On Advice

Boost in SEC examiners to enable closer scrutiny of RIAs

Agency is going after conflicts of interest

Feb 21, 2016 @ 12:01 am

By Bruce Kelly

The typical registered investment adviser may have let out a howl of fear and loathing when he picked up a recent issue of InvestmentNews and read that the Securities and Exchange Commission was planning to increase its number of RIA examiners this year to 630 from 530, an increase of almost 20%.

I'm not Bernie Madoff, the adviser would have said, his head in his hands. I have $100 million in client assets, most of them in exchange-traded funds, and I custody with Schwab. I'm completely transparent. So why is the SEC beefing up its number of examiners, and will they be coming after me?

The adviser, let's call him Joe, certainly has a point. Bernie Madoff was able to perpetrate his massive, $20 billion Ponzi scheme in large part because he was a self-clearing broker-dealer and acting as an unregistered investment adviser for most of his career. No third-party clearing firm oversaw the books, records and flow of customer funds at his broker-dealer. And advisers with in-house custody of assets always raise concerns.

Remember, the SEC has its recent history to deal with. It screwed up royally when its examiners failed to detect Mr. Madoff's Ponzi scheme. And the commission has been criticized for not performing enough exams of RIAs. In fiscal 2015, the agency conducted 1,221 exams, even though it is responsible for supervising about 11,500 RIAs.


However, Joe has a point. His business is as different from Mr. Madoff's as spending a sunny day in the park is from exploring Antarctica.

But that difference won't stop the SEC from taking a hard look at Joe's RIA. In fact, over the past couple of years the SEC has intensified its scrutiny of advisers for what it might have considered trivial matters in the past, according to one veteran industry attorney.

“In the past, the big issue for the SEC was whether advisers were stealing money,” said Terry Lister, a senior consultant with Edgerton & Weaver. “Before, the SEC might have looked at a firm's form ADV and tried to determine if it was correct. Big issues were a firm correctly reporting its assets under management and a correct number of discretionary and non-discretionary client accounts.”

“Now, the exams are more arcane,” he said. “Is an RIA following its own internal procedures and are those procedures adequate, based on [the Investment Advisers Act of 1940]? This is partially a result of Madoff. Instead of taking your word, the examiners are digging.”


“The SEC is bringing enforcement actions - or threatening to - for issues that would not have led to enforcement actions in the past because they were too small,” he said.

What plans does the SEC have for its new 100 examiners? Will they focus on RIAs that have custody of their own assets? What about self-clearing broker-dealers?

An SEC spokesman, Ryan White, declined to comment. Instead, he referred me to a link for the Office of Compliance Inspections and Examinations. One bit of pertinent information regarding advisers with custody of client assets: they must undergo an annual surprise exam by an independent public accountant to verify all client funds and securities of which the adviser has custody.

But what about Joe, whose clients' assets are already sitting on Schwab's custody platform?

The SEC is giving him plenty to worry about, according to Mr. Lister. In particular, the commission wants to eliminate or mitigate an RIA's conflict of interests, he said.

“The SEC is bringing more cases against owners of small RIAs who have different roles, like the CEO also being the firm's CCO,” or chief compliance officer, he said. “The guys that have small RIAs and are trying to do everything and wearing multiple hats are sticking their necks out because the SEC is suing them personally. It's just not enough anymore to say you are CCO and have a procedural manual in your drawer.”

The SEC also is focused on any potential conflicts of interest regarding an RIA and what kinds of outside businesses the adviser is involved in, Mr. Lister said.

For example, the commission is looking more closely at firms' trading and areas where the investment adviser may be gaining benefits through trading platforms that may conflict with clients' interests, he said.

“The issue is best execution and other venues,” he said. “Is the adviser using an affiliate to execute the trades? He may not get as good pricing for those trades with the affiliate if he went elsewhere to trade.”

Joe is not the next Mr. Madoff. But that doesn't mean the SEC, with its clutch of fresh examiners, won't make his life miserable as it digs into all the different corners of his firm.


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