spurred by criticism that the SEC received from lawmakers for missing Bernard L. Madoff's Ponzi scheme, which cost investors $65 billion. But officials from the Financial Planning Association, the Investment Adviser Association and the National Association of Personal Financial Advisors say that the proposal is misguided and would saddle advisers with unnecessary costs. “It's overkill,” said Diahann Lassus, chairwoman of NAPFA, which is based in Arlington Heights, Ill. “I would have a hard time making a case for having surprise audits of all those firms unless I were a certified public accountant who did audits.” Ms. Lassus is also president of Lassus Wherley & Associates PC of New Providence, N.J., which manages about $260 million.

“We're not interested in seeing increased costs for advisers with surprise audits that really don't affect investor protection,” said Duane Thompson, managing director of the Washington office of the Denver-based FPA.

David Tittsworth, executive director of the Investment Adviser Association in Washington, takes ex-ception with the SEC's implication that advisers who deduct fees from client accounts are more likely to commit fraud.

“We're not aware of any major abuses occurring when investment advisers deduct fees,” he said. “We will argue that that's inappropriate to include advisers that just deduct fees for this surprise audit requirement.” Indeed, the FPA, IAA and NAFPA all intend to file comment letters opposing the proposal by July 28, the SEC's deadline for receiving such responses. Advisers are also upset by the proposed rule change. A surprise audit would likely cost his firm about $3,000 a year, said Ben Baldwin, president of Responsive Financial Group Inc. of Rolling Meadows, Ill., which manages $50 million. That fee would likely be passed on to clients, he said. “There should be an uproar be-cause it's going to hurt a lot of consumers,” Mr. Baldwin said. Others contend that the proposal would force smaller firms to stop deducting fees from their clients' accounts — a move that would re-quire them to wait for clients to reimburse them for their services. “When you deduct your fee from the client's account, you have no cash-flow problems,” said Bernard Kiely, president and chief compliance officer of Kiely Capital Management Inc. in Morris-town, N.J., which manages about $50 million. The proposal would apply to about 9,600 investment advisers of the roughly 11,000 that are registered with the SEC, including some 3,000 hedge funds. Fewer than 200 investment advisory firms now undergo surprise audits, said Robert Plaze, associate director of the SEC's Division of Investment Management.


The SEC, for its part, insists that the proposed rule is needed to protect investors.

Advisers “have access to clients' assets,” said Andrew “Buddy” Donohue, director of the SEC Division of Investment Management. “Any time somebody has access to somebody else's assets, there is some degree of concern.”

Barbara Roper, director of in-vestor protection with the Consumer Federation of America of Washington, applauded the SEC for scrutinizing advisers who hold clients' assets in custody. The fact that Bernard L. Madoff Investment Securities LLC of New York self-custodied assets allowed the scheme to remain hidden for years.


“It is eminently sensible to be looking at those kinds of proposals,” Ms. Roper said.

John Coffee, a professor at Columbia University School of Law in New York, agrees.

“An independent custodian is needed,” regardless of the size of the advisory firm, he said. “If the investment adviser serves as its own watchdog, it's no watchdog.”

Critics of the proposal maintain, however, that the SEC is going too far by including advisers who dip into their clients' accounts to deduct fees.

“The costs will end up flowing down from the adviser to the end client,” said Brian Stimpfl, managing director of adviser advocacy and industry affairs at TD Ameritrade Institutional, which holds about $75 billion in assets in custody for advisory firms.

TD Ameritrade Institutional, which is based in of Jersey City, N.J., may make resources available to its advisers to make it easier for them to comment on the rule proposal, he said.

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


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