SEC Investor Advocate: Budget boost 'insufficient' for full adviser exam coverage

The budget increase the SEC received from Congress is “insufficient” to significantly boost investment-adviser examinations, according to an SEC official charged with representing retail investors

Dec 23, 2014 @ 3:52 pm

By Mark Schoeff Jr.

A Securities and Exchange Commission official charged with representing retail investors before the agency asserted on Tuesday that the budget increase the SEC received from Congress is “insufficient” to significantly boost investment-adviser examinations.

During a lame-duck session that concluded last week, Congress approved a $1.5-billion SEC budget, a $150-million increase from the previous fiscal year. The appropriation gave the SEC a bigger budget boost than most agencies.

But the additional money is not enough to help the SEC increase its examination rate for investment advisers, which hit 10% of the approximately 11,000 registered advisers in fiscal 2014, said SEC Investor Advocate Rick Fleming.

“In reality, the recent increase in funding, while helpful, is likely insufficient to provide the full level of examination coverage that is needed,” Mr. Fleming wrote in a report to Congress that was released on Tuesday. “Therefore, we will assess any remaining need and will continue to explore potential efficiencies and funding mechanisms to further enhance investor protection in this area.”

Elsewhere in his report, Mr. Fleming identified unregistered securities, variable annuities and non-traded real estate investment trusts as the “most problematic” products in fiscal 2014. He did not offer policy recommendations for any of them.

In a report to Congress earlier this year, Mr. Fleming promoted the idea of charging advisers user fees to fund their exams, a move that he said would increase exam coverage. Congress would have to approve such a policy.

A user-fee bill died in the House this year after attracting many Democratic co-sponsors but only one Republican backer. The Senate did not introduce a bill.

In a Nov. 24 letter to SEC Chairman Mary Jo White, House Financial Services Committee Chairman Jeb Hensarling, R-Texas, and Rep. Scott Garrett, R-N.J., said that the agency should reallocate resources to adviser exams rather than seek approval for user-fees.

In response, Ms. White said that the agency is more effectively using existing resources to increase adviser exams and that moving money from other exam areas “would not be advisable.”

The status quo is unacceptable, Mr. Fleming said.

The current level of coverage “is simply inadequate to protect investors from fraudulent or abusive practices like excessive or undisclosed fees, unauthorized trading or outright theft,” Mr. Fleming wrote.

On the topic of variable annuities, Mr. Fleming said that financial advisers sometimes sell the products to earn the high commissions they pay, even if putting them in a portfolio is not in a client's best interest.

“Because the problems associated with variable annuities are related primarily to sales practices or certain collateral features of the products, the investor advocate has not made any recommendations for changes to rules or regulations governing their sale,” Mr. Fleming wrote. “Problems in this area can be addressed through continued enforcement of existing rules and ongoing investor education efforts.”

He came to a similar conclusion on problems that can crop up when clients are moved from commission-based brokerage accounts to fee-based wrap accounts. If the financial adviser doesn't do much trading in the wrap account, clients can end up paying more in fees than they would have in commissions, a situation known as “reverse churning.”

“[A]ggressive enforcement action, particularly with respect to enforcing the fiduciary duty of an investment adviser who accepts and oversees a fee-based account, should be sufficient to deter this type of unethical practice,” Mr. Fleming wrote.

Ms. White named Mr. Fleming the SEC Investor Advocate on Feb. 24. His position was created by the Dodd-Frank financial reform law. He must file two reports annually with Congress. He has a staff of six. In September, he appointed the SEC's first ombudsman, Tracey L. McNeil, to field investor concerns and complaints.


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