InvestmentNews Editorials

Two SROs may be better than one

Sep 18, 2011 @ 12:01 am

Seemingly lost amid the contentious battle over how investment advisers are to be regulated is one unassailable truth: Millions of investors are at risk of being defrauded because the SEC lacks the financial resources to do an adequate job of policing the advice business.

It's also true that Congress' bull-headed opposition to a variety of approaches put forth to solve this crisis — increasing appropriations to the Securities and Exchange Commission, allowing the agency to be self-funded or permitting it to levy user fees for examinations — makes it impossible to foresee a situation in which the commission could obtain the resources it needs to fulfill its mandate to protect investors anytime soon.

Steadfast in our belief that regulation that benefits individual investors also benefits the financial advisory business, we have concluded that a well-structured self-regulatory organization or, better yet, two SROs, would be a big improvement over the status quo.

Imperfect as it is, having two effective SROs would be better than having one ineffective regulator.

In a report to Congress, the SEC acknowledged that the percentage of investment advisers that it examined in 2010 fell to 9%, from 18% in 2004. That means that the number of years on average between examinations had climbed to 11, from six.

Investors deserve protection from unscrupulous advisers and abusive business practices.

It's for these reasons that we endorse — in concept — a draft bill proposed two weeks ago by House Financial Services Committee Chairman Spencer Bachus, R-Ala., that would authorize one or more SROs to oversee the nation's 11,539 investment advisers. The draft, as written, would give the investment adviser SRO, or SROs, a broad range of rule-making authority, subject to SEC approval.

Our tentative support of the legislation coincides with a congressional hearing last Tuesday to discuss options for improving investment adviser oversight.

Like leaders of the pro-investor advocacy group Consumer Federation of America, who testified before the House Financial Services Capital Markets subcommittee last week, we encourage Congress to consider putting two SROs in charge of investment adviser oversight.

Under such a scenario, the Financial Industry Regulatory Authority Inc., which already oversees 4,500 broker-dealers, would police the 88% of investment advisers dually registered as broker-dealers. The main benefit of putting Finra in charge of those advisers is that the agency already has an existing enforcement structure and staff in place.

The remaining 12% of investment advisers would be overseen by a newly created SRO and would be more attuned to a fee-based model.

Establishing a separate SRO for fee-based advisers should alleviate concerns that the distrust that some investment adviser/financial planner trade groups feel toward Finra would impede the ability for it to be effective.

To be sure, a two-SRO system isn't perfect.

For starters, it would increase the risk of inconsistency in the making, and enforcement, of rules. Even worse, it's possible that the SROs could find themselves competing for members by adopting less rigorous standards.

One way to mitigate those risks, however, would be to limit the scope and authority of both SROs to performing inspections. That would place full responsibility for consistent rule making squarely in the hands of the SEC. It would also alleviate some of the costs associated with setting up the SROs.

A two-SRO system would require a high level of commitment from the SEC to ensure that the SROs were on the same page in how they interpreted and enforced investment adviser rules and regulations.

The bottom line is that investors deserve more protection than they are getting. If Congress can't see to it that the SEC has the funds it needs to do its job, then its incumbent upon Congress to allow for the immediate creation of an investment adviser SRO, or SROs.


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